By Aude Lagorce
Of MarketWatch
LONDON--European food giants have been sitting pretty for a
while, but the need to bulk up to drive savings means a pickup in
merger and acquisition activity is now firmly on the agenda.
Throughout the recent economic downturn, Swiss food behemoth
Nestle SA (NESN.VX) and French yogurt champion Danone SA (BN.FR)
adopted the same mantra: small is beautiful. At every shareholder
meeting they reassured investors they would only consider targeted
acquisitions and steer clear of mega deals.
But the rules of the game are changing: competition is
intensifying as players fight for market share. The price increases
of earlier in the decade are out of the question as long as demand
remains subdued. Yet cost savings must be achieved if a collapse in
margins is to be avoided. These elements combined indicate the big
players may turn out to be less disciplined than their official
line would suggest.
"The need to do something relatively larger is growing," said
Rahul Sharma, director in the consumer practice of specialist
investment fund Martin Currie.
"What these companies want most is assets with strong brands in
Asia or other emerging markets. But because of current competition
and because it's impossible to get pricing, they may eventually
need to do something in mature markets just to get cost savings,"
he said.
The good news is that financing such deals should not be an
issue.
Citigroup analysts point out that the balance sheets of food
giants are under-utilized, as there has been no large-scale deals
in Europe since Danone's purchase of Dutch rival Numico in
2007.
"The consumer environment remains tough and interest rates are
low, and together with the ability to take on large amounts of
debt, these represent almost ideal conditions for M&A
activity," the broker said in a note to clients.
The risk, in such a scenario, is that companies might make
indiscriminate purchases.
"Finding the right acquisition target is as important these days
as finding the financing," said Ildiko Szalai, a food analyst at
research firm Euromonitor.
In a heavily fragmented food sector, there is no dearth of
targets, but many European firms would make for tricky purchases
because of complex shareholding structures.
Still, there are a handful of attractive independent players.
One of the most notable is Swiss luxury chocolate maker Lindt &
Sprungli (LISN.EB), an appetizing prospect for Nestle in the wake
of U.S.-based Kraft Foods Inc.'s (KFT) purchase of British
confectioner Cadbury at the start of the year.
Bank of America Merrill Lynch estimates a tie-up with Lindt--
which has a market capitalization of $5.5 billion--would give
Nestle a 12% global share in confectionary compared to 15% for
Kraft-Cadbury.
And chocolate is a safe haven in uncertain economic times.
"Premium chocolate is a growth market and it fits the
impulse-purchase category. It may not match Nestle's recent refocus
on healthy categories, but since they recently bought Kraft's
frozen pizza business, anything is possible," Sharma said.
Bank of America analysts agreed, highlighting that although
Nestle has recently said it wants to grow the chocolate category in
emerging markets, "the opportunity to purchase Lindt may prove too
tempting in the end."
The cash is certainly not a problem. Nestle in January
replenished its war chest with the $28 billion sale of its stake in
eye-care group Alcon Inc. (ACL).
Another asset that could change hands in coming months is
private-equity owned United Biscuits. The world's fourth-largest
biscuit group, home to the McVities brand, is also a sizeable
manufacturer of sweets and snacks. Its weakness? It derives nearly
85% of sales from Western Europe, making it only marginally
attractive to firms looking for emerging-market growth.
"United Biscuits will help its buyer add scale. But it wouldn't
add a lot of geographical value. If Campbell Soup (CPB) bought
United Biscuits, the deal would give them scale, but they'd still
end up with a business heavily reliant on developed markets," said
Euromonitor's Szalai.
Biscuits and chocolate certainly make for appetite-wetting
targets, but there is a flurry of attractive firms in healthier
segments.
One of them, Yakult Honsha Co. (2267.TO), a pioneer in
pro-biotic yogurts, would make a good match for Danone, which
already has a 20% stake in the group and three seats on the board,
several analysts said. Listed in Tokyo, Yakult has a market
capitalization of roughly $5 billion and generated sales of $3
billion in fiscal 2010.
"In the food segment, and dairy in particular, companies that
bring you functional expertise are very much in favor. I could
definitely see something happen there," said Sharma, who mentioned
Ireland's Kerry Group (KRZ.DB) and the U.K.'s Tate & Lyle
(TATE.LN) as other firms with such competencies.
And for those looking to spice things up a bit, there's always
H.J. Heinz Co. (HNZ). The ketchup specialist has very strong brand
recognition, including in emerging markets, a sought-after
quality.
But Sharma cautioned that Heinz is struggling to expand rapidly
into new markets.
"As a standalone company they are faced with the fact that it's
extremely costly for them to roll out their products into new
markets where they want to be, in Asia for instance," he said.
For a bigger firm like Nestle, the geographical expansion would
come at a minimum cost considering the sales force and distribution
network already in place in the region.
"All Nestle has to decide is how much of a premium the Heinz
brand warrants in comparison to local players," Sharma said.
Of course, there is always the possibility of a mega deal, such
as a move on General Mills Inc. (GIS) from Nestle. The two firms
already participate in a 50-50 joint venture, Cereal Partners
Worldwide.
While a deal would increase Nestle's sales in the food service
arena and give it the U.S. license to the fast-growing Yoplait
fresh dairy brand, it would also dilute its growth and increase its
exposure to the American market at a time when growth there is hard
to generate, Citigroup cautioned.
By Aude Lagorce, 415-439-6400; AskNewswires@dowjones.com
