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January 25, 2021

What does future hold for Danone CEO with activist investor on scene?

An activist investor is calling for the removal of Danone's CEO Emmanuel Faber. Simon Harvey assesses whether the proposals carry any validity.

By Dean Best

An activist investor has added to the pressure at Danone – which is embarking on a transformation strategy by chairman and chief executive Emmanuel Faber – by calling for the CEO to step down. Simon Harvey assesses whether the proposals are valid.

Views are emerging the time might be right for Danone chairman and chief executive Emmanuel Faber to step down after a number of years of fairly stagnant top-line sales and, more recently, a drop in profits, too.

And the pressure is building with an activist investor appearing on the scene in the form of London-based hedge fund Bluebell Capital Partners, which took an undisclosed stake in the French food giant soon after the fund’s formation in November last year, and is calling for change.

Top of the list is the removal of Faber as chief executive, and the separation of the chairman and CEO functions, requests put forward by Bluebell in a letter to Danone’s management.

“If the CEO is also the chairman, that means the CEO sets the agenda for the group of people that are meant to hold him to account. Clearly, there is a conflict,” Bruno Monteyne, an analyst at US investment bank AllianceBernstein, tells just-food.

“Having an independent chairman ensures that the board can more easily decide what they want to review and discuss …That in turn makes it more likely that if/when a particular strategy isn’t working, the board can find out more quickly and take remedial action more quickly.”

And AllianceBernstein believes time is starting to run out for Faber as CEO, a role to which he was promoted in 2014. “We would think there is at most one year left. Obviously if results improve materially, then there could be many more years left,” Monteyne says.

Danone's board reviews the CEO/chairmanship set-up annually, with the last conducted in 2020, and members take a "pragmatic" approach to the dual roles, a source familiar with the situation told just-food, adding there are no plans to make a change at this stage.

In a response to the public pronouncements from Bluebell earlier this week, a snippet from Danone's statement read: "The leadership team of the company is highly focused on delivering long-term sustainable value for our shareholders. We value constructive dialogue with all our shareholders." 

Meanwhile, Bluebell didn't respond to a request for comment on more detailed information behind its proposals.  

Deflated shares

Faber has recognised Danone is behind the curve with respect to its peers. In November, when the CEO unveiled a new strategy dubbed Reinventing Danone, he said: "Many of them [peers] have gone through heavy restructuring and significant reorganisation plans over the last five, two, three years, and we have not. And it is high time we do." 

Nevertheless, members of the investment community, including Bluebell, were not overly impressed by Faber's new strategy, which is designed to reinvigorate margins and breathe more life into sales and net profits. At its core, the plan is to focus on innovation through six new geographically-centred business zones at the same time as eliminating around 2,000 underperforming SKUs, or about 20% of the portfolio, as well as the prospect of up to 2,000 job cuts through a cost-cutting exercise.

At the heart of the concerns is the deflated share price linked to Danone's recent financial performance, which has undermined investor confidence in the Alpro and Activia brand owner, and the CEO himself. The stock was trading at EUR54.72 today, relatively flat on the year so far but down 25% in the past 12 months. Even five years ago, the shares were not far off what they are today at EUR59.61.

Those sort of valuations leave Danone open to a takeover, according to investment bank and financial service firm Stifel, and that pressure intensifies the longer management fails to act in disposing of underperforming assets.

"Danone has suffered many years of operational disappointments, sending its relative valuation to historical lows versus its peers," Stifel analyst Alain Oberhuber wrote in a research note this month. "We believe Danone is now close to triggering long overdue change, either on its own accord or under activist pressure."

Frequent management changes over the past 18 months also tend to undermine confidence in Danone and its leadership, Oberhuber tells just-food. CFO Cécile Cabanis and Francisco Camacho, who was the executive vice president of the international division of the Essential Dairy and Plant-Based (EDP) business, have recently departed executive roles. However, in a surprise move, Cabanis, who stepped down in October, has been appointed vice chair of the board in a non-executive capacity. 

AllianceBernstein's Monteyne wrote in a research note: "Danone management is starting to lose control over the investment story. Management wants to engage on the new structure, cost-cutting and soon engage investors on how to drive growth. Instead of keeping the focus on 'can/will this work', the debate will shift towards 'how long can the CEO last –  what does he need to do push this away'? 

"That will be unhelpful for keeping the company focused. Maybe having the ex-CFO stay as vice-chairman may be useful after all."

"Muddling through"

Stifel has painted four possible avenues Danone could take but, ultimately, Oberhuber agrees the departure of Faber would be a valid proposition. However, Faber is most likely to stay as chief executive and nominate a chairman, although investors and activists will be more inclined to press for his removal, Oberhuber says.

"Muddling through" is Danone's most likely course, according to Stifel, which it puts at 40% odds, followed by the divestment of "all" underperforming assets (30%) – the 'X scenario' – and then the disposal of "all" of Danone's waters business (20%), dubbed the 'waterfall scenario'. The final and less likely outcome (10%) is what the financial services company deems as the activist scenario, where Danone becomes an investment target and the business gets split up, with competitors waiting eagerly on the sidelines to take up those opportunities.

"We conclude that while a status quo would keep shares under pressure, the risk-reward for more widespread action appears very appealing, and while the downside looks limited," Oberhuber wrote in his note to clients, adding Danone's management maybe unwilling to sell off all of the water business.

