A Unilever Breakup Would Be Expensive But Worth It

(Bloomberg Opinion) -- Unilever Plc wants to buy and sell assets to create a faster-growing consumer-products business. But this strategy of bulking up before slimming down won't serve shareholders well.

With activist Nelson Peltz building a stake in Unilever through his hedge fund Trian Fund Management LP, the prospect of breaking up the giant has come into sharp relief. That's because its businesses might be worth more separately than combined.

Adding up the values of Unilever's distinct consumer arm and food businesses generates an enterprise value of about 175 billion euros ($198 billion), and that's a conservative estimate. Compare that with Unilever's actual current enterprise value of 142 billion euros, according to Bloomberg data.

A breakup would also better serve the units' different value propositions. The food business, for example, is growing more slowly, but generates a lot of cash. Assuming that can be used to pay dividends, it would appeal to investors looking for income. Meanwhile, shareholders who prefer faster growth but a lower payout could choose to stick with personal care instead.

The snag is the costs that might come with a breakup, such as one-off transaction fees and possibly a tax charge. The separated businesses would also not be able to carve up the existing operating expenses between them. Altogether, these could be worth up to 10 billion euros in today's money, according to analysts at Jefferies.

The beauty and personal-care business would lose 20 billion euros of revenue from the foods and refreshments side. But its costs would not fall in proportion to the amount of sales lost. For example, it would largely retain the sales teams that deal with supermarkets, and the trucks that transport Pond's face cream and Pot Noodle.

Successful businesses such as Magnum ice cream would no longer contribute financial support for central functions, such as the legal department and investor relations. Units such as Dove body wash and Domestos would have to cover food's share too. That's sure to take a big bite out of earnings.

This dilemma became clear after Unilever's bid to buy GlaxoSmithKline Plc's consumer-health arm for 50 billion pounds ($68 billion). The company said the major acquisition would help speed up the disposal of its less attractive brands by enabling “separation disynergies to be offset by acquisition synergies.” That's a bit of a mouthful, but in essence it means: We have to solve this knotty problem of a cost base that's too big for its sales.

But a breakup still has to be considered. Not only would it undo the conglomerate discount on the shares, it would also create business benefits that could justify the expense of a split.

Focus is a big one. Despite having household names such as Ben & Jerry's ice cream and Hellmann's mayonnaise, Unilever's food business fares poorly relative to toiletries, cosmetics and cleaning products. With the GSK consumer-health bid, Unilever has made clear its future is in these types of goods. That's not such great news for the managers of the food business. After all they still have to secure resources and recruit the best people.

If food were spun off, it would be more in control of its own destiny. With fewer distractions, management stands a good chance of achieving better performance. There may be more career progression for employees at a more focused company.

Meanwhile, each of the businesses — consumer and and food — could make acquisitions to grow back into their elevated cost base over time. 

If Chief Executive Officer Alan Jope can achieve a split, he may win the backing of investors, something that was lacking when it came to buying GSK consumer health. And if Unilever were able to sell food rather than demerge it, he could have up to about 50 billion euros of cash to spend to fund purchases or share buybacks.

Buying the GSK consumer-health business and then offloading food would have made Unilever a forced seller in rejigging its portfolio. Doing things the other way round — slimming down before buying — rids it of that problem by putting Unilever in control of the timing.

It's worth considering what's happened at rival Nestle SA. CEO Mark Schneider has sold off businesses with sales of about 13 billion Swiss francs ($14 billion), including its skin-health division, while making acquisitions bringing in about 6 billion Swiss francs worth of revenue, such as Starbucks in-home coffee range, according to Jefferies estimates. Yet rather than fret about the inefficiency of shedding sales, the market has rewarded him. Just one of the big brokers rates the shares “underperform.”

Schneider was emboldened by the Dan Loeb's Third Point taking a stake five years ago. That helped him shake up Nestle's cozy collection of businesses. Now that Unilever has an activist on the books, Jope should do the same.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.

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