Qualiport

[ June 7, 2000 ]

Sell Unilever Bestfoods?

By Bruce Jackson (TMFGoogly)

What's Happened?

In case you've missed the news, yesterday Unilever (LSE: ULVR) bought US food company Bestfoods (NYSE: BFO) for a total consideration of $24.3 billion. Within an hour of the news breaking, I'd received an e-mail from Unilever complete with press release and Powerpoint presentation. So, hats off to Unilever's investor relations department.

They've also posted the information on their corporate website (see the link above). Again, hurrah for the investor relations people at Unilever. It's great example of how the Internet is levelling the playing field for private investors.

What's It All Mean?

You can read all about the facts yourself, if you're so inclined. Here's my take.

Unilever are paying top dollar for Bestfoods. The final price paid ($73) is 40% above Bestfoods' pre-bid price, and 10.6% higher than their opening gambit. Bestfoods ultimate aim was to force Unilever to pay more, and our Anglo-Dutch giant didn't disappoint.

Unilever Bestfoods will be a giant of a company, and that alone brings lots of advantages. The pure buying power can be used to screw suppliers on price, ultimately leading to increased profit margins. The global distribution capability is yet further enhanced. For example, Bestfoods are stronger in Latin America than Unilever, but together both companies' products can be distributed to an existing customer base. Cost savings from the removal of duplicate functions, amongst other things, will be significant ($750m annually).

Operating Margins

Unilever's operating margins were 11% in 1999. They were targeting operating margins of 15% by 2004. When combined with sales growth, an increase in operating margins can have a marked effect on a company's profits, as this simple table shows.

               Year 0     Year 1    Change %

Sales             100        105      + 5.0%
Operating Margin   11.0%      12.4%   +12.7%
Operating Profit   11         13      +18.2%

The highlighted line shows exactly why Unilever are looking to stretch those operating margins. They were below 9% back in 1995, and have gradually been edging upwards over the past few years.

When a company makes an acquisition, it often looks to buy a company with operating margins lower than its own. But Bestfoods already has operating margins of above 15%, way above Unilever's 11%. Cost cutting opportunities in order to improve Bestfoods' margins seem limited. Remember, prior to yesterday Unilever were targeting 15% operating margins by 2004.

In light of the acquisition, the combined Unilever Bestfoods has changed its targets. Operating margins of 15% by 2002 and between 16% and 17% in 2004 are now the targets.

Tail And Dog

To me, it smacks of the tail wagging the dog, with Unilever putting together some numbers to make the acquisition make financial sense. For a company this size (over $50 billion annual sales), those operating margin targets will not be easily met. They may never be met. Coca-Cola (NYSE: KO) has operating margins of 20%, and it has very few different brands and products. The higher the number of products, the lower the margins. Unilever is looking to reduce its number of products and brands from 1600 to 400, still way above those of Coca-Cola!

I'm sceptical. At the same time I'm also very respectful of the Unilever management. They know what they're getting themselves into, going into the deal with their eyes wide open. The road ahead will be a rocky one, but it's not one on which I'm entirely sure I'd like to ride.

What Now?

Maynard has written in the past about selling Unilever if and when the shares reached what he saw as fair value. When reviewing their full year results from 1999, he said;

"Should Unilever approach the dizzy 473p level this year, it will be time to push them overboard."

At the time, back in February this year, the shares stood at a rather sick-looking 359p. The 473p level did indeed look a long way off, requiring a 32% jump in the share price. Surely massive and slow growing companies like Unilever just don't see their share prices move by that amount over the course of a year. Don't they?

Well, just to confound us, for one brief and perhaps fleeting moment, Unilever's share price breached that level, closing on May 24 at 476p. At the time, Maynard and I raised our eyebrows at each other, mentioned the word "sell" and did absolutely nothing.

I believe the success (or not) of the Bestfoods acquisition depends on them being able to achieve accelerated sales growth. To that extent, Unilever have raised their revenue growth target to 6% from 5%. Whilst commendable, sales growth is a good deal harder to achieve from an acquisition than is cutting costs.

Sell Now?

Unilever are a solid company, with strong management and a good vision. External factors like index tracking funds being forced to buy the shares -- because of Unilever Bestfoods' increased weighting in the index -- may provide a short term fillip for the share price.

I'm tempted to sell the shares now, due to my uncertainties about the achievability of sales and margin targets. There are risks in selling too, but they are usually outweighed by the risks of hanging on too long.

Your Say

We're asking you to help us out, and have set up a poll on the Qualiport discussion board.

Should the Qualiport sell Unilever?

a. Yes -- do it now (share price currently 445p)
b. Yes -- at soon as they reach 485p
c. No -- the Bestfoods acquisition is a great move by Unilever
d. No -- they are an obviously great investment, and should never be sold
e. Don't know/care

Click here to vote on the Qualiport discussion board.

Maynard's back on Friday.

Related Links

• Unilever Discussion Board
• Unilever's 1999 results reviewed
• Unilever's 2000 first quarter results reviewed
• Unilever buys Bestfoods - the press release