If Reckitt Benckiser Buys Mead Johnson then is a Home Care Spinoff Next?

Reckitt Benckiser Group (RB) is currently in “advanced” talks to buy Mead Johnson Nutrition Co for USD16.7 billion, in a deal that makes little market overlap sense on the surface but could hint at future strategic plans. Reckitt Benckiser’s existing brands currently centre on home care, consumer health and beauty and personal care, and have little to do with baby milk formula, dairy or even packaged food to a larger extent.

As such, Reckitt Benckiser is moving in the opposite direction of most other FMCG companies, by pursuing even further diversification rather than specialization on existing core brands and categories. The “modern era” for RB started with the acquisition of Boots OTC business in 2006, bringing brands such as Strepsils and Clearasil under RB’s umbrella. Since then, RB has been making a steady strategic push into Consumer Health through a number of M&As.

If Mead Johnson’s acquisition goes through, it could become a catalyst for Reckitt Benckiser to spin off its home care brands, some of which it has owned for more than 100 years, and build a more "fit" oriented business focusing on potentially more lucrative consumer health and hygiene businesses.

Mead Johnson’s acquisition rumours in circulation since 2015

The acquisition of Mead Johnson doesn’t come entirely as a surprise and Euromonitor has written about potential acquirers previously. Mead Johnson’s focus is nearly exclusively on milk formula where it is the second largest player globally, behind Nestlé and marginally ahead of Danone Group. Despite the global presence, it relies strongly on just three countries: USA, China, and Hong Kong; which together accounted for nearly 70% of Mead Johnson’s retail value sales in 2016*.

In the milk formula world, all eyes are set on China, as it is by far the largest milk formula market globally, and accounted for the majority of global growth over 2011-2016. With the passage of recent legislations in China, however, pricing pressures and margins are likely to be approaching mature industry levels. In turn, this could be the main reason why Mead Johnson is looking for a strategic buyer and why its stock price has declined recently.

Global milk formula growth, US$ mn, 2011-2016, after removing currency effects

Reckitt’s proposed offer of US$90 a share represents an approximate 30% premium to Mead’s closing price on Wednesday 1 February. However this could be seen as a discount since MeadJohnson was trading at US$90 regularly as recently as July 2016, in part propelled by acquisition rumours. Any acquisition attempt less than a half a year ago, and especially in early 2015, would have commanded a significantly higher premium. While Reckitt Benkiser is buying Mead Johnson at somewhat of a discount, it has to take over any risks coming from the uncertainty about China’s milk formula future.

Mead Johnson’s stock performance since IPO in Feb 2009

Source: Yahoo! Finance

Note: Interestingly, Mead Johnson’s IPO was in 2009 in the midst of the global financial crisis, when it was spun off from US pharmaceutical giant Bristol-Myers Squibb.

A new Reckitt - Benckiser in the making?

What is most interesting about this acquisition is that Reckitt Benckiser is making the bid and not Nestlé or Danone. It is by far the largest acquisition for Reckitt Benckiser since the merger of Reckitt& Colman and Benckiser NV in 1999, with the potential to reshape the company. Reckitt had market capitalization of US$60 billion on Feb 1. It is also an acquisition that makes little sense on the surface.

Reckitt Benckiser is already very diversified and lacks a strong consumer side “identify” in the same way that Danone or Procter & Gamble do. It is currently present across multiple consumer packaged goods industries with seemingly little relation to each other. Its brands range from Durex to Scholl to Dettol cleaners and Finish dishwasher tablets, to over the counter medications such as Strepsils and Nurofen, to Schiff vitamins and dietary supplements. And now baby milk formula is added to the mix.

The trend of recent years in FMCG has largely been the opposite. For example, Procter & Gamble has been selling brands in an effort to increase focus on its core business, selling a number beauty brands to Coty, Pringles snacks to Kellogg, and the Iams pet food business to Mars.

One speculation is that a Mead Johnson acquisition could open the doors for RB to spin off its existing Home Care and Packaged Foods brands (Reckitt is only present with the French’s mustard and Frank’s Chili sauce brands in foods). This could offer the company a chance to build a new consumer identify focused on consumer health & hygiene.

Such a move would not be entirely unusual or unprecedented, and would follow in the footsteps of the 2012 Kraft-Mondelez split, where Kraft and it’s slower growing US grocery business was split from Mondelez’s more dynamic international snacks operations.

There is no secret Reckitt has been been making a steady push into consumer health starting with the acquisition of the heavily bidded Boot’s OTC business in 2006, and then continuing with the SSL International (Durex and Scholl) and Shiff Nutrition (MegaRed krill oil and other brands). In 2013, Reckitt also purchased the rights to sell a number of OTC medications in Latin America from Bristol-Myers Squibb (previous owner of Mead Johnson). Milk formula/nutrition, being intrinsically closer to consumer health than packaged foods, could be seen as a continuation of this strategy. Which then asks a question whether the shift to health/nutrition takes place with or without home care.

