July 4, 2017

Nestle Can Ignore All Dan Loebs Ideas Bar One

by Breakingviews

Nestlé can turn a deaf ear to Dan Loeb’s ideas – except one. While most of the demands the Third Point activist put to the Swiss giant’s board last month wouldn’t obviously juice up the share price, Loeb’s call for old-fashioned margin improvement holds more promise.

Loeb thinks Nestlé’s shares ought to be higher than the current level of around 84 Swiss francs. One option, he contends, would be for the company run by Ulf Mark Schneider to increase its net debt to two times EBITDA, adding 21 billion Swiss francs ($22 billion) for share buybacks. While shareholders might like receiving cash, the only genuine value creation would be from the tax perk of higher interest payments. Assume Néstlé borrows at a 3.2 percent rate and pays 35 percent tax, and the savings would have a present value of 2.4 billion Swiss francs, according to a Breakingviews calculation: just 0.8 Swiss francs per share.

Then there’s Néstlé’s 23 percent stake in L’Oreal worth 26 billion Swiss francs ($27 billion) at current market prices. Loeb wants it cashed in or divested in an exchange offer for Néstlé shares. L’Oreal has created a glossy total shareholder return of 113 percent in five years, but selling the block at a premium would be tough with the Bettencourt family still the biggest shareholder. So it’s not obvious that selling would benefit Nestlé’s share price.

As for Loeb’s call for a portfolio clean-up, that’s sensible, but Nestlé’s share price is already pretty full. A sum-of-the-parts analysis by Berenberg bank values the group just below 83 Swiss francs per share. Say Nestlé was to sell its entire, slow-growing confectionery business for 15 times forecast EBITDA, compared to the 12 times that Berenberg factors into its analysis. A sale on that multiple adds just 4.9 billion Swiss francs to the company, or 1.6 Swiss francs to the share price.

Where Loeb hits home is in calling for better profitability. A 20 percent operating margin target would be just over 3 percentage points more than what analysts see Nestlé achieving in 2020, according to Eikon estimates. Hitting it – by closing superfluous plants, for example – would generate an additional 3.4 billion Swiss francs of operating profit. On Nestlé’s 2020 enterprise-value-to-operating profit multiple of 15.7, that adds 17 Swiss francs to the share price – making it the one piece of Loeb’s advice that’s well worth listening to.

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