By Jacques Bizot and Yasen Stefanov
Heinz-Kraft’s bid of $143 billion for Unilever was set to become the largest ever acquisition in the Consumer Products industry. The acquisition would have been the next step of 3G capital’s strategy to sway the industry subsequent to the acquisition of Heinz in 2013 and Kraft in 2015 and branch out into other industries. This article intends to understand why such a bid was made and what made Unilever a potential target? We will answer this question by introducing the main players in the bid, summarising the timeline of the bid and listing the pros and cons that Unilever has as a target.
The Kraft Heinz Company
The Kraft Heinz Company, the acquirer, was formed after a merger between Kraft Foods Group and H.J. Heinz Co. completed on July 2nd, 2015. The main shareholders of Heinz – 3G Capital and Berkshire Hathaway hold a 51% stake in the newly formed company, so called Kraft Heinz. The Kraft Heinz Company is a principal competitor of Unilever and is the fifth-largest company in the sector worldwide and third in the USA. Kraft Heinz has over 200 brands in nearly 200 countries, with which it generated revenues of $26.5bn (44.4% YoY growth), and a net income of $3.632bn.
Unilever PLC, the target, was formed in September 1929 by a merger between Dutch “Margarine Unie” and British “Lever Brothers”. Since then, the Anglo-Dutch company has grown, spurred on by its numerous acquisitions, to become one of the biggest names in the consumer goods industry, its main competitors including the likes of Nestle, P&G and others. The Anglo-Dutch company operates through its four main segments which are Personal Care, Foods, Homecare, and Refreshment offering approximately 400 brands throughout in more than 190 countries. Its growth is stable and strengthened by continuously strong financial results: in 2016, it generated revenues of €52.713bn, a net income of €5.184bn and FCF of €4.8bn (unchanged with respect to 2015).
3G Capital and Berkshire Hathaway
Furthermore, two main players are involved in the bid given their controlling stake in Kraft Heinz: 3G capital and Warren Buffett. 3G Capital is a Brazilian private equity firm founded in 2004 and managed by Co-founder and CEO Alex Behring. Warren Buffet’s Berkshire Hathaway is an American multinational conglomerate holding company headquartered in Omaha, Nebraska, USA. Their partnership is somewhat curious given their varying approach with regards to target acquisitions, Buffett favouring the investment in strong companies whilst 3G capital having a principal focus on investing in companies requiring efficiency gains. Nonetheless, their partnership has proved extremely successful throughout and together, they have successfully developed a large number of synergies.
3G Capital’s acquisition of Heinz was followed by the replacement of management and the implementation of hard cost-cutting techniques. While their methods can be considered controversial, even Warren Buffett said before the Kraft Heinz merger: “I’m not embarrassed to admit that Heinz is run far better under [3G] than would be the case if I were in charge”.
On February 17th, Kraft Heinz approached the unlikely target Unilever with an offer to buy it for a total of $143bn. The offer was for $30.23 in cash plus 0.222 Kraft Heinz shares per Unilever share, which equates to an 18% premium over the previous days’ closing price. The bid was rejected by Unilever and by the day-end Unilever’s shares rose 13.4% compared to a rise of 10.7% in Kraft Heinz’s share price. On February 19th Warren Buffet announced that Kraft Heinz would not pursue the deal anymore, and thus withdrew from their bid for Unilever. It is clear that the deal was somewhat unexpected and that there was a misunderstanding among top management.
The bid was misinterpreted as a hostile takeover which was likely a principal reason for Unilever’s rejection of the 18% premium bid. An additional motive behind Unilever’s bid rejection is clearly the clash between the company’s corporate cultures. A pillar of Unilever’s business plan is operating with respect to certain standards. They value sustainability and adopt a holistic approach to revenues and profit. Many shareholders value this at a premium and shareholders fear this premium would be lost should 3G capital take control of the company. 3G capital’s two tenure ship of Kraft Heinz has likely indoctrinated the corporate culture into a hub for efficiency and expansion and acquiring Unilever would have a similar effect on it.
According to Bloomberg, there is a “Serious culture class and 3G will destroy a lot of the value created by Unilever.”, given 3G capital’s affinity for zero based budgeting methods.The deal presents us with the likely conclusion that, given Unilever’s diversified portfolio, Heinz-Kraft may be expanding their portfolio into other industries. Another interesting conclusion that can be drawn is that 3G capital has seen potential value in Unilever which raises the question, what is wrong with Unilever?
The hidden value in Unilever
From a financial perspective, the potential of Unilever is massive. About two thirds of the company’s portfolio is growing decently and continuously gaining market share, contributing to the company’s strong cash flow. On the other hand, a third of its portfolio is underperforming with respect to the benchmark and could thus be improved in terms of efficiency or sales.
A potential solution to increase growth would be spinning off subsidiaries, for example in the food and beverage industry, which accounts for a large proportion of Unilever’s business. They would reduce their exposure to what has recently been an industry with lower margins and lower growth (-3.1% growth YoY 2016). Diversifying into the personal care industry, which has recently been a prime focus for Unilever, may be more perceptive and rewarding. Many of Unilever’s past deals have been within that industry, notably Seventh Generation and Living Proof, and there has been a predominant focus on smaller scale companies such as l’Occitaine (Net profit margin 2015: 10.7%) which has assisted growth and offered higher margins. Selling companies that are lagging behind and making way for faster growing companies would be extremely effective in sourcing value.It is clear that the deal would create value for Kraft Heinz and path the way for numerous cost synergies without impacting sales given Unilever’s already strong implementation in the market.
For example, one measure that could be taken would be with respect to Unilever’s workforce. Subsequent to the Kraft Heinz merger, approximately 20% of the workforce was dismissed and given Unilever’s huge workforce approximately 168,000 employees, the deal would likely see this number fall quite dramatically cutting costs in the meantime.
3G capital preparing to pounce
Since the rejection of Kraft-Heinz’s bid, Unilever announced it would strive to speed up the increase in efficiency, particularly because of shareholder discontent. Unilever has been set on increasing efficiency in its businesses but has been accomplishing this at a slower rate and has been attempting to veer into more profitable and growing industries. If 3G Capital truly sees Unilever as a real target, they will pursue the bid and likely increase their offer however, given they also backed out this scenario is unlikely. Uncertainty veils over Unilever’s nearby future but it is clear is that 3G capital is on the verge of acquiring a business and it is ready to intensify its grasp and do what it does best.