This $17 Billion Dilemma Will Make or Break Reckitt's CEO

(Bloomberg Gadfly) -- 2018 is the year for Rakesh Kapoor to show he's worth it.

Because 2017 has been patchy for the CEO of Reckitt Benckiser Group Plc. At one point he could claim he'd more than doubled the company's value since his arrival in 2011. But sales stumbles mean shares have had their worst year since then. Along the way, his outsize pay has been brought to heel.

So his decisions next year -- primarily whether to bid for Pfizer Inc.'s consumer health arm -- will have far-reaching consequences for both the company and his own position.

His $18 billion swoop on infant nutrition business Mead Johnson in February was a surprise not just because its mother and baby products lay outside Reckitt's core business. It was also a pivot from a strategy of hunting for the consumer arms of the big pharmaceutical groups. The challenges from this deal could make or break him.

To start, it may swell net debt to almost 3.5 times Ebitda by the end of 2017, according to Bloomberg consensus forecasts, above the level at which investors start to get nervous. As Gadfly's Chris Hughes noted, the deal also landed Kapoor with a dilemma: whether to bid too for the Pfizer business with a mooted price tag of more than $17 billion.

Reckitt's not the only big consumer group worrying about sales. Its response has been to shift from slower-growing homecare goods into fatter-margin consumer health products, helped by a dose of cost-cutting. There's only so much Cillit Bang cleaner consumers can buy, while ageing populations and wellbeing-obsessed millennials mean healthcare has the potential to keep performing. 

Buying Pfizer's consumer division would accelerate this shift -- for instance, Advil would take Reckitt into U.S. analgesics. But without offsetting disposals, net debt would balloon to between 4 and 5 times Ebitda.

Still, Reckitt has a remedy at hand. The question is whether it will take it. 

Mead Johnson not only stretched the balance sheet but management bandwidth. Reckitt's answer was to split the company into its health brands, such as Nurofen painkillers, and hygiene and home goods, such as Finish dishwasher tablets. The latter could be an attractive target for private equity or trade buyers on the hunt for cash-generative brands. It could have an enterprise value of about $20 billion, according to Jefferies analyst Martin Deboo. That would more than cover the value of the Pfizer arm even if the auction becomes fevered.

Nevertheless, a purchase would present other problems. Before now, Reckitt has absorbed acquisitions pretty well. But digesting two big businesses in quick succession is a lot for even the best operators.

And Pfizer isn't the only route to solving Reckitt's growth problem. Some are less obvious, though Kapoor does have a habit of doing the unexpected. The paths less traveled include buying Merck KGA's consumer health arm, with a potential price tag of about $5 billion. Its sales are expanding faster than the broader market, and it would be more digestible.

But the unit's best known brand, Seven Seas, is well-established so there's less scope for Reckitt to work its magic.

Kapoor could keep his powder dry altogether too. He's a patient man -- playing bridge in his limited free time. Purchasing nothing would mean space for Mead Johnson's performance to improve, and synergies to kick in. What's more, dedicated management of the hygiene and home business should elevate the eventual sales multiple.

He may be holding out for disposals elsewhere. Reckitt might covet GlaxoSmithKline Plc's consumer arm, although there's no sign it is up for sale, and it would be expensive. Still, if anything were to happen here, it would probably be years away.

The trouble is, he may not have as much time as he'd like.

Reckitt's split, together with its equity underperformance, have opened up the possibility of a break-up, as Bernstein analysts led by Andrew Wood have noted. That's catnip to activist investors, for whom consumer giants are a favorite hunting ground.

Sum of the parts valuations range from 72 pounds per share at Jefferies to 92.80 pounds at Bernstein. The latter assumes that Reckitt first sells the hygiene and home division, and is then gobbled up by a big pharmaceutical group.

Either way, all are above the current share price. Unless Kapoor can lift growth and reassure investors that enviably high margins aren't at risk, the gap will only widen. Kapoor may be ready to play a long game. An activist may be less patient.

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

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

To contact the author of this story: Andrea Felsted in London at afelsted@bloomberg.net.

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.

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