Nestle SA has met activist investor Dan Loeb more than half way. The company has announced a 20 billion Swiss franc ($20.8 billion) share buyback, shown a willingness to rejig its portfolio and will look at ways to lift the margin.
As Gadfly has argued, a buyback was always an easy way to address Loeb's calls for change, and one that the company could comfortably afford. Nestle says it has been examining its capital structure since the beginning of this year. But news this week of Loeb's letter to shareholders probably influenced the timing of Nestle's announcement.
But this is no love-in. Nestle and Loeb's Third Point are still at loggerheads over one thing: the consumer goods company's 25 billion euro ($28.4 billion) stake in L'Oreal SA. Loeb wants it gone. Nestle has previously said it is a strategic asset.
In divesting the stake, Nestle would lose some options.
The first is the opportunity to co-operate with L'Oreal. Both companies are converging in the area of skin health: Nestle's new chief executive, Ulf Mark Schneider, specifically mentioned consumer healthcare investment in his brief strategy update on Tuesday. L'Oreal, meanwhile, is moving further into the area of skincare that does more than make the wearer look pretty, it helps with underlying skin problems.
But Nestle ended a cosmetic nutritional supplement joint venture three years ago, indicating that cooperation might be trickier than it first appears.
Then there's the possibility of doubling down on L'Oreal, and using the existing stake as a starting point to buy the rest of the cosmetics group that Nestle doesn't own at a future date. After all, rival Unilever NV has been gobbling up premium personal care brands. L'Oreal has a ready stable of labels, from Kiehl's to IT Cosmetics.
But buying the rest of the company would be a huge move: L'Oreal has a market capitalization of 106 billion euros and the shares are close to a record high. Any deal may also be complicated by the Bettencourt family holding, as well as French politics (officials could well regard the Paris-based company as a national champion and object to it falling into foreign hands).
The reality is that the path to full ownership of L'Oreal looks both expensive and uncertain. Even if the goal could be achieved, it would only advance Nestle's "wellness" strategy a tiny bit -- L'Oreal is still fundamentally a cosmetics group, after all.
What about keeping the stake to use as a possible acquisition currency, or as a source of funds for a deal? The Arnault family trod this path in April, when it used its stake in Hermes International to buy out minority positions in Christian Dior. Putting the L'Oreal stake to work in this fashion overlooks the point that in acquisitions, the preferred currency is always cash. Placing it to fund an agreed deal would make Nestle a forced seller, never a good position to be in when raising money.
In any case, Schneider has loads of other options for amassing an acquisition war chest. Even with the planned buyback, net debt to Ebitda would only be 1.5 times. He's made clear that if any big deals come along, he can "adapt" the capital return. What's more, there are some chunky assets within Nestle's portfolio that it should be selling anyway, including more of confectionery, the U.S. frozen food business and joint ventures with R&R Ice Cream and General Mills Inc. Analysts at Kepler Cheuvreux estimate that divestments could give Nestle 100 billion Swiss francs for acquisitions.
The method for disposing of the L'Oreal holding would probably depend on the tax implications. There could be some complexities here, but that's not a reason not to try. Keeping the stake is a bad use of capital, and Schneider should divest it while conditions are ripe.
It's always wise to get rid of assets when you don't need them.
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