LONDON (Reuters Breakingviews) - The success or failure of Reckitt Benckiser's $17 billion deal will be decided in China. The cleaning products-to-condoms group is splashing out $90 a share in cash for baby formula-maker Mead Johnson. Cost savings only justify around half the $3.8 billion premium, though. Making up the balance depends largely on boosting sales in the People's Republic.
The $64 billion group unveiled its deal with Mead on Feb. 10, just over a week after confirming the two were in talks. It expects the tie-up to generate around $250 million of annual cost savings after three full years, mainly by merging the duo's back-offices and driving a harder bargain with suppliers.
Taxed at 25 percent, those savings are worth about $1.9 billion in today's money - half the value of the 30 percent premium that Reckitt is handing to Mead shareholders. Add the savings onto Mead's expected earnings for 2020, and the return on Reckitt's total investment is just over 5 percent - short of the 7 percent cost of capital typical for a large consumer goods group. The company run by Rakesh Kapoor says the purchase will exceed its cost of capital after five years. That will depend on boosting sales in the $46 billion global infant nutrition market.
On paper, prospects are bullish. Chinese children will be responsible for around half the global growth in milk formula sales in the next five years, according to Euromonitor. China's decision to relax its one-child policy and more women reaching for baby formula as they head out to work should bode well for Mead.
Yet it's also a hugely fragmented market, with around 2,000 baby food brands, many of whom are aggressively cutting prices. Food safety scandals have made middle-class buyers wary of buying domestically. A government crackdown on informal imports of baby formula via Hong Kong hurt Mead's sales in Asia in 2016.
The U.S. group is struggling to adapt as new regulations push sales online. Reckitt, which generates nearly a third of all its China revenue online, should help to get its target's e-commerce offering up to scratch. Reckitt's financial targets depend on it.