Back to the drawing board: what does Unilever do now?

That went well. A monster £50bn-plus bid for GlaxoSmithKline’s consumer healthcare business from Unilever – months in the making and designed to shore up its ailing share price – scotched in the space of days.

So what on earth just happened? It’s fair to say Unilever started this week on the back foot. And it never really recovered.

Reports emerged over the weekend that three pre-Christmas bids from Unilever for GSK’s consumer health joint venture with Pfizer had been rejected, the latest £50bn bid still “fundamentally undervaluing” the business. With its hand shown, Unilever confirmed in a statement to the London Stock Exchange on Monday it was still in talks, with CEO Alan Jope hastily outlining the business case, and providing an updated strategy briefing. But the investment community hated the deal, with its shares falling to five-year lows and wiping another £11bn off its value in two days.

Backed into a corner, on Wednesday Unilever announced it would not increase its bid after all.

Why such a big deal? Unilever has been focused on selling off low-growth businesses – and buying into more high-growth categories in hygiene, prestige beauty and functional nutrition among others. In April 2019 it bought US-based vitamins, minerals and supplements (VMS) brand Olly Nutrition, followed up with a deal for New Jersey’s SmartyPants Vitamins at the tail end of 2020.

In early 2021 Jope signalled an appetite for larger, game-changing deals. But progress has been slow, particularly around key disposals of the spreads and tea empires. Unilever has dipped his toes in the consumer health market, but Jope’s dealmaking has looked more like tinkering when lined up against Nestlé boss Mark Schneider, who has made bold moves to reshape the Swiss giant’s portfolio.

Martin Deboo at Jefferies estimates Jope has closed 15 deals worth $2.5bn in sales, while Mark Schneider at Nestlé has struck 25, accounting for $16.6bn.

It has left Unilever lumbering behind its great rivals. Shares sank 10% in 2021, compared with 20% growth for Nestlé and P&G. Unilever’s market cap has tumbled from a £133bn high in August 2019 to £92bn.

Respected fund manager Nick Train of Lindsell Train Investment Trust described Unilever’s performance as “crushingly pedestrian”. And fund manager Terry Smith made headlines last week with a blistering attack on Unilever, accusing the business of fixating on sustainability credentials at the expense of fundamentals.

AJ Bell investment director Russ Mould says Unilever looks to be bidding for GSK’s consumer health unit to “inject some excitement” into its business, having recently disappointed with sales and profit margins.

Would £50bn-plus GSK consumer arm acquisition cure Unilever’s headache?

So why GSK? Jope was banking on 4% organic sales at the Glaxo consumer health business from 2019 to 2021 to supercharge Unilever’s numbers.

In a statement to the London Stock Exchange on Monday, Unilever said consumer health was “a highly complementary category”, highlighting the “strong strategic fit” of GSK’s oral care brands (such as Sensodyne) and VMS brands, which together account for 45% of the consumer health business. And it flagged “an attractive” move in adjacent over-the-counter categories, where it currently has no expertise.

“The acquisition would create scale and a growth platform for the combined portfolio in the US, China, and India, with further opportunities in other emerging markets,” it said.

Warren Ackerman of Barclays calls the deal “a real stretch” but points out it would lift consumer health sales at Unilever from 2% currently to 20% to create a world leader.

It would also be “a game-changer” for Unilever’s oral care category, he adds, where it currently holds the number three position in the world, and for its VMS brands, with the addition of market leader Centrum.

Unilever also hopes to leverage its strength in emerging markets, where it is more heavily weighted than its peers, by plugging the GSK brands into its powerful distribution system and scaling up rapidly.

Ackerman highlights only 30% of GSK’s consumer health sales are in emerging markets. It’s double that for Unilever.

What does this all mean for the Unilever food business? Even though it’s baulked at upping its bid, any deal of this size would still turn current debt levels of €22.4bn (£18.6bn) into a mountain of leverage that shareholders and ratings agencies will likely find unpalatable.

A large-scale offloading of assets is the most obvious way of raising capital, with Unilever flagging in Monday’s statement an “accelerated divestment of intrinsically lower-growth brands and businesses”.

That’s been interpreted as an acknowledgement that the food business will head to auction, particularly given its renewed focus on expanding in hygiene, skincare, prestige beauty and functional nutrition.

