Finanzas: Reckitt Benckiser (Officially) Buys Into Mead Johnson’s Magic Formula
- RBGLY has announced their formal bid for MJN at $90 per share.
- Adding to my previous article, the more I look at the deal the more compelling it looks.
- Combined company will be attractively exposed to the emerging markets, highly cash generative and despite the acquisition costs emerge with a robust balance sheet.
- Despite RBGLY’s share price rising significantly post-deal, I believe they continue to hold attractive long-term value right now.
Its official. UK-headquartered global consumer healthcare company, Reckitt Benckiser (OTCPK:RBGLY), has finalised terms to buy infant formula maker, Mead Johnson Nutrition (NYSE:MJN). Recently I wrote a more detailed article on the attractions of the deal possibly going through. Here I will provide an addendum to that discussion.
Some Deal Details
The final deal was announced at $90 per share. This is an equity value of $16.6 billion and a full value (including debt) of $17.9 billion. For Mead Johnson shareholders the immediate value of the deal of fairly obvious. Mead Johnson was trailing on a share price of just $69.50 on 1 February 2017 before the deal was announced-a 29% premium. Of course, for those who invested at Mead Johnson’s highs early in 2015 it may hardly seem a perfect deal:
Yet since Danone’s (OTCQX:DANOY) was presumed to have dropped out of a potential acquisition with its announcement of buying WhiteWave (NYSE:WWAV) it seemed only acquisition activity of another sort (either Nestle or, as happened, RB) seemed likely to prop up their share price anytime soon.
Whatever the case, despite my belief that the synergies were limited between the businesses. RB reckons that they can put together annual costs savings around the £200 million mark by the end of the full third year. This would be quite an attractive saving for a combination in which obvious synergies, as I explained in my previous article, were hardly the most obvious. Unsurprisingly, the levers they intend to pull to achieve those savings are fairly generic ones:
The integration of RB’s and Mead Johnson’s businesses is expected to deliver cost savings of £200 million per annum by the end of the third full year following completion. These arise principally from removing duplication in back office functions and leveraging the enhanced scale of the combined business in the procurement of raw and packaging materials, advertising and promotional expenditure and other spend. One-off costs to achieve the savings are expected to be approximately £450 million.
Nothing spectacular, perhaps. Yet something which will be a welcome addition to profitability and margin growth in the future. What is more, the further I look at the deal and how the new combined company will look the more attracted to it I have become even setting aside potential cost savings. Here I will explain a little.
In the process they will be bringing the Enfa brand (including Enfamil). Interesting, this will make Enfamil the biggest of RB’s key “powerbrands.” This is perhaps little surprise. Whilst RB has to be admired for its remarkably focused brand portfolio, it still contains a number of key “powerbrands” from their Durex condoms to Nurofen painkillers and Dettol cleaning products to Scholl footcare items (Source: Reckitt Benckiser):
Indeed, compared to Mead Johnson’s brand portfolio, RB’s brand portfolio looks positively sprawling. As the announcement points out:
Mead Johnson’s portfolio is attractive in its simplicity and focus, with approximately 80% of 2015 net sales from the Enfa family of brands.
This means that immediately the Enfa brand will rocket to the top of RB’s powerbrand list.
Interestingly, RB is taking a more modest view of the infant nutrition market’s growth prospects. They argue that:
RB expects the [global infant and children’s nutrition] category to grow at approximately 3-5% per annum in the medium to long term.
This is slower than some other commentators are predicting. One, for instance, sees the market growing at a CAGR of over 6% per year to around $76.5 billion globally in 2021 (Data Source: Zion Market Research Report from August 2016):
The fairly conservative expectations from RB related to the market growth is encouraging to some extent. Indeed, it introduces the prospect of further upside in the value of the acquisition than currently anticipated.
Developing Market Powerhouse
Mead Johnson’s geographic focus, in particular, suggests that RB’s predictions may be a little on the conservative side. As noted previously, Mead Johnson derives most of its revenue from its Asian operations with its further developing markets in Latin America expanding its presence in some of the other high growth markets
Mead Johnson’s geographic footprint significantly strengthens our position in developing markets, which will account for approximately 40% of the combined group’s sales, with China becoming our second largest Powermarket.
This certainly appears to be the case. RB takes a rather unconventional approach to breaking up its regional revenue share figures. Chiefly they are split between “ENA” (developed) and “DvM” (developing) markets with the geographically-neutral “Foods” tagged on afterwards (Source: RB 2015 Annual Report)
The combined company’s revenue will certainly be increasingly tilted towards emerging markets with RB’s 30% “DvM” revenue set to grow to over 39% after RB and Mead Johnson combine (Data source: RB’s FY2016 Results)
Indeed, those areas where Mead Johnson are currently less established do not overlap much with RB. As such, the potential for geographical expansion of the Enfamil brand are immense
RB’s multi-geography supply chain infrastructure and distribution network will enhance Mead Johnson’s go-to-market capabilities. RB’s scale and expertise will also enable accelerated market entry into nascent territories for Mead Johnson where RB has existing and deep understanding of the local consumer health dynamics.
