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June 29, 2017

Activist grabs headlines but change was already on way at Nestle

Activist investors putting pressure on food companies is not new, especially not in recent years, although Nestle's stature in the industry may have raised eyebrows as US investment fund Third Point made the world's largest food business the latest to feel the heat. However, there were already signs of change at Nestle under new CEO Mark Schneider, Dean Best argues.

By Dean Best

Activist investors putting pressure on food companies is not new, especially not in recent years, although Nestle’s stature in the industry may have raised eyebrows as US investment fund Third Point made the world’s largest food business the latest to feel the heat. However, there were already signs of change at Nestle under new CEO Mark Schneider, Dean Best argues.

Nestle may be the world’s largest food company but it is just the latest in our industry to become a target of an activist investor.

The moves by US investment fund Third Point to buy a stake in Nestle, publicly criticise its management and call for change follow similar episodes at HJ Heinz (2006), the former Cadbury Schweppes (2007), the old Kraft Foods (also 2007), Hain Celestial and Maple Leaf Foods (both in 2010), Danone (in 2012), Mondelez International (2014) and SunOpta (last year).

Not every activist investor affects change at the subject of its dissatisfaction. Even when an agitated (or opportunistic) shareholder causes some change, it may not be in the direction or scale it wants. But, in the decade your correspondent has been covering the food sector, these episodes have reared their heads pretty often.

The surprise this weekend may have been caused by the fact Swiss giant Nestle is the behemoth of the food industry, with its portfolio of storied brands, a global presence and annual sales of over CHF89bn.

However, in some ways, given 2016 was another year in which Nestle missed its own sales target (dubbed the Nestle Model, now abandoned), it should not be too much of a shock some in the investment community felt emboldened to publicly agitate for change.

There was a feeling of surprise again on Tuesday, just 48 hours after Third Point went public with its investment in the KitKat maker and criticism of the business, when the company issued its clunkily-worded announcement “Nestle outlines future value creation model including strategic growth priorities and supporting capital structure”, in which it, among other things, announced a share buy-back and set out where it plans to prioritise investment.

The sceptics would have raised a wry eyebrow at the timing and the fact Nestle, two days after Third Point called for the company to buy back shares, saying it would snap up CHF20bn of its stock by the end of June 2020.

However, Nestle sought to emphasise how its board and management had “early in 2017” started a review of its “capital structure and priorities”. We asked if Tuesday’s publication of its review had been accelerated by Third Point’s investment in the business. Nestle said: “We have said previously we have no comment on specific shareholder requests or positions. Separate from that and in relation to the announcement today, the reason we are releasing this today is because we received regulatory approval for the share buyback programme today.”

We will never really know whether Nestle, with an investor day planned for September, did bring forward the results of the review in the wake of Third Point’s investment.

But, what really matters, is where Nestle goes from here. And there are signs that journey was started before Third Point went public. Ever since Nestle appointed Schneider, the former chief of German healthcare business Fresenius, as its new CEO just over a year ago, there has been speculation among analysts he –  the first outsider to take the helm at the company for nearly a century – could spark change at the Swiss food giant.

In September, MainFirst analyst Alain Oberhuber labelled Nestle as one of his “core investments”, in part due to the expectation “the new CEO will trigger a multiple expansion through improved investor communication, portfolio changes and higher shareholder returns and cash flow”.

At the time of Schneider’s appointment, Oberhuber argued the market was likely to see the former Fresenius executive up Nestle’s focus on its health science and skin health divisions. “We will see faster growth through acquisitions in Nestle health science and Nestle skin health,” he said. 

Jefferies analyst Martin Deboo said at the time he was less disposed to “over-interpret health focus”. Deboo acknowledged it was reasonable to expect “increased focus and scrutiny of Nestle’s quasi-pharmaceutical health sciences and skin health businesses but stressed he was “not inclined to over-conclude around any increased emphasis on healthcare” and suggested more change could come elsewhere with a more radical approach to Nestle’s cost and portfolio management.

