Rumours linking Danone to Mead Johnson have periodically surfaced over the past five years. Much of the rationale justifying such a significant move lies in Danone’s strategy in key emerging markets such as China. Following a tie-up with Chinese infant formula maker Yashili International Holdings it would seem Danone is intent on developing strategic partnerships with local players to foster growth. But would a big-bang acquisition make more sense? Katy Askew reports.
Mead Johnson, the US-based infant formula group, was spun off from pharma giant Bristol-Myers Squibb in 2009. Since then, Mead Johnson has been viewed as of a digestible size to be a tasty takeover target for the likes of French dairy giant Danone.
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Late last month, the rumour mill once again went into overdrive when Reuters suggested Danone is gearing up to pursue a highly-anticipated takeover of Mead Johnson. Days later, Danone said publicly such a move had not been discussed by its board.
Many a shareholder will have breathed a sigh of relief. A Mead Johnson acquisition would no doubt command a hefty price tag, with analysts speculating Danone could pay something north of US$20bn – approximately 20 x EBITDA – for the group.
While that kind of deal could be partially funded by the disposal of Danone’s medical nutrition business (also said to be on the block) the sale would only raise in the region of $7bn. To make up the difference, Danone would need to take on additional debt and consider an equity issue. Neither of these options are overly attractive to the short-term interests of some shareholders.
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But, in the long term, would a play for the Enfamil maker be a sound strategic move from Danone?
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By GlobalDataAccording to Stefan Kirk, of M&A advisors Glenboden, such an acquisition would be in line with Danone’s long-term strategy. Kirk says the group aims to grow the proportion of sales it generates in high-value, high-margin, nutrition categories.
“It was very much a long-term strategy to increase weighting in nutritional products as opposed to ‘real’ food. Fresh dairy on the whole counts as real food, especially since Danone’s pipeline in terms of mega-hits in functional dairy appears to have silted up,” Kirk tells just-food.
Danone has faced a number of challenges in its fresh dairy unit. The group has been squeezed by weak consumer sentiment in its largest markets, on the one hand, and by rising input prices, on the other. Management believes a focus on improving its mix in developed markets will boost its profits. All the while Danone has been positioning to drive the top line in emerging markets. But these are not quick fixes. The appeal of reducing reliance on fresh dairy, which accounts for 53% of revenue, and diversifying sales by increasing exposure to high-value nutritional products is clear.
Much of Mead Johnson’s allure also lies in what the acquisition would do for Danone’s already strong infant nutrition business in key emerging markets, notably China.
Mead Johnson CEO Kasper Jakobsen outlined the group’s competitive advantages in developing markets at the recent Barclays Back to School conference. The company, he said, generated sales of US$4.2bn in 2013. Almost three quarters of these were from emerging markets in Asia and Latin America. Around a third of group sales originated from Hong Kong and China alone, making it Mead Johnson’s single largest market ahead of the US.
Mead Johnson entered China in 1993. According to Jakobsen, the group had a “very painful start” in the market. “We made a huge number of mistakes, just like everybody else did, and really struggled to get the business going,” he noted.
“By about the year 2000, we finally broke even. We have really, since then, been on a tear in China and have learned to understand both the parts we understand – but more importantly, perhaps, we’ve learned to understand what we don’t understand. And that’s an important part of being in China.”
Today, Mead Johnson is the second-largest infant formula player in the country behind Nestle. The group’s brands, including Enfa, command a 10% market share. This is well ahead of Danone’s own market share of 5%.
With a high birthrate – around 16m births annually – a growing middle class, new and developing channel growth and consumer interest in premium products, the Chinese market will be an important force for those seeking to grow in the baby food space.
Mead Johnson is ramping up investment to increase capacity in order to support an evolving product portfolio. It recently revealed it is using the strength of its deleveraged balance sheet to invest in the region with the opening of an R&D and production facility in Singapore. The move, Mead Johnson said, represents the largest capital investment in its 100-year-plus history.
Danone has also set out a clear growth strategy for the prized Chinese market. The group is focused on building strategic partnerships with local players, exchanging its production expertise for improved distribution.
