Unilever Swiftly Dodges Kraft Takeover Bullet

Kraft’s surprise $143 billion offer outright rejected by Unilever

US-based packaged food giant Kraft Heinz Co. (NASDAQ: KHC) made a surprise $143 billion offer for UK-based Unilever N.V. (NYSE: UN), the owner of Lipton and Dove brands, in a bid to build a global consumer goods juggernaut in packaged foods and household items. However, Kraft’s offer was flatly rejected just two days later on February 17th, 2017, as reported by Bloomberg on February 19th, 2017.

A potential combination would be the third-biggest takeover in history and the largest acquisition of a UK-based company, encompassing brands like Kraft Macaroni & Cheese, Heinz Ketchup, Ben & Jerry’s ice cream and Marmite, and combining Kraft’s strength in the US with Unilever’s in Europe and Asia. The proposed deal would have created a company with combined sales of $84.8 billion in 2016, second only to Switzerland-based Nestle S.A.

Although Kraft, controlled by US billionaire investor Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK-A) (NYSE: BRK-B) and private investment firm 3G Capital, was looking forward to talking over the deal terms, Unilever said it saw no reason to discuss a deal without financial or strategic merit. Berkshire owns about 27% of Kraft Heinz, and 3G holds about 24%, according to Bloomberg. 3G Capital is a global investment firm focused on long-term value creation, with a particular emphasis on maximizing the potential of brands and businesses. Hence, Kraft decided that Unilever’s negative response made a friendly transaction impossible, prompting it to abandon the deal, since it could face an uphill battle going forward.

Unilever stated that the $50-a-share cash and stock offer, an 18% premium to its closing price on Thursday, February 16th, 2017, “fundamentally undervalues Unilever”. Unilever management was also worried about the cost-cutting model at Kraft, which sells products like Velveeta and Jell-O, and its lack of vision for cultivating brands.

Unilever was defended by law firm Linklaters and bankers at Centerview Partners, Morgan Stanley (NYSE: MS), UBS AG and Deutsche Bank. Kraft Heinz was working with law firm Paul Weiss and bankers at Lazard.

Kraft-Unilever merger seen as a misfit

Kraft’s pursuit first gained ground after a 2.5% decline of Unilever’s stock in 2016, its worst annual performance since the financial crisis in 2008. Unilever, which has struggled in recent months amid slowing growth and currency fluctuations, saw its shares tumble 4.5% on January 26th, 2017, its worst day in nearly a year, when the company reported lower-than-expected fourth-quarter sales. The share plunge encouraged Kraft to make an approach.

Unilever has been hit by a slowdown in emerging markets as well as in its home market, where consumers have been rattled after Britain’s decision to leave the European Union last year. During Q3 FY16, Unilever’s total turnover declined 0.1% to €13.4 billion due to currency headwinds and weak economic conditions in a number of countries. The results were also negatively impacted by an increase in import prices due to weak sterling, high commodity prices and low consumer confidence in emerging markets. This in turn mirrors slowing growth in the global packaged food industry, where new competition from upstart brands, deflation in developed markets and more health-conscious consumers are causing a tectonic shift in consumer preferences and food habits.

For Kraft, its move comes as low interest rates and cheap debt have fueled big cross-border deals, making it the busiest start to the year for M&A activity on record. Still, Kraft-Heinz is faced with its own problems of finding means to boost sales, even when it is evaluating whether it can help Unilever cope with sluggish growth. Kraft’s sales fell 3.8% to $6.86 billion in the fourth quarter ended December 31st, 2016, and its US sales, which account for more than 70% of total sales, fell 3.1% to $4.84 billion. Kraft is smaller than Unilever, with a market value of $106 billion as of February 16th, 2017.

Given this scenario, Kraft’s bid reflects consolidation among consumer goods companies that are searching for ways to increase profitability as consumer habits shift and conditions for the industry become tougher globally. Kraft Heinz itself was forged in a $55 billion combination orchestrated in 2015 by 3G and Buffett’s Berkshire, which had teamed up two years earlier on a buyout of H.J. Heinz.

A potential deal would have brought together two companies with radically different business cultures. With a stable of slower-growing brands, Kraft is heavily concentrated in the US and was formed in the last few years through debt-laden deals. Using 3G’s approach to management, it implements aggressive cost-cutting strategies to generate margin expansion that allow it to repay the debt and bolster shareholder returns. On the other hand, Unilever is better known for its strong brands and presence in some of the biggest emerging markets. Under CEO Paul Polman, Unilever has also attempted to focus on trying to better balance profitability with environmental sustainability.

Kraft believes that investing in innovation would be an important part of the combined company. The potential merger would have benefits such as cost savings, an expanded geographic footprint and improved product diversification. A deal would offer opportunities to combine marketing, manufacturing and distribution in addition to cutting costs, but some industry analysts said Kraft might not want Unilever’s household and personal goods brands and could spin them off.

Political hurdles

Kraft has until March 17th, 2017, to make a final bid for Unilever under UK takeover rules. In the meantime, Prime Minister Theresa May had asked senior officials to study the proposed takeover in the wake of the country’s vote to exit the European Union and see if it warranted government intervention since such a merger would involve heavy job losses and higher levels of financial leverage. The UK government also plans to examine takeover plans in detail – or appoint an independent body to do so – to see how they fit with the public interest.

The Kraft Heinz bid would have been a big test for the UK government’s industrial policy. May had already called for greater powers to prevent predatory takeovers, citing Kraft Foods’ 2010 takeover of UK chocolate maker Cadbury, where the acquirer later reneged on promises to retain factories in Britain. May also cited the example of pharmaceutical major AstraZeneca PLC (NYSE: AZN), which fended off a $120-billion takeover by drug behemoth Pfizer Inc. (NYSE: PFE) in May 2014 on grounds of undervaluation.

Takeover fended off to prevent job losses

Britain’s largest union, Unite, which represents employees at Unilever, has urged Unilever to continue fending off the takeover attempt to prevent job losses. Unilever employs 168,000 people and generates roughly 17% of its revenue in the US compared to Kraft-Heinz, which generates roughly 78% in America.

A recent wave of cross-border deals in Europe is leaving British businesses vulnerable to possible job cuts. Peugeot S.A.’s proposed acquisition of General Motors Company’s (NYSE: GM), Opel business may eventually lead to heavy restructuring at the Vauxhall brands, which employ 4,500 people in Britain.

The end of Kraft Heinz’s bid for Unilever will also restart speculation over its next big acquisition target. Analysts speculate that Kraft was more likely to go after targets such as Mondelez International Inc. (NASDAQ: MDLZ), the snacks company, or cereals group General Mills Inc. (NYSE: GIS). More importantly, it would more pressure on CEO Paul Polman to accelerate, or at least deliver, on reforms that he outlined last year, which form the backbone of a three-year plan to improve profitability and growth at the UK’s third-largest company by market value.

Stock Performance

Unilever’s stock ended the day at $46.75, gaining 3.68%, at the close on Wednesday, February 22nd, 2017, having vacillated between an intraday high of $47.51 and a low of $46.01 during the session. The stock’s trading volume was at 12,095,265 for the day. The Company’s market cap was at $120.19 billion as of Wednesday’s close.

Kraft’s stock ended the day at $93.36, slipping 1.59%, at the close on Wednesday, February 22nd, 2017, having vacillated between an intraday high of $95.00 and a low of $92.99 during the session. The stock’s trading volume was at 4,998,435 for the day. The Company’s market cap was at $113.62 billion as of Wednesday’s close.

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