BREAKINGVIEWS-Unilever finds elegant M&A recipe for dud food

By Neil Unmack

LONDON, March 31 (Reuters Breakingviews) - A spoonful of Hellmann's mayonnaise, a dash of Cholula hot sauce and a Knorr stock cube. It doesn't sound like much, but Unilever ULVR.L has concocted a passable M&A recipe from some questionable ingredients. The $122 billion Dove soap maker is hiving off its nutrition unit and merging it with U.S. rival McCormick MKC.N, creating a $66 billion food and flavourings giant. There's a lot for Unilever investors to digest, but it's a more palatable deal than the alternatives.

The London-based group, run by Fernando Fernández, has been cutting calories for years. It sold spreads brands like Flora almost a decade ago, and recently spun off Magnum Ice Cream. Tuesday's deal concerns remaining products like Hellmann's, Knorr, Marmite and Maille Dijon mustard. The relevant unit typically grows more slowly than Unilever's core beauty and wellbeing products, helping to drag down the group's valuation to around 12 times this year’s EBITDA – a near 20% discount to health and consumer goods peers like Colgate Palmolive CL.N and Procter & Gamble PG.N.

Simply selling would be tricky. Unilever would likely owe tax on capital gains of decades-old assets, while giving up any future upside from a combination. A straight listing, meanwhile, would come without deal goodies like cost savings.

Enter the Reverse Morris Trust. Using this structure, Unilever will spin off the foods unit and merge it into French's mustard maker McCormick at a $44.8 billion enterprise value, while creating $600 million of annual net cost savings in the process. The UK group itself will own 10% of the combined group, while its investors get 55%, leaving McCormick's shareholders with just over a third. The new entity will also lever itself up to pay Unilever $15.7 billion in cash.

The deal values both McCormick and the Unilever food business at 13.8 times 2025 EBITDA, which the companies reckon matches the U.S. firm's trading multiple. In that case, the British group and its shareholders get a majority stake in a combined entity, plus cost savings, without having to pay a material deal premium. And the implied multiple for Unilever's food business is close to the wider group's rating – not bad since the unit in question is one of its worst.

The merging parties also reckon that extra scale will help boost annual growth to at least 3%, versus around 2% currently for the two sides, using a blended average. And Unilever will hope that its racier remaining businesses, like Tresemme shampoo, should attract a higher valuation now that the company is rid of slow-growing assets.

Shareholders aren't seeing that, for now. Unilever's London-listed shares fell over 7% on Tuesday, erasing $9 billion of equity value. That more than offsets the net present value of Unilever’s share of the synergies, which are worth perhaps $3 billion to the UK side. Investors may dislike the fact this is not a clean break: Unilever shareholders will own stock in a U.S.-listed food group with net debt equivalent to around 4 times EBITDA. A costly, risky integration beckons. Still, the real question is whether Unilever's other options would have been better. The answer is probably no.

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CONTEXT NEWS

Unilever on March 31 announced a spinoff and combination of its food business with U.S. group McCormick, in a deal that values the division of the UK-listed company at $44.8 billion including debt.

The so-called Reverse Morris Trust structure, designed to minimise taxes, will see Unilever separate its food unit and effectively sell it to McCormick in a cash-and-stock structure.

Unilever and its shareholders will receive equity worth $29.1 billion, using McCormick's one-month volume-weighted average price, equating to a 65% holding in the combined group. Unilever will also receive a cash payment of $15.7 billion.

The deal values both McCormick and the Unilever foods business at 13.8 times 2025 EBITDA. The combination will initially generate some $600 million in net cost savings, according to the statement.

Goldman Sachs and Morgan Stanley advised Unilever, while Citigroup and Rothschild advised McCormick.

Unilever shares were down 7.2% as of 1451 GMT on March 31, while McCormick's shares were down 4%.