CNBC: The Battle for the Soul of Capitalism Explained in One Hostile Takeover Bid
Published on March 24, 2017
Last month’s quickly aborted bid by Kraft Heinz (KHC) to take over Unilever brought into sharp relief the ongoing war between two different philosophies of capitalism. On one side Unilever CEO Paul Polman champions sustainable growth in earnings to raise long-term shareholder value. On the other side KHC and its Brazilian owner 3G advocate maximizing short-term earnings to increase near-term valuation.
Long-term investors’ perspective
CEOs of companies aiming for sustainable growth in shareholder value know they must achieve short-term results while they continue to invest in R&D, capital expenditures, global expansion, and people development to sustain their growth. During economic downturns, this can be a difficult balancing act, but nothing less is required.
These long-term value creators use compound growth in revenues, earnings per share, and return on capital invested as measures of longer-term performance. The great value creators of recent decades like Berkshire Hathaway, Johnson & Johnson, and Disney have mastered the ability to achieve these long-term metrics as well as their near-term goals, thereby sustaining growth in shareholder value.
But this doesn’t protect them from activist investors seeking immediate returns.
Traders seek immediate gains in stock values to demonstrate above market returns to their investors, with little regard to the long-term future of the companies.
In recent years, fund managers have shifted their focus to cash flow available for shareholder distribution, either through dividends or repurchase of shares, with growing pressure on companies to increase share buybacks. However, there is scant evidence that buybacks produce sustainable increases in shareholder value.
Corporate leaders are thus faced with ongoing tradeoffs between using their cash flow for internal expansion and acquisitions versus increasing dividends and buybacks
Latest battle: Anglo-Dutch Unilever versus Brazilian 3G
Last month’s proposed takeover of London-based Unilever by Brazilian private equity firm 3G provided a real-time example of how these conflicting objectives collide.
Unilever’s roots date to 1872 with the founding of Margarine Unie and 1885 founding of Lever Brothers. Their 1930 merger as Unilever created the first modern multi-national company with equal roots in Britain and the Netherlands. When Dutchman Paul Polman took the helm in early 2009, he declared bold goals to double Unilever’s size from 40 billion Euros to 80 billion by 2020, and generate 70 percent of revenues from emerging markets.
“The larger issue at stake here is not just the fate of a single company, but the fate of capitalism itself.”
Polman has transformed Unilever into a growth-oriented global competitor that has more deeply penetrated emerging markets than any other consumer products company. To date, Unilever has made significant progress toward Polman’s goals, with 2016 revenues of 53 billion Euros, including 57 percent from emerging markets. He takes justifiable pride that Unilever has increased its dividends 8 percent per annum for the past 36 years. Polman has used “sustainability” as the company’s unifying force, introducing the Unilever Sustainable Living Plan in 2010 with dozens of metrics to measure progress. For his advocacy of environmental sustainability, Polman received the UN’s “Champion of the Earth Award.”
Yet, some investors worry that Polman’s commitment of Unilever resources to sustainability is detracting from its financial performance.
Unilever’s track record attests to Polman’s success: in his eight years as CEO, Unilever’s revenues have grown 32 percent, averaging 3.8 percent the past four years, making it one of the top performers in consumer products. Its stock price is up 144 percent, with a total return to shareholders of 214 percent.
3G is the brainchild of Jorge Paulo Lemann, a former investment banker who built Brazil’s “Goldman Sachs.” 3G’s playbook is to buy moribund companies in need of shaking up, cut operating expenses 30-40 percent, including longer-term investments, replace the entire management team with hungry young Brazilian managers, and rapidly increase earnings and cash flow. With its aggressive, “take no prisoners” style, 3G uses the cash it generates to pay down debt and buy additional companies. 3G has successfully applied this formula to the retail, beer and fast food industries.
In 2013 3G saw the opportunity to shake up old-line food companies whose iconic products were out of favor with Millennials. It purchased Pittsburg-based Heinz with Warren Buffett’s Berkshire Hathaway as co-investor, and immediately applied its cost-cutting formula. Initial success led 3G to buy a failing Kraft Foods in 2015 and merge it with Heinz as Kraft Heinz (KHC).
Since then, revenues have fallen by 4-5 percent per year, raising questions about whether KHC can sustainably grow earnings without further investment or acquisitions. Most security analysts predicted 3G would tack on additional acquisitions, with food company targets like Mondelez, Campbell Soup or General Mills. Few suspected KHC would attempt to take over a top performer like Unilever, whose business is 60 percent personal care and home care.
KHC launched its attack by offering $50 per share, 18 percent above Unilever’s stock price. This was equivalent to its price last fall before it fell in sync with the weakening Euro, making KHC’s low-ball offer easy for Unilever’s board to reject. According to British press reports, KHC’s executives were taken aback by the ferocity of CEO Paul Polman’s rebuff, along with its cold reception from the British government.
“Those of us who believe capitalism is a great long-term value creator must care about the fate of great companies that are role models for the way capitalism should work.”
Consequently, KHC withdrew its offer just 50 hours after the takeover was launched. Many suspect that Buffett, who has always opposed hostile offers, told Lehman he wasn’t willing to fund a war between Unilever and 3G. Although the war ended as quickly as it began, it sent shock waves through Unilever’s organization and the British investing community.
. . . and Unilever responds
In response, Unilever’s leaders mobilized, recognizing KHC’s offer was “a shot across the bow,” and the battle is far from over. Immediately following KHC’s withdrawal, Polman met with his board and announced that Unilever will undergo a complete assessment by April of its product portfolio, cost structure and balance sheet in order to enhance near-term shareholder returns.
It is likely that Unilever will consider leveraging up its balance sheet and announcing stock buybacks rather than letting an aggressor buy the company using its own balance sheet. More cost reductions may be in order going forward if the softness in the consumer packaged goods market continues. Also on the docket is the analysis of Unilever’s vast product portfolio, which may trigger the sale of declining brands and categories, or even breaking the company in two by spinning off its foods business.
Reflections on this battle
Nevertheless, the question remains: why did 3G choose to attack 145-year old Unilever, a top performing company with aggressive leaders that are creating great value for shareholders as well as customers, employees and society at large through sustainability initiatives?
3G’s attack on Unilever raises important concerns about these competing models of capitalism. Those of us who believe capitalism is a great long-term value creator must care about the fate of great companies that are role models for the way capitalism should work.
Sustainable enterprises that prosper for many decades – General Electric, Procter & Gamble, IBM, Ford, and Exxon, just to name a few – have created enormous value for everyone involved, from employees to shareholders. If a top performer like Unilever can be attacked, then no company is safe from hostile takeover.
The larger issue at stake here is not just the fate of a single company, but the fate of capitalism itself. In a world increasingly concerned with disparities between the haves and have-nots, the voters that chose Brexit and elected President Trump are expressing deep feelings of powerlessness in a world dominated by wealthy elites. Unconstrained capitalism focusing strictly on short-term gains can cause great harm to employees, communities and the greater needs of society. In this case capitalism will face the wrath of democratic nations as their citizens demand significant constraints on all companies that limit their freedom to operate.
If this happens, we will all be worse off.
Commentary by Bill George, a senior fellow at Harvard Business, former Chairman & CEO of Medtronic, and the author of “Discover Your True North.” Follow him on Twitter @Bill_George.
This content was originally posted on CNBC.com on 3/24/17.