Mondelez, Kellogg, et al – let the food deal frenzy begin

Packaged-food investors, you’re out of luck … for now.
Speculation about 3G Capital’s next target has been bubbling since the private equity firm orchestrated the merger of Kraft Foods Group Inc. and H.J. Heinz in 2015. We finally know what it’s chosen: Unilever on Friday confirmed Kraft Heinz Co. had offered $143 billion to acquire the European consumer goods giant. It’s an unusual choice: Unilever makes some grocery-store staples like Lipton tea that jibe with Kraft Heinz’s products, but the bulk of its revenue comes from home and personal-care offerings.
Investors were caught off guard (even though Gadfly’s Tara Lachapelle tried to warn them). Shares of Mondelez International Inc., General Mills Inc., Kellogg Co. and Campbell Soup Co. fell on Friday, adding to declines they sustained on Thursday amid reports that 3G was looking beyond packaged food for its next target.
The buyout firm’s typical playbook has been to target companies with weak margins and then slash costs like crazy to boost profitability. But even a cost-cutter extraordinaire like 3G needs to eventually find revenue growth. Sale gains at Unilever’s personal-care business slowed in the most recent quarter, but that industry is certainly growing faster than the staid cereal and sandwich-spreads markets.
The bid may fail. Unilever has rejected Kraft Heinz’s offer and at least one analyst is bashing the idea, calling it a “sloppy” combination with questionable logic. There may also be antitrust pushback. But it’s hard to see 3G going back to hunting for slow-growth food brands after this. It clearly has its eyes on a different sort of prize. That should be a wake-up call for packaged-food investors who may have been hoping for salvation via 3G and Warren Buffett, the firm’s dealmaking billionaire sidekick.
Would-be 3G targets Kellogg, Mondelez, Campbell Soup and General Mills have all implemented some form of zero-based budgeting — one of the buyout firm’s favorite tools whereby every expense has to be justified each year — as well as other productivity self-help efforts such as shedding lower-margin and non-core assets. Kellogg is targeting an operating margin of nearly 18 percent by 2018, while Mondelez is aiming to cut $3 billion in costs. Campbell upsized its cost-savings target to $450 million by fiscal 2020, while General Mills says its on track to drive down expenses by $880 million with its margin-management and efficiency plans.
In some ways, that may have made the companies less attractive to 3G because there’s less fat to trim, but it hasn’t done much to help their stock prices. What they need — like Kraft Heinz — is growth, and their efforts there are falling flat. Campbell bet big on fresher, healthier and organic foods with the acquisitions of Plum Organics, Garden Fresh and Bolthouse Farms, for which it paid $1.55 billion in 2012. But it’s not easy for companies with histories in canned goods to veer into fresher foods, and Campbell said on Friday that its C-Fresh division won’t grow this fiscal year. Also on Friday, General Mills, another company whose healthier-foods acquisitions haven’t really done the trick, had to cut its 2017 forecasts because of challenges in the yogurt and soup evironment.
These companies might be better off trying to mimic the 3G model: merge with other packaged goods companies in order to cut costs even further. Should their own growth efforts fail, don’t be surprised if more activists start showing up, seeking to shake up management teams or lean on packaged-goods companies to change their strategies.
With Nelson Peltz’s Trian Fund Management LP and Bill Ackman’s Pershing Square Capital Management LP already on its shareholder roster, Oreo-maker Mondelez may feel the pressure more than others. More clarity on the structure of Hershey Co.’s controlling trust could empower Mondelez to revive deal talks. A combination of General Mills and Nestle SA is another oft-speculated transaction that might finally have a catalyst, especially if Nestle’s European counterpart Unilever gets acquired. Campbell and Kellogg, both of which have large family or trust owners, could maintain that dynamic by combining with each other.
Whatever the iterations wind up being, more food deals are — and should be — coming.
—Bloomberg