Less than three days was all it took for Kraft Heinz’s GBP112bn (US$139.1bn) takeover approach to Unilever to become public, be rejected and subsequently taken off the table. UK takeover rules mean a further offer from Kraft Heinz is not on the cards for at least six months. It is hard to see how future agreement between the two camps could be reached. Berkshire Hathaway, one of Kraft Heinz’s two major investors, has insisted it will only pursue friendly acquisitions. Meanwhile, Unilever’s management has argued the proposal not only undervalued the business but delivered little strategic benefit for the company or long-term opportunity for its shareholders. Nevertheless, Kraft Heinz’s takeover attempt is likely to have some significant and far-reaching consequences for Unilever. Here, just-food takes a look at the impact the episode could have on the Dove-to-Knorr manufacturer.
Strategic review launched
Unilever brushed off the Kraft Heinz takeover approach for two reasons. The consumer goods group’s management argued the offer “substantially undervalued” the Magnum ice cream and Knorr soups maker at a price-to-earnings ratio of 19.1 times. Unilever also insisted Kraft Heinz’s model is at odds with its own approach.
Kraft Heinz focuses on cost reduction to generate immediate earnings growth. But, without investment in organic growth, its model relies on M&A to fuel continued returns. According to Unilever, that contrasts with its own strategic objectives and longer-term approach to creating value for shareholders.
Speaking at the Consumer Analyst Group of New York investor conference last week, Unilever CEO Graeme Pitkethly explained: “We see two very different approaches to shareholder value. One is a model of compounding returns on investment, attractive return on invested capital and a robust balance sheet that gives the flexibility for M&A. We like this model because it means we can go on generating high returns indefinitely and so it is inherently sustainable in the longer term. The other model relies more on leverage to generate stronger short-term growth in earnings but, without the foundation of strong organic growth, this model is more dependent on repeated portfolio change and portfolio expansion. It may well be that there was a strong strategic rationale for Kraft [Heinz] in combining with Unilever but there was no strategic rationale for Unilever.”
Nevertheless, Pitkethly said, the proposed bid represented an “inflection point” for Unilever. “The events of last week show us the challenge to unlock more value faster in the shorter term rather than focusing more heavily on steady value creation over the longer term, which is what we do. This has been a trigger moment for Unilever and we will not waste it.”
To this end, Unilever promptly launched a review of its operations in order to improve the returns the company can give to its investors.
“Unilever is conducting a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders,” the company said in a statement last Wednesday. The company hopes to “capture more quickly the value we see in Unilever”.
While Pitkethly suggested it would be inappropriate to comment in detail on the review until its findings are made public in April, he did reveal it would be a far-reaching probe into Unilever’s business. “This will include options for our organisation, our portfolio, our cost structures and for our balance sheet and use of cash,” he said.
Does that mean food disposals?
Unilever has been focusing its M&A strategy on expanding its higher-growth personal care business, through acquisitions including the recent purchase of Dollar Shave Club. As a result, an increasing proportion of Unilever’s sales come from its personal care brands. In 2008, the group generated 28% of revenue from personal care. By 2016, this had grown to 38%.
At the same time, the company has sold off lower-growth food brands, such as Slim Fast, Ragu and Bertolli. As a result, the group’s food business now accounts for 24% of sales, compared to 35% in 2008.
This evolution has prompted some to speculate Unilever could be prepared to sell or spin-off its entire stable of food brands or refreshment (a second unit that includes its ice cream and tea brands) assets. According to a report in The Sunday Telegraph, Unilever is understood to be giving what the newspaper called “serious thought” to a spin-off of its food business into a separate listing.
It is impossible to rule out this move. A leaner Unilever would be free to go after deals that could potentially create a personal care behemoth, such as a possible combination with the likes of Colgate. But, while all options are apparently open in the review process, this would represent a significant departure from the strategic direction Unilever’s management is committed to.
To suggest Unilever’s existing strategy has been to use its food and refreshment businesses as a cash generator to fund M&A in its home and personal care operations is something of an over-simplification. Unilever has also used M&A to expand its ice cream businesses, with recent deals including the purchase of Italian high-end gelato group Grom and US firm Talenti Gelato & Sorbetto. It would perhaps be more accurate to characterise Unilever’s strategy as selling off low-growth businesses in order to focus on higher-growth, higher-margin, ‘premium’ brands in non-food and food, although, in food, its M&A has focused on the “refreshment” side of the business than the “foods” division.
In this context, an obvious contender for disposal is Unilever’s spreads business. The unit operates in a market shaped by structural decline and investor pressure for an exit has been mounting for some time.
