Unilever's $68 billion toothpaste tilt needs another squeeze

GlaxoSmithKline Plc is right to snub Unilever Plc's 50 billion-pound ($68 billion) proposal to buy the UK drugmaker's consumer healthcare arm. Unilever's offer may be in the ballpark, but the consumer-goods giant can justify stretching further — and could easily be forced to.

The asset is a unique business with scale and strong brands, including Panadol painkillers and Sensodyne toothpaste. Glaxo's current plan is to spin it off this year, leaving the company to focus on discovering new medicines. The separation will not provide a clean break: Glaxo will be left to sell chunks of the business in the stock market over time. An outright sale at a decent price would surely be better, both for Glaxo and for partner Pfizer Inc., which owns a minority stake.

For Unilever — currently a mix of food and personal-care businesses — the acquisition would mark a shift to faster-growing healthcare categories. Its core skills are marketing and global distribution, so it ought to be able to sell branded, over-the-counter medicines better than a science-led pharma company. Developing some of the Glaxo brands in emerging markets is the obvious opportunity.

And bulking up the personal care side of Unilever would make that business even more viable as a candidate to be hived off as an independent company.

Glaxo's rejection of Unilever's proposal on the grounds of price is, nevertheless, justified. The mooted offer is equivalent to 18 times the unit's expected earnings before interest, tax, depreciation and amortisation for 2022. That may be a slight premium to where Glaxo consumer-health might trade if listed. Procter & Gamble Co. currently commands the same valuation, but the US firm is on a real tear right now.

UK consumer-healthcare rival Reckitt Benckiser Group Plc trades at only 15.2 times, but the lower valuation reflects that firm's recent challenges. Colgate-Palmolive Co. is in the middle, at 16.7 times. Assume something similar for Glaxo's consumer healthcare and it would be worth roughly 45 billion pounds. Glaxo on Saturday issued upbeat sales growth guidance for the business, helping support the idea that a high-teens multiple is appropriate.

So Unilever's approach is no knockout. Its real attraction is that it gives Glaxo a substantial exit, instead of via a series of piecemeal share sales at unpredictable prices, each of which would involve taking a discount.

File photo of Unilever headquarters in Rotterdam. Photo: Reuters

But ultimately the crunch comparison here is not going to be with hypothetical stock-market valuations later this year but what other buyers might pay now. A counter bid from P&G, or from a private-equity consortium on its own or in partnership with, say, Reckitt, is plausible. 

As things stand, Unilever is already stretching. The debt capacity of the combination wouldn't be enough to fund an all-cash bid. Unilever would need to make disposals and still have to use some of its own stock. On Monday, it said it would seek to sell off lower-growth businesses to fund the transaction and was committed to keeping a single-A credit rating. Exceeding current levels of leverage would be only temporary, it added.

The company has held talks with banks about how to finance a potential higher offer, Bloomberg News revealed on Sunday. It could justify a sweetener. The savings in consumer deals can be up to 10 percent of the acquired company's sales. Here, that would imply a boost of around 1 billion pounds to Glaxo consumer healthcare operating profits of 2.7 billion pounds in 2025 (as forecast by analysts at UBS Group AG). After tax, that points to returns of nearly 6 percent after three years on the current offer price. Not stellar, but probably good enough in such a time frame. Juicing the offer would push the payback out a few more years — potentially a wait worth enduring for such a deal.

Unilever Chief Executive Officer Alan Jope must weigh the damage of missing this transaction and letting a rival get it. His overture to Glaxo can be seen as a recognition that his current strategy isn't delivering fast enough — indeed, he's going to set out a "major" performance-improvement plan later this month. The cost of paying a bit more may be less than the cost of missing the opportunity forever. 

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.