“Sprexit” - the so-called £6bn auction of Unilever’s spreads divisions - was the widely anticipated headline grabber from Unilever’s strategic review last week, but after seeing off Kraft Heinz, what other measures did the fmcg giant announce?
Get back on the acquisition hunt
Far from selling off its entire food division - as some had speculated - CEO Paul Polman has already revealed the board is running the rule over Reckitt Benckiser’s food division - including French’s mustard and Frank’s Red Hot sauce - after RB kicked-off its own £2bn auction last week. As part of an acceleration in “the active management of our portfolio through bolt-on acquisitions”, the RB interest raised some eyebrows, with acquisitions thought more likely away from the lower growth food space.
“While it did not specify that home and personal care and refreshments would be the main target for acquisitions, we expect this to be the case,” said Bernstein.
In recent times Unilever has built its HPC business through mid-scale acquisitions - including Dollar Shave Club and Dermalogica - while selling off food brands like Ragu & Bertolli.
The reference to “bolt-on” acquisitions seems to poor cold water on large-scale, transformative deals - such as a mooted approach for Colgate. Nevertheless, analysts at Societe Generale note an important change of tone to “hear Polman talk about strategic M&A, something he has always argued doesn’t add value”.
Keep food and merge it with drinks
The City was generally pleased Unilever resisted the temptation to go too far, too soon in terms of a wholesale de-merger of its food business. Instead it announced the combination of food and drink into one unit to create a “leaner and more focussed business that will continue to benefit from our global scale and footprint”.
In one sense merging its food division with higher growth refreshments suggests Unilever is committing to food for the long-term. But there is also speculation the move could be a precursor to a more radical move in the future - potentially splitting the portfolio into a separate HPC business and a demerged food & drink unit once it has built a track record of improved performance.
If Unilever can’t find a buyer for its £6bn-plus spreads business it has suggested it will look at demerging the new unit - analysts at SG wonder if the declining brands represent a “credible investment” and suspect other food assets may need to be injected to make it palatable in the City and effectively create a “halfway house to a full foods spin”.
Ditch dual UK/Dutch listing
Unilever’s dual-listing in London and Rotterdam seemed to help see-off Kraft Heinz as the difference in takeover codes between the UK and the Netherlands ratcheted up the complexity of the bid. The trouble for Unilever is it has admitted the structure also “adds complexity” to its own business as it wants greater “simplification and flexibility”.
This review of its structure is expected to end dual listing, which raises two important questions.
First, what would a single listing be a precursor to? That added strategic flexibility would open up a variety of more radical options for Unilever, most significantly reducing the difficulty of raising new capital to pursue large-scale acquisitions - such as Colgate. However, a demerger of its food and drink business also becomes easier with a single legal structure.
Second, will Unilever choose London or Rotterdam for its sole listing? The issue is further sharpened by Brexit and Unilever’s fate could become a high-profile political football with the implications of Unilever ditching Brexit Britain only marginally less controversial than selling up to Kraft Heinz in the first place. Polman’s protests that UK takeover laws put target companies at a disadvantage perhaps suggests Rotterdam is the more likely destination.
Boost margins and accelerate cost cutting
Unilever is now targeting underlying operating margin (excluding restructuring) of 20% by 2020 and pledged to accelerate its Connected 4 Growth cost efficiency plan to find an extra €4-€6bn by that date.
Turning up the performance dial was widely expected and vitally important to head off investor disquiet over the outright rejection of Kraft Heinz’s approach. The move signifies a shift in emphasis to the shorter term and will see Unilever become a more highly leveraged, financially aggressive operation.
Ironically, this move apes the model promised by Kraft Heinz’s ownership in the first place, including its renewed commitment to zero-based budgeting. However, analysts at SG point to an important difference, noting “Unilever’s end game isn’t the same as 3G’s end game of extreme cost savings and margin growth”. The broker argues it can dial up its cost in categories which are more mature, but dial down efficiencies in others which need investment to fund growth. “Unilever is treading a fine line in ensuring the right balance between top-line growth, investment requirements and margin delivery,” SG notes.
As such there are concerns over the potential impact of marketing cuts, which will cut its creative media agencies used from 3,000 to 1,500 and the number of ads by 30%. Unilever said it would spend €30bn on marketing over four years, which Goldman Sachs said represented a 200-250bps cut as a percentage of sales over its 2016 ad spend. “We expected Unilever to reduce brand marketing investment to grow EBIT margins but we believe this creates downside risk to growth,” Goldman said.
Ramp-up short-term investor rewards
Another example of Unilever’s move from long-term investor reward to more short-term benefits is its decision to raise its full-year dividends by 12% and launch a share buy-back of €5bn this year. Deutsche analysts speculate Unilever could theoretically buy back €3-4bn of shares annual (before even considering the spreads proceeds) - but this welcome boost to shareholders is also cash not being reinvested into growing its brands.
It also signifies a marked turnaround by Polman, who just last year protested: “Companies in the US now spend more money on share buybacks or special dividends than they do reinvesting in their companies and protecting their futures. Many in the financial community are starting to be concerned about that.”
Business as usual at the top
One update notably missing from the review was any firm guidance on succession plans. Polman has been in charge for eight years and there has been some consternation that it has taken a shock takeover approach to kick Unilever’s CEO and board into action to get serious about investor returns.
Polman told analysts he still had “plenty of energy” to see the strategic review through, which SG noted suggests he will remain at the helm until at least 2020. The Financial Times’ influential Lex column is less convinced Polman should stay for the long haul - arguing: “Any serious signs of failure would trigger demands for a break-up. The burden of that contingency should perhaps fall to a new chief executive… Mr Polman may consider retiring on his laurels”.