Strained Peas,Strained Profits?David Woodruff
The top brass at Swiss drugmaker Sandoz Ltd. have long drooled over Gerber Products Co.'s fat margins and huge, 73% U.S. market share. So in late April, when word got out that investment bankers Goldman, Sachs & Co. and Wasserstein, Perella & Co. were quietly auctioning the baby-food maker off, Sandoz executives quickly cooked up a $3.7 billion offer. Just as quickly, on May 21, Gerber's board of directors met in Chicago to approve the deal.
The vote was followed by a champagne toast--with very good reason. At 29 times Gerber's fiscal 1994 earnings from ongoing operations of $127.4 million, Sandoz will shell out a premium well above even the rich food-industry deals of the go-go 1980s. "They paid top dollar," marvels Prudential Securities Inc. analyst John M. McMillin. "It's going to take five years before they see any kind of return on this investment."
Indeed, Sandoz faces a daunting task in actually making this merger fly. The companies fit geographically, with Gerber strong in the U.S. and Latin America while Sandoz has solid bases in Europe and Asia. But melding the very different organizations "represents a very tough challenge," says John A. Quelch, a Harvard University marketing professor. And by pushing Gerber into Europe, Sandoz could start a fierce price war among powerful, moneyed giants in a fragmented market.
Gerber dominates the U.S. baby-food market, generating aftertax profit margins of 11%--nearly tops for the food industry. And outside the U.S., the potential for growth is tremendous: As women in developing parts of the world join the workforce and incomes rise, so should consumption of prepared baby food. In Poland, for instance, per-baby consumption is less than 12 dozen jars per year, far below the 55 dozen in France and 50 dozen in the U.S.
But it could take years before large numbers of consumers in places such as Eastern Europe and Asia switch to jarred baby food. In the meantime, Sandoz' sales and distribution networks in Western Europe could get indigestion from the slew of Gerber products. Sandoz' food operation, based in Bern, will have to swallow a company as big as itself. Though it sells products such as Ovaltine, a malted beverage, and Wasa, a crispbread, through supermarkets as well as small specialty shops, it has no experience selling baby foods.
time for goodwill. It likely will learn the hard way. "We will invest what it takes to develop the business," says Raymund Breu, Sandoz' finance director. But the largely stagnant European market is brutally competitive. Rivals such as H.J. Heinz, Nestle, and French multinational Danone (formerly BSN) already have hobbled Gerber's efforts at breaking in. Gerber Chairman Alfred A. Piergallini admits the company is barely breaking even there, after years of effort. "That's where we're the weakest," he says. Heinz, which has an industry-leading one-fourth share of European baby-food sales and is investing aggressively in international markets, vows to be particularly combative. "You'd be foolish to try to compete with us there," warns Heinz Chairman Anthony J.F. O'Reilly.
Gerber may face as many obstacles distributing Sandoz' food products in the U.S. While it has successfully handled Bristol-Myers Squibb Co.'s baby formula for two years and just took on Scott Paper Co.'s baby wipes, it had little success with products aimed at both kids and adults, such as Juice & More, a juice-and-fiber blend. And the company's 350 merchandising specialists, who work full-time sprucing up Gerber displays in grocery stores, could get spread too thin. "The minute you take those folks out of the baby-food aisle, you dilute their effectiveness," says Kidder, Peabody & Co. analyst David Rabinowitz.
Some unique financial factors are working in Sandoz' favor. The Swiss franc's strength against the dollar makes this the perfect time to buy in the U.S., as intense dealmaking by Swiss conglomerates bears out. Current international accounting standards, moreover, allow Sandoz to write off against earnings the $3.2 billion in goodwill it will acquire in this deal.
And Gerber's annual cash flow of about $165 million would be 70% of what Sandoz could earn by investing $3.7 billion at 6% interest. By selling off duplicated buildings and equipment from the newly merged companies, says Breu, "in Year One, we will not have any dilution of [earnings]." Some analysts think he's right. But even if the math adds up easily, the looming battle in supermarket aisles looks a lot tougher.