PARIS (Reuters) - L'Oreal (OREP.PA) shares climbed 5 percent on Monday on speculation the French cosmetics group might buy some of Nestle's NESN.VX 30 percent stake in the company, in a move that would boost its earnings per share.
Bloomberg reported on Friday that Swiss food group Nestle was looking at ways to reduce its L'Oreal stake, which is currently worth more than 23 billion euros ($31 billion). Nestle and L'Oreal declined to comment on the report.
"We believe that the most likely outcome is that L'Oreal purchases the stake from Nestle via a conventional share buyback," said Exane BNP Paribas analysts. They added that Nestle's own acquisition intentions could be "somewhat more material" than the bolt-on deals it has said it is open to.
Analysts estimated buying back Nestle's stake could boost L'Oreal's earnings per share by as much as 20 percent but would not materially alter Nestle's earnings.
Other options for Nestle's exit include selling the shares to the Bettencourt family, the largest shareholder in L'Oreal with 30.9 percent, selling on the public market, or selling to a third party.
Nestle is under pressure to make its intentions clear towards L'Oreal, its partner of 40 years, when a key plank of the shareholder pact that binds them ends in April, investors have told Reuters.
The Bloomberg report came out just a few days before Nestle's annual results on Thursday, when management will likely be grilled on its intentions. Some analysts say Nestle may try to hold out until its annual shareholders' meeting in mid-April to clarify its position.
L'Oreal is due to report results on Monday afternoon.
L'Oreal Chief Executive Jean-Paul Agon said last year the French group had the financial firepower to buy back Nestle's stake - ending years of silence on the issue. However, such a deal could take years to complete as companies are limited in the amount of share capital they can cancel every two years.
"Given Nestlé's decision to embrace a more rigorous approach to capital discipline it seems logical to us that Nestlé will take seriously what is likely, in our view, to be its biggest capital allocation decision of the next decade," RBC Capital markets said.
"We see little benefit to Nestlé's shareholders' in Nestlé retaining its stake in L'Oréal ... individual shareholders can buy L'Oréal shares themselves if they feel it's a good investment."
Nestle, which owns brands such as Kit Kat chocolate bars, Gerber baby food and Alpo pet food, owns 29.5 percent of L'Oreal, the world's biggest cosmetics group, worth about 78 billion euros in total following Monday's rise.
The Swiss group has been a major shareholder in L'Oreal since 1974, when L'Oreal heiress Liliane Bettencourt, now the world's richest woman, entrusted nearly half her stake to Nestle for fear it would be nationalized if Socialists came to power.
According to a shareholder pact agreed in 2004, Nestle cannot increase its stake until six months after Bettencourt dies. Bettencourt and Nestle also promised not to sell their stakes without first offering it to the other until April 29, 2014, 40 years after the initial deal was signed.
Nestle Chairman Peter Brabeck, who has a remit to review the future of the stake, said in August he wanted to keep all options open. Nestle, which had 3.9 billion Swiss francs ($4.4 billion) in cash on its balance sheet as of end-June, does not need to raise funds.
The Swiss firm is trying to reduce its reliance on processed foods and develop higher-margin products with a focus on "nutrition, health and wellness" and is seeking to maximize its use of capital and dispose of non-core, under-performing assets.
In December, Nestle sold its 10 percent stake in Givaudan GIVN.VX, raising expectations that a sale of L'Oreal shares could follow. It also recently struck deals to sell its PowerBar, Jennie Craig and U.S. frozen pasta businesses, and is reviewing a possible sale of its frozen food unit Davigel, sources have told Reuters.
Shares in Sanofi (SASY.PA) also rose on Monday as investors bet that any move by L'Oreal to buy its shares from Nestle would prompt it to sell its 9 percent stake in Sanofi, worth $12 billion, to finance the deal.
Sanofi Chief Executive told Reuters in a recent interview the French drugmaker could be a buyer of the stake, calling such a deal potentially "very accretive" to earnings.
L'Oreal shares were up 4.13 percent at 128.6 euros by 1605 GMT, while Sanofi shares were up 1.8 percent. Nestle shares were up 0.5 percent.
($1=0.8982 Swiss francs)
Additional reporting by Martinne Geller and Anjuli Davies in London, and Astrid Wendlandt and Pascale Denis in Paris; Editing by David Evans and Mark Potter