This could be very handy. Mead Johnson does generally have robust market shares in most (except France) of the top 10 largest infant formula markets (Data source: JP Morgan via HF Research)
Nonetheless, Mead Johnson’s exclusive focus on the infant formula market has meant that it has kept out of many markets (or at least retained a small presence) where the cost of setting up a distribution network outweighed the potential benefits from the market itself. With the potential of piggy-backing off RB’s more broad-based global distribution network Mead Johnson’s brands should be able to enter new markets quickly and comparatively cheaply (and thus profitably).
Healthy Post-Acquisition Balance Sheet
As I noted in my previous article, RB was in a good condition from a debt perspective to take on a big acquisition like Mead Johnson. Yet their FY2016 results released about the same time as the acquisition announcement highlights just how well prepared with debt (and net debt) materially lower than the already low levels seen in H1 2016.
Indeed, it has historically retained low debt to equity levels (including net debt to equity) which has continued to shrink.
This means that even after RB describes its deal-related debt facilities-“$9 billion of term loans over 3 to 5 years and $8 billion of bridge funding to cover the cash consideration plus a further $3 billion to refinance existing Mead Johnson bonds if required”-investors can still come away comfortable with the company’s leverage levels. Sure we should expect to see their credit ratings decline somewhat. Nonetheless, they currently have such healthy credit ratings-A+ (Stable) from S&P and A1 (Stable) from Moody’s-they should continue to attract solid interest rates even after the deal is closed.
I suspect that RB will seek to reduce debt levels pretty sharply after completion. This is especially true as my prediction that RB’s FCF for FY2016 would come out around the £2 billion mark was about spot on. Combined with Mead Johnson’s FCF (also for FY2016) suggests a total FCF figure around £2.5 billion ($3.1 billion).
Although not all of that FCF will be going to servicing debt (RB plans to maintain its current 50% adjusted net income dividend payout policy even though it is retiring its share buyback program) a lot of it will be able to courtesy of its modest dividend payout ratio.
Yet here is the thing, their FCF to Debt ratio remains around 13.5% even with the massive addition of the acquisition debt load. Sure, not as impressive as RB’s current 85% FCF to Debt ratio (an incredibly high level) yet still a healthy looking level.
RB’s move for Mead Johnson was, as I noted before, something of a surprise. Yet it strikes me as an inspired move. Digging deeper into what the company will look like as a combined entity only encourages me further. RB has added another compelling global brand which, in particular, enhances their sales position in key developing markets.
RB’s intense focus on expanding their powerbrands global clout has proven an effective strategy in the past. With Enfamil aboard too, I see no reason why this strategy won’t continue to reap rewards.
According to the announcement, they expect the deal to close by Q3 2017. Quite a quick turnaround reflecting the fact that competition authorities are unlikely to find much to aggravate them in RB’s acquisition of Mead Johnson.
Of course, there are still hurdles to its completion. Should Mead Johnson terminate the deal, they are in line to pay a $480 million fee to RB (only $20 million if due to shareholders failing to approve the deal). The same $480 million fee will be paid by RB to Mead Johnson if they cancel the deal or RB’s shareholders reject the proposal.
Nonetheless, I expect it to close and I find it hard to argue against RB making it a success. As they stated themselves:
RB has a track record of effectively integrating consumer health companies as evidenced by the acquisitions of Boots Healthcare International, Adams and SSL. Each has delivered an important inflection point of growth for RB.
This is certainly true. RB has successfully bought Boots Healthcare International (2005, £1.9 billion), Adams (2007, $2.3 billion) and SSL International (2010, £2.5 billion) as well as most recently Schiff Nutrition (2012, $1.4 billion). Over time they have successfully integrate and expanded brands bought such as Nurofen and Strepsils (Boots), Mucinex (Adams) and Durex and Scholl (SSL International) as well as increasingly MegaRed (Schiff). Enfamil is now set to join this family. If RB can do as they have done for these historic brand acquisitions, RB shareholders will be fortunate in holding a company with another market-leading global brand under their ownership. Mead Johnson is, however, an acquisition on a different scale altogether to these historic ones. Nonetheless, their incredibly focused portfolio of brands should allow integration to be smooth and expansion of opportunities to be rapid.
Of course, this deal is not without risks. Naturally the acquisition will require a high level of debt to be taken on. Yet as becomes apparent, RB’s incredibly strong balance sheet going into the deal as well as strikingly high levels of FCF should see it be able to pay down debt levels quickly whilst also satisfying shareholders through continued dividend payments. Indeed, its debt levels (and FCF to Debt ratios) even after the acquisition closes remain remarkably robust compared to their peers despite this hefty acquisition. There are few companies which you can say that about.
For me, RB’s move for Mead Johnson is very attractive for a long-term investor. Short term, I expect the market headwinds facing Mead Johnson’s business will continue. Yet for the patient, the long-term growth potential of the baby nutrition category remains compelling. Mead Johnson’s leading brand profile, in particular, leaves it in a very strong position indeed to take advantage of this secular category growth.
I’d argue that despite the additional risk an acquisition of this size poses, the acquisition story is one worth investing in. RB’s established portfolio of brands continue to be solid performers with high levels of FCF generation. Mead Johnson’s brands will add to this increasingly as the acquisition matures. With the acquisition also not overstretching RB’s financial capabilities, RB’s share price still looks attractive as it sets about extracting additional value from its newest powerbrand as it has done with its others.
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