Unilever (ULVR) announced the acquisition of GlaxoSmithKline’s (GSK) health food drinks portfolio for €3.3 billion, payable primarily through its shares in its Indian subsidiary Hindustan Unilever, or HUL, as well as around €470 million in cash.
We think the deal is very rich, at a stated post synergy valuation of under 20 times enterprise value/earnings before tax, but the firm expects the acquisition to be accretive to return on invested capital by year four.
Separately, Unilever announced that CEO Paul Polman is retiring at the end of this year and will be replaced by Alan Jope, currently head of the personal care division. We are maintaining our fair value for share class and believe there is only modest upside to the market value.
Acquisition is Overvalued
Unilever will acquire GSK CH India with HUL stock at an exchange ratio of 4.39 HUL shares for each share of GSK CH India. This translates to an implied equity valuation of €4 billion, and will leave Unilever with a slightly diluted economic interest in HUL of 61.9%.
Unilever will also acquire 82% of GSK Bangladesh and several other small Asian operations for a total of €639 million in cash. Although few financial details were disclosed, Unilever stated the post-synergy valuation was “below 20 times” and we estimate the deal to be valued at almost 7 times sales.
The assets Unilever is acquiring are fairly attractive. Around 90% of the business’ turnover is generated in India, where the hot malted drinks category has grown steadily at a 12.5% 10-year compound annual growth rate, slightly above that of other hot drinks categories such as tea and coffee.
Horlicks and Boost command large market shares, giving them strong supply chain competitive advantages that will fit Unilever’s go-to-market strategy. We estimate that the acquisitions will add 12 basis points to Unilever’s consolidated revenue annual growth rate. Although too small to move the needle on our valuation, however, we think Unilever has paid a very rich price, probably as a result of competitive bidding by other suitors.
CEO Polman to Retire
The retirement of Polman comes as no surprise to us. We had believed that Polman was approaching the end of his tenure anyway, and that the botched attempt to simplify the capital structure to a single share class, traded in Amsterdam, probably accelerated his retirement. We expect his successor to continue along a similar path of attempting to reignite growth and drive margins higher, and we expect the current 2020 targets of 3% to 5% revenue growth and a 20% earnings before tax margin to remain in place.
Although we think Unilever’s strategy of decentralising operations is the right one to address the industrywide problem of structurally slower growth, much more work needs to be done to achieve these medium-term targets.
We have no doubt that M&A will play a significant part of that as Unilever attempts to increase its portfolio exposure to faster-growing categories, but we think it will be difficult to extract value from deals struck at lofty multiples such as this acquisition of Horlicks.
Jope has very strong experience at Unilever, including managing units in China and Africa, as well as digital marketing savvy, but as head of the personal care business, he sanctioned the $1 billion purchase of Dollar Shave Club. The jury is out, therefore, on whether Unilever’s change of leadership will lead to more disciplined capital allocation.
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