April 19, 2018 / 11:57 AM / 10 months ago

Breakingviews - P&G drug deal needs vitamin shot to persuade Peltz

Procter & Gamble's Oral-B toothbrush heads are seen in a store in Manhattan, New York, U.S., August 1, 2016

LONDON (Reuters Breakingviews) - Buying stuff is not the standard prescription for companies under pressure from activist investors. Procter & Gamble’s 3.4 billion euro splurge on Merck KGaA’s consumer unit, the maker of Seven Seas vitamin pills, will need a booster shot to earn the support of newly appointed board member Nelson Peltz.

Parting with its portfolio of self-declared “lovebrands” is a good move for the German group, which is unconnected to the U.S. pharmaceutical giant of the same name. Merck makes most of its revenue selling prescription medicines and crystals used in smartphones or televisions. That makes it an illogical owner for over-the-counter drugs like pregnancy supplement Femibion. The sector is consolidating, and may come under pressure as consumers switch to online suppliers such as Amazon.

Given those challenges, Merck has secured a good price. The deal values the business at 3.7 times last year’s sales, higher than the 3.3 times that Nestlé paid for vitamin maker Atrium in December.

The appeal for P&G is less clear. Admittedly it is buying a relatively robust business which has seen revenue grow by 6 percent annually over the past two years. That sounds appealing given the sluggish 1 percent sales growth P&G reported in its healthcare division in the quarter ending March. The new owner should also be able to boost margins. The Merck business generated operating profit of 140 million euros last year, equivalent to a margin of just over 15 percent.

Assume P&G can ramp up the unit’s sales growth to 8 percent a year, and slice 10 percent off its cost base, boosting the operating margin to 25 percent. After five years, the business would bring in roughly 244 million euros after tax. The return on invested capital would just scrape over 7 percent, in line with P&G’s cost of capital.

Those are quite bold assumptions. And P&G might struggle to integrate the business. Peltz argued last year that the Cincinnati-based company should do more deals, but criticised its integration of past acquisitions. True, the latest purchase is relatively small for the $197 billion group. But P&G will have to work hard for it to pass the Peltz test.


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