LONDON (Reuters Breakingviews) - Close shaves sometimes leave scars. Unilever boss Paul Polman can keep his M&A defence powder dry following Kraft Heinz's decision on Feb. 19 to walk away from its spurned bid. But the shock to the system will have an effect on the Anglo-Dutch food and household goods company.
Unilever shareholders may emphatically agree with their management's rejection of a deal that would probably have seen top line growth sacrificed to lift the group's 15 percent operating margin towards Kraft's 23 percent. But the U.S. giant's offer would have allowed them to exchange a company worth around $42 a share on Feb. 16 for cash and shares worth $50 a share. The onus is therefore now on Unilever to outline a plan to get there under its own steam.
Polman had recognised the problem, and unveiled a cost-cutting programme last year. At the optimistic end of its own assumptions, Unilever might be able to boost its margin by 80 basis points a year. Imagine it can do so until end-2019, and also manages top line growth at the upper 5 percent end of its expectations. Put the resulting $11 billion of 2019 operating profit on Unilever's 2019 operating profit multiple of 13, strip out net debt, and Unilever's shares might be worth around $44 each - roughly where they are now trading.
That's below Kraft's initial offer, and itself relies on bullish assumptions. Meanwhile, big deals between consumer packaged goods companies have seen synergies worth 10 percent of sales in the past, according to Kepler Cheuvreux analysts. Tax and capitalise the $5.8 billion of savings this would imply and Kraft could theoretically have forked out $58 a share - implying double the 18 percent premium it had offered.
Faced with these kinds of figures, Polman would either have to dramatically grow the group's top line, or try a version of what Kraft owner 3G might have attempted. Cutting costs further and boosting the operating margin to 20 percent could push the share price to well over $50.
Given how hard this looks to achieve, Unilever's backup plan could be to tell shareholders what it told Kraft: too many cuts would impede top line growth. The shares' current valuation implies they would hear him out. But they probably also want Polman to use Kraft's approach as a spur for more self-help.