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OPINION

Smart but dim

Smart but dim
February 22, 2017
Smart but dim

Once Unilever had taken the opportunity to robustly reject Kraft's suggestion, the whole exercise became pointless because Kraft's bosses had nowhere else to go. Unilever had said a curt "no thanks" to Kraft's cash-and-shares proposal, which was worth almost £40 per share, and Kraft lacked the financial muscle to raise the bid. The US company's bosses were already valuing Unilever's equity at £113bn against a market value of £94bn for their own company and £69bn of the Unilever offer was in cash. True, the enlarged group could have supported the extra debt. Even so, it would have tripled its debt load to over £100bn. From there, raising the bid would have triggered a process of self-necrosis, as the effect of raising even more debt or equity would have eaten away at the value of Kraft's existing equity.

Besides which, it is not as though, in Unilever, Kraft was going for an enfeebled or bloated beast, which is what its bosses claim to do. Kraft is run by 3G Capital, a New York-based and Brazilian-funded private equity firm, which styles itself as the ultimate cost-cutter - doing it rapidly and relentlessly.

What's really happening may be slightly different. 3G, in partnership with Warren Buffett's Berkshire Hathaway (US:BRK.B), bought HJ Heinz for $23bn (£18bn) in 2014 and merged it with Kraft Foods in a $46bn deal in 2015 to form Kraft Heinz. These deals left 3G and Berkshire controlling Kraft Heinz with 51 per cent of the equity. 3G's day-to-day chiefs, Alex Behring and Bernando Hees, run the show, while Warren Buffett stays on the sidelines as cheerleader-in-chief. The great man is smart enough to stress that 3G's approach of strict dieting is very different from Berkshire's, which is never to buy bloat in the first place.

Yet Kraft Heinz is changing so rapidly that, from the outside, it is difficult to gauge progress. Sure, in 2016 - the first full year of the current entity - profit margins looked great at 27 per cent, up five percentage points from 2015's non-comparable figure. But use of capital was not so impressive. Return on assets was just 5.9 per cent and return on equity - 6 per cent - got no benefit from the group's leverage. By contrast, Unilever managed a 15 per cent return on assets and 24 per cent on equity, even though its profit margin was a more modest 15 per cent.

Granted, Kraft's balance sheet may be overloaded with goodwill and intangibles, and it's a form of guesswork to compare one company's capital employed with another's. Even so, these figures hardly flatter Kraft and the Ivy League MBAs running it.

Besides, the MBAs - like so many clever people - were a bit stupid, too. Did they really imagine that a US company bearing the name 'Kraft' could take out a UK institution such as Unilever? After all, following its takeover of Cadbury Schweppes in 2010, Kraft - which, since then, has been split in two - became a by-word for corporate vandalism. At least in the popular imagination, Kraft ripped apart one UK company that demonstrated in its Bournville heartland all the benevolent good that a company can do. Immediately, the foreigners would have been targeted as wanting to do the same to the company that, in Port Sunlight, built a workers' village on a par with Cadbury's Bournville.

Also, the botched attempt leaves the sceptic's thought that Kraft's real motive was to foster the illusion of progress by engineering a giant deal made feasible by the dollar's strength against sterling - in dollar terms, Unilever's share price is 11 per cent below its peak in mid-2014. Full marks for opportunism, but the move reduces 3G to the status of so many takeover artists from the past.

Meanwhile, some Unilever shareholders must have been lucky enough to sell when the price peaked at almost £38. It's a decent bet we won't see that price again in a hurry and a better bet that - at their current £35.35 - the shares offer no more than a 5 per cent compound return over the next five years.

For almost 10 years Unilever's price has been boosted by the company's status as a major beneficiary of the dual process of globalisation and the creation of a mass middle class in the developing world. As globalisation retreats, these themes may have run their course. If that were the case, Unilever's shares would be badly hit since their price rise has outstripped the company's ability to deliver higher earnings. The rise in the share rating, from about 12 times earnings during 2009's financial crisis to 22 times at the peak, tells us this. If earnings growth can continue to trundle along at 6 per cent a year (the average of the past five years) then maybe, just maybe, that rating could be sustained. But if interest rates rose, forget it.

For what it's worth, I lost interest in the shares when the price crossed £22 back in 2012. It may not be too long before they pass that way again.