"Therefore, we see a higher probability that Danone could be willing to make even deeper cuts to the portfolio. We find the 'X' or the 'waterfall' scenario the most interesting from an investor risk-reward perspective." 

At the end of the day, the share price is the contentious issue and "there are a lot of weaknesses in the portfolio that they should get rid of", Oberhuber tells just-food, many of which have been "a drag for many years".

Jon Cox, an analyst at finance house Kepler Cheuvreux, has a mixed view. "Danone has what I regard as the healthiest portfolio in diversified food and it has strong environmental and sustainability credentials. However, it has not been able to really leverage that great position to deliver on a consistent basis and there is some fatigue among investors."

Stifel has gone to some length to point out potential disposal targets, which it estimates could raise as much as EUR2.6bn (US$3.1bn), including EUR1.7bn from "some underperforming assets" in water, and EUR400m from dairy brands, where it expects "only smaller divestments in EDP" but, excluding key brands like Activia, Danone and Actimel.

"Smaller" disposals in underperforming infant-formula brands could reap another EUR1.85bn, while finding a buyer for the Vega brand, which Danone put under review last year, along with its Argentina business, could bring in EUR100m, Stifel estimates.

If Danone comes good on its commitment to trim less productive SKUs, then it can "absolutely" achieve its margin targets but, should Faber adopt the so-called muddling through approach, then margins and organic sales could be put at risk, Oberhuber says.

Lagging peers

Danone's financial performance came under the spotlight when it reported like-for-like sales fell 1.6% in the first nine months of its current fiscal year and margins dropped to 14%. "The margin this year is not going in the right direction, and there is no way we can reconstruct our agenda without a significant margin improvement in the years to come," Faber said when those results were reported in October.

The Cow & Gate baby-food owner is aiming for a recurring profit margin above 15% in 2022, from the expected 14% for the current year, which would only put it on par with the 2019 print of 15.2%, albeit above the 13.85% average seen from 2015 through 2018. And a mid-term target of "mid to high teens" would only put the margin around the 15-16% area.

Meanwhile, sales have been chugging along, growing on a like-for-like basis of 2.5% or slightly above from 2015 to 2019, below a mid-term target of 3-5%. And net profits have been on the decline, falling 17.9% in 2019, based on sales of EUR25.3bn, and they were down 4.1% the previous year.

"Our margin has expanded faster than ever but it is still lagging behind a series of our peers," Faber said in November when he announced the restructuring programme, which also seeks to realise EUR1bn in cost-savings by 2023, with a plan to reinvest 20-25%. "The share price is not where we believe it should be," he complained.

And the performance is a concern for Bluebell too, which cited "a poor operational record and questionable capital allocation choices", behind its decision to press for change.  

Cox at Kepler Cheuvreux says: "The company has a new margin improvement plan and execution on that plan is going to be key for the current team. The company has said all of its portfolio is up for review as part of the new plan. 

"I would expect piecemeal disposals of businesses and lines that are not contributing to growth and profitability but not an outright disposal of any of its divisions. I suspect there will be disposals in parts of water where its portfolio is more commoditised, and a similar thing for dairy."

What might a new CEO bring?

Monteyne says Faber is too engrossed on cost-cutting, Danone's responsibilities related to environmental, social and corporate governance (ESG), including its status as a B-corp business, and reorganising the company. The "main thing is to reset priorities", he tells just-food.

A new chief should be focused on growth, while "being ESG-responsible".

"Invest the cost-cutting into higher brand support, more innovative products, and more support for growth," he says.

Elaborating on the theme, Monteyne wrote in a research commentary, which highlighted the difficulties Danone is having in China in relation to its infant-nutrition sales amid a reduction in tourism linked to Covid-19: "In the short term, discussion of a potential CEO change drives up the shares. However, that will be short-lived. The reason the results are disappointing is because the company is in such difficult categories, with weak brands and accumulated under investments in brands and innovation, with a strategy that is (wrongly) focused on margin expansion through cost-cutting.

"A potential new CEO might quickly build on the H1 margin cut, and lead to lower margins and potentially painful M&A to rectify past issues or to deal with China infant nutrition. It may be years of pain before investors will know whether that new plan is any better than the old one."

Asset disposals under Stifel's 'X recommendation' "would have a positive impact on growth, margins and returns, leading to a focus on higher growth brands", Oberhuber wrote, adding his firm has price target of EUR76 a share on Danone.

"We conclude that the 'X' scenario would clearly improve the attractiveness of the company and would lead to a fair value of EUR76 per share. We highlight that in our 'X' scenario, Danone would have a significant improvement of its operating free-cash flow of around 10% per annum. As a consequence, returns would see a strong improvement and warrant higher valuation multiples."

Danone, and in the same breath Faber, have shown they are serious about addressing the current issues with the recent formation of a strategy and transformation committee to support the new initiatives. And it will be "in charge of monitoring progress on [the] portfolio review and execution of the growth and efficiency plan" under the leadership of Benoît Potier, who will retire from the board after 18 years in April.

For now, eyes will be on Faber's future and his success in executing the new strategy but having an activist investor on the sidelines pressing for change could lead to a period of uncertainty, as Danone rival Nestlé itself found out a few years ago.

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