Schneider entered the CEO office at Nestle in January and, in his first major appearance a month later, when the company announced its 2016 financial results, he chose his words carefully when discussing the group’s plans in areas such as M&A and the balance between growth and margins. However, he indicated Nestle would step up its restructuring efforts in 2017 and said it would “increase restructuring costs considerably” in the year. Restructuring costs will rise to CHF500m in 2017, up from CHF150m in 2015 and CHF300m in 2016, he said.

Those in the investment community wanting concrete action would have noted with interest Nestle’s earlier this month of its plans to “explore strategic options” for its US confectionery division, including the possible sale of the Butterfinger-to-Raisinets business. The move has divided analysts but, nonetheless, is a sign Schneider is willing to at least consider some significant decisions.

“The new CEO is more focused on return on capital employed and higher-growth categories. Nestle is more willing to sell underperforming businesses with low margins and low ROCE, as recently illustrated by the announced disposal of its slow growing and lower return generating US confectionery business,” MainFirst’s Oberhuber wrote on Tuesday in the aftermath of Nestle’s “strategic growth priorities” announcement.

There has been some frustration Nestle has not followed peers including Unilever and Mondelez International and announced a formal target to improve margins. It was one of Third Point’s key demands. Nestle’s announcement on Tuesday did not include such a target, although analysts expected – and still expect – one to be announced later this year. “We continue to expect a margin target to be announced at the investor seminar in September,” Sanford Bernstein analyst Andrew Wood wrote on Tuesday evening.

One of the most notable parts of Nestle’s announcement on Tuesday was its hints at future M&A activity. Nestle said it had decided to focus its “capital spending” on “advancing high-growth food and beverage categories such as coffee, petcare, infant nutrition and bottled water”. Capital investment to expand organically or inorganically in these areas is a sign of a change of emphasis at Nestle. 

The company will also look to expand its presence in “high-growth geographic markets” and “pursue growth opportunities in consumer healthcare”.

The scheduling of the CHF20bn share buy-back programme, which starts next month, is set to be affected by Nestle’s M&A agenda. “The volume of monthly share buybacks will depend on market conditions but is likely to be backloaded in 2019 and 2020 to allow the pursuit of value-creating acquisition opportunities,” Nestle said.

The mention of consumer healthcare in Nestle’s announcement on Tuesday could be significant. Kepler Cheuvreux analyst Jon Cox highlighted the company’s comments on consumer healthcare as “something that could point to acquisitions in consumer health areas, such as vitamins and over the counter medicines, where Nestle has not shown interest previously”.

No doubt between now and then – and for the rest of this calendar year – the market will be abuzz with speculation of where Nestle and Schneider. Sanford Bernstein analyst Wood’s appraisal of the prospects of moves by Nestle to reshape its portfolio were not changed by the Maggi maker’s announcement on Tuesday. He rates the chance of “major” re-shaping at 10% but says it is “100%” some minor work will be done.

“We do not believe that Nestle’s portfolio is substantially flawed, and we therefore did not expect any major announcements of disposals, or moves into new areas,” Wood said. “Our view remains that [minor re-shaping] was already happening, as evidenced by the strategic review of the US confectionery business. We believe it is more likely to pursue bolt-on M&A within adjacent categories and/or markets, or to build on the presence it already has.”

Others have been suggesting a more transformational deal. Kepler Cheuvreux’s Cox this week repeated an assertion Nestle could approach Danone, if, as some reports have suggested, the French group is the next target of activists.

“The food industry is going through unprecedented upheaval, which could trigger a takeover bid for Danone, we believe, as players look to bulk up to
avoid being taken over themselves. In the event of any hostile takeover bid emerging for Danone, we believe that Nestle could emerge as a white
knight. Culturally, the companies are similar with a focus on growth and nutrition, compared to the cost cutting model seen in North America (as
personified by 3G). Building a European champion with a growth and sustainable model in food could make such a move politically acceptable,” Cox said.

In any case, change is happening at Nestle. In some senses, Third Point was pushing at an open door.

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