Nestle should resist the temptation to acquire L'Oreal, says report

By Guy Montague-Jones

- Last updated on GMT

Related tags: L'oréal, Liliane bettencourt

Nestle can’t, shouldn’t and probably won’t mount a takeover bid for L’Oreal, according to a new report from Bernstein Research.

In 2004 Nestle acquired a 26.4 per cent stake in L’Oreal, which has since risen to almost 30 per cent, but despite relentless questioning management has been vague about its long term plans. However, in 2007 chairman Peter Brabeck said that 2009 would be a very important year for the L’Oreal relationship.

So should we expect a move from the Swiss giant in the coming year? Rumours have pointed to the partial sale of US eye care company Alcon last year as evidence that Nestle is freeing up cash in preparation for a takeover bid.

Options available to Nestle

But under the terms of the L’Oreal agreement, Nestle cannot acquire any more shares in the cosmetics company until after the death Liliane Bettencourt, who is the principle shareholder and daughter of founder Eugene Schueller.

In a report on the future of the L’Oreal stake, Bernstein Research said the agreement can easily be torn up and rewritten but that Nestle would be well advised to keep the scissors and ink in the drawer.

The report said the agreement also grants Nestle the right to sell its shares from April this year and that some investors will interpret a failure to do so as a clear sign that the food group intends to acquire the company. Bernstein Research does not ascribe to this view.

Senior analyst and report author Andrew Wood said Nestle has little reason to sell come April because the company does not need the cash and is happy with the L’Oreal investment so far.

Reasons not to acquire L'Oreal

Equally, Wood claims that acquiring the remaining shares in L’Oreal would be bad for business and destructive to shareholder value.

While L'Oreal is a market leader backed by strong brands, the analyst believes the cosmetics company would be a bad buy because it will not enhance the operating performance of Nestle.

Bernstein Research marked out the cosmetics company as a troubled business in need of repair. As reported yesterday in, Bernstein Research has published a sister report claiming that L’Oreal has been mismanaged in recent years.

The report accuses the L’Oreal management of focusing too hard on earnings growth in recent years and letting investment in research and marketing slip to the detriment of sales growth.

Wood said: “Nestle has been delivering ‘best ever’ results, while L’Oreal has been breaking ‘worst ever’ records.”

To acquire L’Oreal could therefore be a drag on sales and margin growth, according to Bernstein Research.

Organic sales growth at Nestle has surpassed L’Oreal’s in 3 out of the 4 last years and while margins are wider at L’Oreal, the research firm expects these to fall over the next year.

Wood said Nestle’s margins could exceed those of L’Oreal by 2010 because of the impact of ill-advised merger and acquisition activity and the need to invest in advertising and promotion in order to reinvigorate the top line.

The report listed several other reasons unrelated to operating performance that should sway Nestle away from the temptation to bid for the remainder of L’Oreal.

There is very little overlap between Nestle and L’Oreal and management at the food company knows very little about personal care. There are opportunities on the boundary between food and cosmetics but these may be exploited through joint ventures.

Acquiring L’Oreal would lumber Nestle with massive additional debt and confirm and exacerbate its reputation for being wanton with investors’ money. Bernstein Research concludes that for all these reasons Nestle shouldn’t and probably won’t put in a bid for L’Oreal.

Related topics: Business & Financial

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