The company announced last week it is taking a 25% stake in Yashili International Holdings, the Chinese infant formula business controlled by state-owned enterprise Mengniu. The move builds on Danone’s existing strategic partnership with Mengniu in fresh dairy.
According to Kepler Cheuvreux analyst Jon Cox, the deal is likely to be earnings accretive for Danone. Although he describes the HK$4.4bn (US$567.4m) price as “rich”, his overall assessment of the deal is upbeat. “Danone is clearly moving to secure local ties in cement (amid government efforts to build national champions) and from that perspective the strategy makes sense along with the rebuilding of its China business,” he says.
The tie-up with Yashili will provide Danone with increased exposure to mass-market infant formula sales. This is an area in which Danone is unrepresented and, as such, there is little overlap between the Yashili and Danone businesses.
The alliance could help Danone further rebuild its sales in China. Danone was forced to issue a consumer-facing recall last summer after Fonterra warned an ingredient it supplied to the company could be contaminated with a botulism-causing bacteria. While it transpired the scare was a false alarm, Danone’s sales in China plummeted.
In its most recent trading update, Danone said it had seen something of a rebound, with infant nutrition revenue up 19.2% on easy comparisons. Any resurgence could well be furthered through increased co-operation with Yashili, which can use its distribution network to sell Danone’s products. In return, Danone can help improve Yashili’s product quality and brand image.
BNP Paribas analyst Charlie Chen tells just-food: “Danone and Yashili clearly have different products and target consumers, and it makes sense for Danone and Yashili to imagine they can share each other’s distribution platform.”
However, the BNP researchers note the divergent positioning of Danone and Yashili brands means products are fed into distinct channels. This could potentially hinder any synergistic benefits that simply combining the two businesses would bring.
Chen also sounds a note of caution on some of the difficulties Yashili is facing. “The fact we have seen in China is Mengniu does not seem to have sorted out how to turnaround Yashili since [it] was acquired in early 2013, so the consolidation and integration of two infant formula businesses in China may not be as easy as expected.”
Yashili has felt the impact of New Zealand milk powder price hikes, which have hit margins. Mengniu and Yashili claim they can generate “significant synergies” when the integration of the businesses is complete. However, Mengniu has carried out multiple equity transitions in relation to Yashili, which is itself not ruling out further equity fund raising. This instability could potentially hamper the implementation of restructuring plans, proving a distraction to management and adding further layers of complexity.
It would seem, then, the tie-up with Yashili is unlikely to represent a silver bullet for Danone’s woes in China. Nor will it lead to a short-term step change in Danone’s share trends in the market. In contrast, an acquisition of Mead Johnson would catapult Danone to the number one spot in the country with 15% of total sales, just ahead of Nestle’s 13% market share.
Sanford Bernstein analyst Andrew Wood also notes the combination of Mead Johnson and Danone would dramatically change the profile of the global infant formula sector.
Wood observes: “In 2012, Danone missed out on [Nestle’s] acquisition of Wyeth Nutrition from Pfizer. This acquisition significantly increased Nestle’s market share to 24%, providing strong global leadership, with Danone and Mead Johnson the somewhat distant number two and three players. As such, the acquisition of Mead Johnson would catapult Danone to 22% global share and almost joint global leadership with Nestle… The global market would become, effectively, a two-horse race, with significant scale and dominance benefits for both Nestle and Danone.”
The industrial logic behind such a large scale piece of M&A is strong. Acquiring Mead Johnson would transform Danone’s footprint in the high-growth, high-margin infant nutrition sector. The geographic fit is also complimentary. In short, Danone would emerge a strong global leader with an even more significant emerging market presence.
But in the end it all boils down to brass tacks. Is the price tag attached to Mead Johnson prohibitively high? For the time being at least, it looks like the answer is yes. The dilutive effect of a major equity issue would be highly unpopular with investors. Danone seems comfortable with its less risky – but much slower – strategy of developing strategic partnerships to expand in markets such as China.
