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Analysis: Fate of $23 billion L'Oreal stake points to future of Nestle

A Nestle logo is pictured on a factory in Orbe April 20, 2012. REUTERS/Joao Vieria
A Nestle logo is pictured on a factory in Orbe April 20, 2012. REUTERS/Joao Vieria

By Astrid Wendlandt and Silke Koltrowitz

PARIS/ZURICH (Reuters) - Marriage, divorce or continued cohabitation? Nestle, the world's biggest food company, is under pressure to make its intentions clear towards L'Oreal, its partner of 40 years, when the ties that bind them loosen next year.

The decision is the preserve of long-serving Chairman Peter Brabeck, who is trying to reposition Nestle away from reliance on processed foods toward higher-margin products with a "nutrition, health and wellness" profile.

One can argue that L'Oreal's cosmetics and shampoos are compatible with that mission, but eight of the nine analysts that spoke to Reuters thought Nestle was likely to sell down its holdings in L'Oreal, once restrictions on doing so end in April.

They think the company can sell the stake, worth 23 billion euros ($30 billion), in tranches and use the cash on something central to its own business or return the cash to shareholders.

"If investors want to invest in L'Oreal, they can invest directly in L'Oreal," said a consumer industry banker who spoke on condition of anonymity. "They don't need Nestle for that."

The Swiss food group has been a major shareholder in the French cosmetics firm 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.

It turned out to be a great investment for Nestle, as L'Oreal shares have yielded a total return of 15 percent on an annualized basis since then. Nestle's own shares yielded 11.6 percent.

Nestle owns 29.5 percent and Bettencourt owns 30.5 percent of L'Oreal, the firm her father founded as a maker of hair dye. The heiress is now 90 and under the guardianship of family members since a court fight ended with a 2011 ruling that she was incapable of looking after her fortune.

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 stake without first offering it to the other until April 29, 2014, 40 years after the initial deal was signed.

The Bettencourts have said they had no plans to sell.

Last month, Brabeck said Nestle did not plan to renew its right of first refusal with the Bettencourts, arguing that the lock-up depresses the value of the stake.

He said Nestle wanted to keep options open, which include maintaining the status quo.

That prompted speculation that the maker of Nescafe coffee, KitKat chocolate bars and Purina dog food might be preparing to part company from the world's biggest beauty firm, which makes Lancome skin cream, Garnier shampoo and Maybelline mascara.

"The comment makes us think that Nestle has no intentions to increase its stake in L'Oreal, and we now believe that the scenario of Nestle selling its stake in or after April 2014 is more probable," Liberum Capital analysts said in a note.

L'Oreal was quick to say it would be able to buy back the stake from Nestle, thanks to a net cash position of 572 million euros that frees it to raise debt, and a 9 percent stake in drugmaker Sanofi worth 9 billion euros.

The speculation has contributed to a nearly 2 percent decline over the last eight days in shares of L'Oreal, the third most valuable company in France, while slightly pressuring those of Sanofi, the second biggest.

"It would be very surprising if Nestle remained nebulous about their plans," one fund manager said. "It is their responsibility to state out clearly what they plan to do."

Nestle might prefer to keep the market guessing, but L'Oreal will want a decision soon, because keeping cash in place to buy the stake curbs its firepower for other big deals.

Last month, L'Oreal offered to buy Chinese facial mask maker Magic Holding International for HK$6.54 billion ($840 million).

Formerly best-in-class Nestle, which is grappling with disappointing results for the first time in years, will be grilled on the issue at an investor seminar at its Vevey headquarters on September 30 and October 1.

Were Nestle to decide to sell out, L'Oreal could buy back its shares and cancel them, a move that analysts gauge would lift earnings per share for remaining shareholders by around 20 percent.

Depending on how a deal were structured, if Nestle returns proceeds to shareholders from selling its L'Oreal stake it could potentially increase its own earnings per share by more than 10 percent, and lift its underperforming shares.

In the year to date, Nestle shares have risen 3.4 percent, while L'Oreal shares are up 20 percent, and the Stoxx European personal and household goods index is up 11.6 percent.

Nestle declined to comment beyond pointing to a statement on its website that says the board is addressing the future of the stake "with great attention in the framework of the group's global nutrition, health and wellness strategy".

Former chairman and CEO Helmut Maucher, who is still honorary chairman, stated in 1992 that Nestle eventually wanted to buy L'Oreal, souring relations with Liliane Bettencourt that were only patched up with the shareholder pact in 2004.

Although a merger to create a giant food and cosmetics conglomerate could be seen to fit Brabeck's "health and wellness" strategy, no Nestle executive has expressed any interest in a takeover in recent years, and the companies share little operationally apart from two dermatology joint ventures.

Any attempt would likely face resistance from the French government, hostile to foreign takeover attempts in the past.

Nestle, which started as Europe's first condensed milk factory 147 years ago before growing into a global food and beverages giant, selling everything from baby formula to bottled water, has been independently pursuing its health ambitions by developing foods that help prevent chronic diseases.

Brabeck, 68, will be keen to cement his legacy by giving more clarity on Nestle's strategy before he retires in 2016.

"He will want to have defined a clear line for his 'nutrition, health and wellness' concept, and the future of the L'Oreal stake ultimately depends on that," said Friedhelm Schwarz, author of books on Brabeck and Nestle.

A member of the L'Oreal board since 1997, Brabeck stepped down as CEO in 2008 after a decade in the job but stayed on as chairman with a remit to review Nestle's stakes in L'Oreal and eye care firm Alcon, which the firm sold later that year.

Nestle has no urgent need to sell its L'Oreal stake, which contributes roughly 10 percent of its earnings per share. It does not need the cash; it had 3.9 billion Swiss francs ($4.1 billion) as of end-June and generates earnings before interest, depreciation and amortization of around 18 billion francs.

Nestle is also still integrating its $11.9 billion acquisition of Pfizer's baby food business, which it funded with the Alcon proceeds.

JP Morgan Cazenove says one scenario could be that L'Oreal buys the Nestle stake in three tranches over four years, which it estimates would lift L'Oreal's 2018 earnings by 23 percent.

It would be difficult for L'Oreal to buy more than 10 percent a year as companies are limited in the amount of share capital they can cancel every two years.

Unlike Nestle, L'Oreal is outperforming its peers, having successfully revamped and repositioned many of its big brands such as Vichy creams and Garnier shampoo, with sales growth of 5-6 percent in a market growing at 3.5-4.0 percent.

L'Oreal declined to comment for this report.

(Additional reporting by Emma Thomasson in Berlin, Martinne Geller and Francesco Canepa in London and Pascale Denis and Alexandre Boksenbaum-Granier in Paris; Editing by Peter Graff and Will Waterman)

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