Unilever may have taken tentative steps towards this eventuality two years ago, when it moved to separate its spreads brands like Flora and Becel from the rest of its food business into a stand-alone operating unit. However, with a poor top-line performance, it is unlikely strategic buyers are lining up to increase their exposure to a business in decline – and, for that matter, a category in decline across the developed markets in which Unilever’s spreads arm generates the majority of sales. Unilever’s management has repeatedly stressed it does not intend to give the business away at a bargain basement price.
Nevertheless, MainFirst analyst Alain Oberhuber believes that some portfolio adjustments in food should be expected. “We conclude that the Kraft Heinz bid will result in significant strategy adjustments within Unilever with possible divestments in its foods business and a stronger focus on HPC with potential acquisitions in HPC,” he suggests.
Increased focus on margin
In the wake of the Kraft Heinz bid, Unilever raised its guidance for margin expansion and cash conversion over the coming year.
Speaking at CAGNY, Pitkethly claimed the implementation of Unilever’s so-called ‘Connected 4 Growth’ programme – devised to make the business simpler and more agile – and the company’s use of zero-based budgeting meant the Magnum owner could up its forecast for 2017 margins.
“In recent years we have increased core operating margin by 20-40 bps and by 50 bps in 2016. Looking ahead to the next few years, we said that we expect to accelerate this to between 40 and 80 bps… for 2017 we now expect to be at the upper end of that range,” he said.
In particular, the company has signalled a more aggressive approach to costs through the zero-based budgeting programme it launched last year. But Pitkethly was also quick to stress Unilever will be selective in where and how it slashes.
“Everybody has ZBB models now and it is the generic word for ‘we will try harder on costs’. Ours wasn’t like that. Ours was a full-on programme that has driven tremendous insight into our business,” he claimed. “Yes, it is about reducing costs but it is also about new thinking… so we can invest smarter. ZBB is part of our growth mode. And this is fundamentally an investment model… but it is clear we can go harder and faster in some of our business, like developed market foods for example… How we make those more selective choices across different parts of our business whilst recognising that we operate as a 1 Unilever entity is really the challenge now and that will be a full part of the review coming up.”
‘Connected 4 Growth’ as value driver
Unilever has also painted its ‘Connected 4 Growth’ reorganisation plan as a lever to deliver increased organic growth.
The programme aims to bring Unilever’s innovation closer to local consumers and support its ability to roll-out products at speed while its global teams remain focused on strategic launches. The new structure has facilitated recent product launches including Hellmann’s BBQ sauces in the UK and Knorr meal makers for local dishes like Ginataang Gulay in the Philippines.
“There really is no such thing as a global consumer; the ability to gather relevant insight closer to market and move it with greater speed into our business is a winning capability…We are already starting to see the benefits of the mindset change of Connected 4 Growth, even before it is fully implemented, with faster local innovation,” Pitkethly said.
Innovation coupled with marketing is central to Unilever’s aim of delivering “continuous” underlying sales growth ahead of its markets, as called for by Unilever’s 2019 financial model. Pitkethly stressed: “The most important feature of our growth model is sustained investment.”
Between 2009 and 2016, Unilever has driven a cumulative additional investment in marketing of EUR12bn, the CFO noted.
The company said it is “confident” of delivering 3-5% organic growth in 2017. “The most important driver of growth for the foreseeable future will be growing the core of the business, i.e. the high-value, most-frequently purchased SKUs that represent most of our sales,” Pitkethly said as he showed a slide including both the Knorr and Wall’s brand logos.
When Pithethly took to the stage at CAGNY, he was at pains to highlight the merits of Unilever’s existing strategy.
While the Kraft Heinz bid was presented as something of a wake-up call on the need to deliver immediate returns to shareholders, the executive was keen to stress the value of Unilever’s longer-term approach to delivering “sustained” value for its shareholders.
He suggested, part of the company’s problem – and the reason why its shares have been trading at something of a discount to its peer group – has been its failure to “land the message” effectively.
“Unilever has a business model that generates high, unlevered returns on our capital through compelling organic growth, building brand strength through sustained investment, technical and benefit-led innovation through research and development and a continuous improvement approach to costs,” Pitkethly said. “We believe that we can do more to communicate the value creation from our existing plans.”
Nevertheless, it is doubtful whether the same message delivered more effectively will be enough to satisfy the appetite of those investors who are hungry for change at Unilever.
As Sanford Bernstein analyst Andrew Wood notes: “We have been most struck by investors wanting to see something much bigger, with calls for a complete split of food and HPC, or a major acquisition (like Colgate), or both… We do worry that investors who are expecting a ‘revolution’ in this regard might end up disappointed.”