Kraft Heinz has made an initial offer of $143 billion to acquire Unilever; its bid is likely to be raised. – Seeking Alpha

On February 17, Kraft Heinz (Nasdaq:KHC) approached Unilever (NYSE:UL, NYSE:UN) with an offer to buy it out for $30.23 in cash plus 0.222 Kraft Heinz shares, a total consideration of some $143 billion and an 18% premium over Unilever’s closing share price the previous day. Unilever promptly rejected the offer in no uncertain terms, but Kraft Heinz indicated to the press that it intends to pursue the idea.

The offer certainly has an element of opportunism to it, which doubtless has not impressed the target. Unilever’s share price has suffered since October as a result of a weaker-than-expected Q3 report and an uninspiring revenue growth outlook. Prior to that, Kraft Heinz’s proposed deal structure did not look anywhere near so generous, although it still offered a premium:

Markets’ reaction to the bid suggests that arbitrageurs are not expecting the matter to end with Unilever’s initial rejection of the idea. Unilever ended the day up 13.4%, yet the price premium of Kraft Heinz’s offer remained 9.4%. This is because Kraft Heinz’s share price also rose on the announcement, by 10.7% ─ a fairly remarkable development for a company making so large an offer.

Unilever is probably right to hang tough on valuation grounds: while it certainly faces some challenges in recapturing the unit growth it has enjoyed in recent years, the prospect of doing so is not so daunting as they might seem, given some stabilization among emerging market economies. Further, the strategic logic of the combination is not entirely clear, and probably more to the benefit of Kraft Heinz shareholders than Unilever’s. And the financial condition of Kraft Heinz means that purchasing Unilever, even at such a price, would be something of a stretch, leaving the resulting company rather highly leveraged by the standards of consumer staples businesses.

Any deal so large would inevitably face regulatory scrutiny. This is a wild card, particularly in the European Union, because the E.U. is so arbitrary in its definition of what constitutes a market, and therefore the extent of market dominance. As a trivial example that may nevertheless be significant for the proposed combination, do ketchup and mustard constitute separate categories (in which case the group might face no problems retaining these products) or are they both components of the condiment market (in which case the combination might be forced to make disposals)? The proposed deal will probably face fewer challenges in other jurisdictions.

Forced disposals may not necessarily be a bad thing, however. Unilever has been very actively pruning and optimizing its product portfolio, but this is not always easy to do in Europe, where unions may have an effective veto over restructuring plans. Competition authority rulings trump union power, however, and if the longer-term consequence of the combination is to reduce its presence in Europe, this is not necessarily a bad thing, either: the stubborn refusal of volumes in Europe to grow has been at the center of several of the challenges facing Unilever.

In any case, there is some question whether Kraft Heinz would want to retain all of Unilever. Personal Products and/or Home Care could easily be spun off or sold as discrete entities. Since Unilever’s position in both sectors is strong, there would certainly be demand for them, and they could be used to reduce debt.

It is unlikely to receive much discussion, but it is likely that one of Kraft Heinz’s motivations is to apply the restructuring and cost-cutting expertise of one of its largest shareholders, 3G Capital Partners, to Unilever. Although Unilever has made major strides in reducing bureaucracy and streamlining reporting structures, in a large, disparate and geographically disperse company that turns eighty-seven years old this year, there is, inevitably, plenty more that can be done. 3G has demonstrated in several situations, most notably Anheuser-Busch, that it has the determination and discipline to reduce costs even against entrenched resistance.

Regardless of Unilever’s initial response, this story is by no means over. Under U.K. takeover rules, Kraft Heinz must make a final offer by March 17th.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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