Reckitt Benckiser’s split competitive landscape with health/nutrition and home care/foods players

Source: Euromonitor International (Competitor Analytics)

Note: Procter & Gamble is present in both.

Should we expect a counterbid?

Reckitt Benckiser still has to close the agreement, and until then counterbids are possible. In theory, the best fit for Mead Johnson acquisition would be Nestlé or Danone, both of which are focused on packaged food and growing their early life nutrition businesses specifically, and both were the centre of earlier acquisition rumours before Reckitt Benkiser's bid.

Nestlé is the world’s leader in milk formula with 21% retail value share and milk formula is very important for Nestlé strategically. However, Nestle would have serious regulatory headaches with such an acquisition. It would have to divest a number of markets – including Philippines, Thailand and many markets in Latin America. Some key markets such as the US are extremely close calls too - Nestlé had a 14% retail value share and Mead Johnson had a 36% share in the US in 2016, putting any acquisition at the mercy of regulators. Given so many potential anti-competition hurdles, acquiring Mead Johnson would not make much sense for Nestlé, except perhaps for the sake of denying it to other companies.

Nestle would need to divest many Mead Johnson markets

Source: Passport (Competitor Analytics)

Note: Numbers refer to market share, retail value terms. Highlighted squares refer to markets which are the most likely to require spin-off. This is defined as change of 800 points in Herfindahl–Hirschman (HHI) Index which is a broadly accepted measure of industry concentration. The 800 benchmark is already a rather loose assumption, and many regulatory authorities may consider change of 300 as significant.

Danone could be the most realistic candidate in theory. Because both companies’ strengths lie in different geographic regions - Danone is strong in Europe, but lacks presence in Americas, which is where Mead Johnson is strongest– there would be much less regulatory headwinds. However, Danone only recently acquired Whitewave Foods for US$12.5 billion in a strategic move to enter a milk alternatives sector that had been eroding the company’s sales. Hence, Danone is not likely to be in the market for an acquisition of this scale just yet.

Danone would have less regulatory issues because it plays in different geographies

Source: Euromonitor International (Competitor Analytics)

The above two reasons likely explain why Mead Johnson didn’t sell out in 2016, when rumours circulated and why it’s selling now for what could be viewed as discounted price. In terms of other potential bidders:

• Abbott Laboratories could be another contender for Mead Johnson as it has a fairly similarly sized milk formula business. However, a purchase would see the same regulatory issues as those for Nestle. Abbott currently has the number-1 retail value share in the US, and Mead Johnson is number-two.
• Pharmaceuticals companies like Pfizer could potentially have the financial resources for an acquisition, but given that several pharmaceutical companies have already spun off many nutritional businesses (best illustrated by Mead Johnson’s own example), or Pfizer which sold their baby food to Nestle in 2012, a sudden reversal in this trend seems rather unlikely.
• A “surprise” contender could be a Chinese company like Inner Mongolia Yili Industrial Group Co Ltd or Bright Food Group. Chinese companies had a record year for M&A outside of China in 2016 and can be looking to bring “quality food” to Chinese consumers.

Different futures for Reckitt-Benkiser

There is little doubt that Reckitt Benckiser’s recent acquisitions indicate a strategic push into Consumer Healthcare. Since loosing out to Bayer AG for the acquisition of Merck’s consumer health business in 2014, Reckitt Benckiser has been actively looking for another large acquisition. Now that it has found one, the main question remains whether it will start a bigger transformation into a more typical “fit” oriented company with a clear consumer health identity. Alternatively, it may opt to keep its diverse portfolio, and continue to own many distinct brands – similar to Unilever Group or Orkla Group.

The spin-off of its historic home care and packaged food brands, like Calgon or Finish, will be sure to receive bidders including Unilever and Henkel. One more alternative could be to form a joint venture where RB could retain the majority stake and strategic control, such as Nestle’s R&R Ice Cream joint venture that separated ice cream from its core business without entirely relinquishing control.

Keeping its home care and packaged food brands is also not out of question. It’s worth noting that Procter & Gamble, despite its many spin-offs to streamline its business, still owns a number of OTC brands– from Align probiotics, to Prilosec heart burn remedies and Vicks for cough, cold and allergy. In turn, Reckitt Benckiser may also choose to keep its varied business together, especially provided how central brands such as Dettoll are to RB’s history. Yet, if recent history is any guide, ReckittBenkiser sold it’s equally historic Colman’s food business to Unilever Group in 1995.

• Note: retail value sales figures refer to industries covered in Passport only. Sales outside of these industries are not considered. Retail value sales figures show the final price paid by consumers for company’s products and include consumer taxes such as VAT, retail markups, and other markups. As such, these figures are different from published company sales figures (i.e. net revenues) and should not be compared on like for like basis.