Nestle SA (NESN) is figuring out whether L’Oreal SA (OR) is worth it.
Ahead of April’s expiry of restrictions on selling its 29.4 percent stake in the French cosmetics maker, Nestle has said it is keeping all options open. That brings in the possibility of raising the holding, according to Natixis analyst Pierre Tegner, a scenario not envisaged by most analysts and investors.
For Nestle, increasing its stake in Paris-based L’Oreal would create “the indisputable worldwide leader in consumer staples,” Tegner said, and “would be a good way of leveraging this very profitable investment.”
It would also enable Nestle to look beyond food and beverages, where sales growth has slowed over the past year, making the company’s long-term goals a push for 2013. L’Oreal last month reported an estimate-beating 7.7 percent increase in first-half earnings on stronger sales in emerging markets.
While in the short-term the Nespresso maker probably won’t increase the stake, “if their growth has slowed, and the push into new areas does not work, then something like L’Oreal looks better,” said Martin Schulz, head of international equities at PNC Capital Advisors and a Nestle investor since 1997.
Most analysts say Vevey, Switzerland-based Nestle is more likely to sell and exit about 22.4 billion euros ($29.5 billion) richer or simply maintain the position since the holding today generates about a 10th of its net income. Nestle bought a stake in L’Oreal in 1974 from the Bettencourt family, the billionaire heirs of the cosmetics maker’s founder.
L’Oreal shares fell 0.8 percent to 124.80 euros at the close of trading in Paris today. Nestle dropped 0.7 percent to 60.90 francs in Zurich.
The question of whether to stick, twist or fold on L’Oreal has taxed Nestle since 2000, when Chairman Peter Brabeck-Letmathe was chief executive officer and proposed a stronger push into cosmetics. The board deemed that too ambitious and Brabeck decided instead to focus on nutrition and health, according to the company’s official history.
The restrictions on Nestle’s stake -- imposed by a shareholder agreement with the Bettencourt family -- have gradually been expiring. Nestle can already sell its shares, though it has to offer them first to the family, which owns 30.6 percent of L’Oreal. That preemption right expires April 29, along with a provision forbidding alliances with third parties.
Still in effect will be an agreement barring Nestle from acquiring more L’Oreal shares until six months after the death of the daughter of L’Oreal founder Eugene Schueller and family matriarch, Liliane Bettencourt, who turns 91 in October. A court in 2011 put Bettencourt under the care of her family, ruling she was no longer mentally fit to manage her affairs.
Nestle’s first-half organic sales growth was its worst in four years, hurt by price reductions in Europe and decelerating expansion in emerging markets. The slowdown has made achieving 5 percent growth in 2013 a “stretch,” Chief Financial Officer Wan Ling Martello said on an Aug. 8 conference call.
A deeper push into personal care would follow a path blazed by peers Procter & Gamble Co. (PG:US) and Unilever (UNA), which are benefiting from faster growth in shampoos, deodorants and skin creams and have sold billions in food assets over the past decade.
The global personal-care industry will grow 16 percent over the next five years, versus 12 percent for packaged food, according to data tracker Euromonitor. Boosting its stake in L’Oreal could provide Nestle “an entree to a range of new products,” Marcia Mogelonsky, an analyst in New York for market researcher Mintel, said in an interview.
Buying the family out now would cost 22.5 billion euros and require lifting Nestle’s pledge not to buy more shares until after Bettencourt dies. The shareholder agreement isn’t “etched in tablets of stone,” according to Exane BNP Paribas analysts Jeff Stent and Eamonn Ferry.
A buyout, though, may alienate shareholders as it “would be against the wishes of virtually every investor that I speak to,” said Andrew Wood, an analyst at Sanford C. Bernstein.
A gradual sale of Nestle’s stake is more likely, the Exane analysts said. The Bettencourt family remains committed to L’Oreal and has no plans to sell its stake, the family said in a statement Aug. 21. L’Oreal Chairman and CEO Jean-Paul Agon has said he doesn’t see any synergies with Nestle.
Nestle has said it may sell underperforming units, though it hasn’t disclosed which brands. Analysts say candidates for divestment include PowerBar snacks, Jenny Craig diet centers and some North American bottled water brands.
Nestle has little experience in beauty products besides two joint ventures in skincare with the French cosmetics company, which operates in 130 countries. In 2009, Brabeck said it “could make sense to have L’Oreal as a strategic investment” rather than simply holding the stock.
France could also seek to block a foreign takeover of a “national champion,” according to Exane. French lawmakers voiced opposition to a potential buyout of Paris-based Danone (BN) in 2005 following reports that PepsiCo Inc. (PEP:US) was readying a bid.
“If yogurt is a strategically important industry in France, we would suggest that L’Oreal Paris is akin to an extension of the tourist board,” Stent and Ferry wrote. “The only real choice for Nestle is one of either maintenance of the status quo or a sale of the stake.”
Upon selling its stake, Nestle could use the cash on a big food acquisition, said Martin Deboo, an analyst at Investec Securities. “Why would Nestle want to enter personal care and battle Unilever and P&G? I struggle with the idea.”
Brabeck, 68, who stepped down as CEO in 2008 when Nestle agreed to sell a majority stake in contact-lens maker Alcon Inc. to Novartis AG for about $39 billion, could entrench his legacy at the company by settling the L’Oreal issue.
“Nestle moves slowly,” said Pablo Zuanic, an analyst at Liberum Capital. “But presumably Peter wants to tidy things up before he steps down.”
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