The division generated revenues of €19.1bn in 2020 (almost 40% of the total group), but generated growth of just 1.3%.

Despite the sluggish top line, there are plenty of jewels in the Unilever crown, with Knorr and Magnum in the top five of its 15 biggest brands and Jope telling journalists that Hellmann’s and Ben & Jerry’s were growing at 10%.

“We have an excellent foods and refreshments business with global leading positions,” Jope commented: “It has performed well during the pandemic, but it is true the long-term growth profile has been below other parts of the portfolio.

“We have no immediate plans to separate foods and refreshment, but rotation of our portfolio is part of upgrading into higher growth spaces.”

So what would the food businesses be worth? Deboo calculates a multiple of 12x EBITDA could lead to a £47bn sale of the division, with Bernstein’s Bruno Monteyne flagging it could go to £50bn with a premium thrown in – almost offsetting the eyewatering GSK price tag.

“But Unilever is likely to pay full price or more for the high-growth business and the reverse for the low-growth business,” he adds.

Deboo also thinks Unilever would struggle to find a buyer for the whole lot, in what would be a forced sale.

“The obvious strategic buyer would be Kraft Heinz, but they remain heavily leveraged. That leaves private equity, who have plenty of dry powder and active interest in staples assets but no synergies.”

It may be that a piecemeal sale of the food assets could be easier to swallow, with the ice cream brands – such as including Cornetto, Carte D’Or, Magnum and Ben & Jerry’s, Solero, Viennetta and Grom – looking particularly enticing.

However, a sale of food assets does not come without its own challenges, not least the distraction of conducting a £50bn disposal at the same time as pulling off huge deals to generate growth.

AJ Bell investment director Russ Mould also points out the food business is a cash cow and not something to give up lightly. “Even proposing the sale of the food arm could kick up a major fuss with shareholders.”

What now for GSK’s demerger plans? It’s had its own investor problems in the recent past and the plan to spin out its consumer joint venture was largely driven by shareholder unrest over its low growth compared with pharma rivals.

That GSK’s own share price was up more than 4% on Monday indicates it finds itself in a win-win situation over the split of its consumer business.

It either presses ahead with a demerger and mega-listing, which has largely been the preference of shareholders as they get to retain their stakes in a newly listed independent business; or they receive a knockout offer for a clean, profitable exit.

Reports suggest that even before Unilever’s climbdown, a spinout remains GSK’s preference, with the Telegraph reporting GSK courting the sovereign funds of Qatar and Singapore to underpin a summer listing this summer and “head off a risky takeover by Unilever”.

Although some GSK investors have called for the pharma giant to explore a sale, most notably activist investor Elliott Management, there are concerns that selling to another consumer giant – like Reckitt Benckiser, P&G or Nestle – will kick off a lengthy, complicated process involving competition issues in multiple jurisdictions, meaning a sale could drag on longer.

Barclays’ Warren Ackerman suggests other trade buyers would not have the same strategic fit with the business, while private equity could not extract the same levels of synergies as a consumer giant.

And Russ Mould adds: “GSK has a plan of action that it has clearly outlined for some time, so I doubt it feels under pressure to consummate a deal.”

Is Unilever’s GSK deal dead? Unilever has effectively put the ball back in GSK’s court by declining to up its bid, but leaving its £50bn offer on the table.

The market sent Unilever’s shares back up 4.5% on the news it would not go higher and the widespread belief is that its refusal effectively kills the deal.

Deboo suggested the odds of GSK accepting £50bn is “low, although not zero”.

More likely is Unilever “starts architecting a more measured transformation” including acquisitions and disposals.

But it is increasingly clear lower-profile portfolio optimisation and the odd strategic bolt-ons like Graze and The Vegetarian Butcher are not enough to satisfy increasingly restless investors.

Jope vowed: “There are other consumer healthcare businesses that also represent very attractive potential additions to the Unilever portfolio.” Meanwhile, observers note that Johnson & Johnson, the world’s largest healthcare company, is also planning to spin off its consumer division.

As well as other consumer health options, Unilever could also look to deepen its exposure to consumer health, faster growing categories in beauty and hygiene, that will not represent quite such a hefty bet.

However, with market confidence in management clearly shaken, Unilever will need to move fast and hope investor faith can be restored