Nestle is ripe for activists looking for next Mondelez: Real M&A

[LONDON] Nestle could be the next food company to draw interest from an activist investor after Bill Ackman targeted Mondelez International.

Food and beverage companies have been popular targets for activist shareholders because of their bloated expenses and lackluster growth. Just this week, Mr Ackman disclosed a stake in Mondelez, spurring speculation that he would seek cost cuts and potentially a sale. ConAgra Foods and Boulder Brands have also recently faced calls for shakeups.

So far, activist investors have mainly targeted US food companies, but Nestle's underperformance could draw them to Europe. The US$240 billion Swiss maker of Lean Cuisine frozen meals and KitKat bars will probably miss its long-term average sales growth target for the third time. After rising 0.6 per cent Monday in Zurich trading, its stock is up only about one per cent this year. That trails the almost six per cent gain in the Swiss Market Index and the 17 per cent advance for the Stoxx Europe 600 Index.

Nestle reports first-half results on Thursday.

"What an activist could finally do is look into all of the issues which are currently prevailing," Alain-Sebastian Oberhuber, a Zurich-based analyst at MainFirst Bank. "It seems at the moment that they have red flags in several places." Nestle is grappling with waning demand for its biscuits and peanut-milk beverages in China and a recall in India of its popular Maggi instant noodles. Its stagnant frozen-food business isn't helping things. Shedding that division, along with the company's 23.2 per cent stake in cosmetics maker L'Oreal, would allow management to focus on the emerging-market challenges and its faster-growing brands.

Nestle could add 21 billion euros (S$31.9 billion) of cash flow through 2018 by gradually reducing its stake in L'Oreal, said Jeff Stent, an analyst at Exane BNP Paribas. The company could use that money to boost its share buyback or to make acquisitions. Nestle already sold 8 per cent of its L'Oreal holding in 2014 in what many analysts speculated was just the first step.

Another division that an activist investor could push Nestle to sell is its skin-health business. Nestle acquired full control of the Galderma wrinkle treatment and acne medication business from joint-venture partner L'Oreal just last year, but skincare doesn't have a lot to do with food and beverages. Nestle in 2010 sold its stake in eye-care company Alcon to Novartis for US$28.3 billion.

"Then a couple of years later, they go into more or less pharma again - which is difficult to understand," Mr Oberhuber of MainFirst said. "When I talk to investors, a lot of them have question marks regarding Galderma." Nestle's European domicile and large market value may prove little defense against an activist investor.

Even Apple, the world's biggest company with a market value of almost US$660 billion, became a target for Carl Icahn. While European firms haven't seen as much activism as their US counterparts, investors who specialize in strategy shakeups now have more than US$130 billion in assets under management that they need to put to work, said Chris Young of Credit Suisse Group AG.

Most of the "low-hanging fruit" has been plucked in the US, so European companies may gain the attention of such investors, said Mr Young, head of contested situations in the mergers and acquisitions department in New York.

Other possible targets include British distiller Diageo or Dove soap maker Unilever, whose growth has been pressured over the past few years as emerging markets have cooled.

Nestle wouldn't be cheap. An activist investor would need to have at least a one per cent stake to effect change, said Urs Beck, a fund manager at EFG Asset Management. That would cost more than US$2 billion.

And there may not be much to gain, even if a shareholder succeeds in persuading Nestle to sell businesses.

Parting with the frozen meals unit and L'Oreal stake are two things that Nestle "should be considering," said David Ragan, a fund manager at Mawer Investment Management, which oversees more than US$30 billion of assets including shares of Nestle. "They're not exactly adding value there." But "I can't see a significant upside," Mr Ragan said. "There are a lot of other worse-run companies." Even so, Nestle may need the extra push to make changes quickly. Jenny Craig and PowerBar are two examples of businesses that the company acquired, held onto for too long and got less-than-desirable prices for in later divestitures.

"The Nestle strategy is always long term," Mr Oberhuber of MainFirst said. "They look at it and try to turn it around but it usually takes a couple of years. An activist would clearly help a lot." The political environment gives activist investors another reason to give Nestle a shot. Switzerland, home of the Nespresso maker, has instituted a "fat-cat" referendum that gives shareholders more say over salaries and the ability to eject an entire board.

Nestle chairman Peter Brabeck-Letmathe has said such measures threaten the company's long-term strategy. A new proposal that would allow investors to sue management and directors, even amid opposition by most shareholders, is also flawed, he has said.

"Activist shareholders and plaintiffs' lawyers would be granted free reign," he told this year's annual meeting.

Activist investors are probably coming for European food companies anyway.

"There is appetite for European companies in the sector from US investors," said Daniel Kerstein of Barclays, who helps advise companies on strategies to deal with activists. "A lot of consumer companies are struggling with portfolios that combine growth and non-growth businesses. Activists are arguing that some such businesses don't fit together."

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