Qualiport

[ June 9, 2000 ]

Food For Thought

By Maynard Paton (TMFMayn)

Carburton Street, London -- Bruce commented on Wednesday on the recent purchase of Bestfoods (NYSE: BFO) by Unilever (LSE: ULVR). He gave a "sceptical" view. My thoughts are no different.

A quick run through of the figures shows Bestfoods was no bargain. Dick Shoemate, chairman of the US firm, commented during his recent AGM that Bestfoods' earnings could be expected to grow by about 10% in the current year. Using this statement and adjusting for the amortisation of goodwill, Unilever bought Bestfoods on a multiple of 24 times prospective earnings.

More evidence that implies a top price was paid comes from looking at the expected savings, interest payments and the inevitable exceptional costs that will be incurred.

Unilever will take on $20b of debt to fund the purchase, and will expect to have "blended" (whatever that means) interest costs of 6.75%. In other words, we're looking at an annual interest bill of around $1.3b. Worryingly, that's equal to the operating profits generated by Bestfoods in 1999.

Imagine that Unilever remains financially the same, and all the costs and savings are accounted for within Bestfoods. Thus, with the additional interest payments of £1.3b offsetting the acquired profits, the deal's all about what's expected from the proposed synergies. Unilever declares that $750m of annual savings can be found, although earlier rumours, which I tend to believe will be more accurate, had suggested benefits of $1b.

Assume that the $1b level can be reached. Then bring into the picture the $1.1b of exceptional acquisition charges to be levied over the next four years, equating to an annual amount of $275m. Subtract this annual exceptional charge from the expected benefits and we arrive at $725m of operating profits. Half as much as the figure Bestfoods generates now.

From these simple calculations, Unilever must have either a huge increase in revenues planned for Bestfoods, or much more likely, there will be chunky disposals needed to reduce the debt and interest payments. When drawn many times on the subject of disposals during a teleconference call, the Unilever management refused to remark on the operations or figures that could be involved.

Shuffling the Brands

Unilever declares the purchase would improve the rates of sales growth to "nearly 6%". But there's obviously going to be some jiggery-pokery with the top-line figures, in order to account for the businesses that will have to be discontinued. All in all, Unilever is not going to grow its overall turnover as fast as it has implied. Through the corporate shuffling of brands, the plan is simply to swap some low-margin goods for some higher-margin ones.

Looking at both Unilever and Bestfoods, I do feel that the branded foods industry, from an investment angle, isn't particularly appealing. It's a combination of low sales growth combined with acquisitions, disposals and the annoying reoccurrence of "exceptional integration" charges. Bestfoods has accounted for these types of "special items" in four out of the last six years.

Then look at Unilever. To increase operating margins by 4-5% to 15%, and to eventually gain an extra £1b of annual operating profit, the company will have to spend £3.3b over the next five years in various one-off costs. With all the corporate juggling of acquisitions and disposals, and chunky exceptional charges being a regular feature on both company's profit and loss accounts, it's very difficult to get a realistic grip on the true financial performance.

Compare Unilever to Emap (LSE: EMA). Both, with their pedestrian organic sales growth, increase profits through raising operating margins. But the difference lies in their ability to achieve the required cost-cutting. Unilever has to lay out huge charges upfront, with the expected savings only to exceed these costs many years down the line.

Emap on the other hand, has no such problem. Year after year, devoid of any additional expense, margins at Emap rise without problem. Of the two, I really do prefer the economics of Emap and the media industry, to those of Unilever and food manufacturing. And if that's the case, why do we hold both companies? Why not just Emap?

Selling Unilever

Bruce and I are not particular fans of the Bestfoods acquisition, nor indeed are we excited about the fundamental characteristics of the food manufacturing industry. We're selling Unilever. In the next five trading days, and according to our Foolish trading rules, the Qualiport will dispose of its 266 Unilever shares.

Apart from the corporate shenanigans, a few other factors came into play with this decision.

Unilever is by far our smallest holding. On a good day, it is worth about 6% of the Qualiport's total value. Although I've said in the past about selling Unilever at a "fair value" of 473p, waiting for this price just isn't going to improve our overall performance too much. Lingering indefinitely for an extra £100 or so, when the portfolio is worth £20,000, is not the way forward.

Basically, the attention we've paid to Unilever in the past far outweighs its contribution to the overall Qualiport return. Our time could be better spent evaluating opportunities elsewhere. Of a greater importance is that the money tied up in Unilever can be reinvested in more attractive companies.

Buying PizzaExpress

When I recently looked at the valuation of PizzaExpress (LSE: PIZ), I set an entry price of 660p for any top-up.

And guess what? After dropping 13.5p today, PizzaExpress shares currently languish at 661.5p. When it comes to PizzaExpress and Unilever, there's no comparison. PizzaExpress have significant revenue opportunities, a superior financial record and no complications through acquisitions and disposals that can muddy the analytical waters.

As I've written in the past, I'm all for concentrating our investment firepower. Topping up one of our existing holdings, a business we fully understand, at an attractive price is far more appealing than looking to invest the Qualiport's cash elsewhere.

So, again in accordance with the Foolish trading rules, the Qualiport will purchase £1,500-worth of PizzaExpress over the next five trading days.

We do listen

Although we've gone against popular public opinion in our sale of Unilever, we really do enjoy your feedback.

So, another poll.

Should we have announced a PizzaExpress top-up?

1. Yes -- 660p is a very good price.
   
2. Yes -- but at below 660p.
   
3. No -- PizzaExpress has limited investment potential
   
4. No -- A Unilever top-up was required instead
   
5. Don't know / care

Click here to vote.

I'll see you on the on the Qualiport discussion board. I look forward to your comments about the "switch".

Related Links

• Sell Unilever Bestfoods?
• Unilever's 1999 results reviewed
• Unilever's 2000 first quarter results reviewed
• Unilever discussion board
• PizzaExpress valuation
• Pizza Battle
• Less is More
• PizzaExpress discussion board