How to Survive on Just $18 Million a Year

(Bloomberg Gadfly) -- Reckitt Benckiser Group Plc has listened to shareholder concerns about pay -- up to a point.

Kapoor pay cut

43 percent

CEO Rakesh Kapoor's total remuneration for 2016 has been cut by 43 percent after a scandal over toxic goods in South Korea. But it was still a hefty 14.6 million pounds ($18.2 million). 

The maker of Cillit Bang and Durex, which has form for paying top whack to its CEOs, has also given ground on concerns about whether Kapoor's performance-related rewards will be unfairly boosted by his $16.6 billion purchase of Mead Johnson Nutrition Co.

Plus it seems to be putting less store on long-term performance plans, as Kapoor's award will be halved for the next two years.

The important measure for Reckitt's long-term incentive scheme is earnings per share. The Mead deal is expected to increase EPS from the first year, potentially making it easier for Kapoor and other top executives to hit targets.

Reckitt's answer is to exclude Mead's contribution from the calculations of EPS growth this year, when determining variable pay. The remuneration committee will also have the discretion to cut awards if Mead Johnson's results are "materially" worse than forecast.

Mead's EPS will be re-included when pay for 2018 is determined, but there will be a like-for-like comparison to 2017, again including the Mead contribution. This means there won't be a point when the acquisition provides a sudden bump to EPS, at least as far as long-term pay awards are concerned. 

While this is clearly better than a straight EPS performance measure, with no takeover adjustments, it doesn't go far enough.

The purchase of Mead will lift Reckitt's debt to about four times Ebitda. Although the company generates lots of cash, and will pay this down quite quickly, that's a high starting point.

The lack of overlap with Reckitt's other businesses also means predicted savings are relatively low given the deal size: just 200 million pounds annually after three years. As a result, it will take as long as five years for the returns to cover the threshold 7-8 percent cost of capital.

So using return on invested capital to measure Kapoor's success, alongside EPS, is prudent. Reckitt says it will do this, but it will be up to the board's "discretion" to decide whether ROIC is disappointing or not. Surely it would be better just to set a target.

Using total shareholder returns, relative to Reckitt's rivals, would be another positive approach. As long as the peer group was chosen sensibly, it should help determine whether the Mead deal benefits shareholders, and also strip out any advantages Kapoor might get just from broader shifts in investor sentiment towards consumer goods.

So far, Reckitt's total shareholder return has been industry-leading: performing better than both the FTSE 100 Index and the Stoxx 600 Europe Consumer Goods Index over the past five years by some distance.

If Mead performs as billed, and Reckitt's returns continue to outpace rivals, then Kapoor would have nothing to fear. If not, there would be an automatic mechanism to adjust his pay, without having to rely on the discretion of board members. Whatever happens, the household goods boss will probably clean up.

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: James Boxell at jboxell@bloomberg.net.