Mergers on the Verge

No one’s big enough. That’s the lesson to take away from the shocking decision by Gillette to give up and surrender to Procter & Gamble for $57 billion. For the longest time, large consumer-product companies like Gillette or General Mills or Hershey’s have insisted that their independence is the key to their long-term success. They have shunned merger discussions simply because they believe they will make you more money by growing their own businesses than by surrendering to another, consolidating company in the packaged-goods industry.

Until now. Gillette, perhaps the most fiercely independent company in the sector, the one that went to incredible lengths to stop repeated bids in the previous millennium, initiated the talks to be acquired by P&G because the dominant company in razors and batteries didn’t think it had the scale to compete worldwide. Despite its fantastic market share and unassailable brand, Gillette recognized that it could not generate consistent long-term growth in a global economy where China and India now mean more to the future than the United States and Europe. And, without publicly admitting it for fear of retribution, the people at both Gillette and P&G like the idea of presenting a united front of 21 brands, each worth a billion in sales to its worldwide master, Wal-Mart, especially when the Bentonville colossus so often pits them against each other, and a host of other soft-goods companies, when negotiating prices.

Most deals get hailed as transformational by the lackey business press, but they’re usually just the opposite. They’re about one failed company giving up, deciding that the growth is gone and the prospects bleak. Not this one. Gillette’s a winner; a huge success ever since Jim Kilts reenergized the company when he took it over four years ago. It didn’t need to be bought anytime soon; it was headed for another year of record earnings.

Managements are faced with a simple question: If Gillette can’t go it alone, who the heck are we to think we can?

That’s why this merger actually will make a difference to other name-brand entities. There are a half-dozen companies in the same situation as Gillette, dominating their businesses and currently making good money, but lacking the scale to compete globally down the road. Their managements are now faced with a simple truth: If Gillette can’t go it alone, who the heck are we to think that we can?

We should soon see some remarkable deals involving companies that would have thought merging equals defeat and failure, but now present a quick profit opportunity from a takeover. I’ve put together a list of classic brands, none of which I would ever have thought would be considered takeover candidates until Gillette gave them the cover to be bought.

Kimberly-Clark, a proud $31 billion equity synonymous with tissues and toilet paper, always seemed too big to be acquired, and never had a desire to combine. It’s difficult for me to see, though, after P&G-Gillette, how it could say no to a Unilever if it were to come calling. At Gillette-like valuations, you’d get $74 per share from Unilever, a 14 percent premium over the current price. I don’t like to recommend stocks just on a takeover basis because, typically, if there’s no deal, you lose money. But Kimberly’s on the upswing regardless: In the quarter just reported, it showed terrific high-single-digit growth. Why Unilever? It’s been suffering from a severe aisle smackdown from P&G, and it needs both the heft and the management from Kimberly—which is top-of-the-line—to reclaim critical shelf space.

Kraft’s another company that never figured it needed anyone else to be great. Through generous line extensions and takeovers in the baked-goods and cereal aisles, Kraft’s got tons of supermarket mindshare, and it generates a decent, if not spectacular, return for parent Altria (né Philip Morris). Before P&G-Gillette, Kraft managers figured they were safe from an acquirer and couldn’t do much better combined with anyone else anyway. Now another once-high-flying packaged-goods company needs to buy Kraft just to maintain its own standing as a growth company, a standing that has been tarnished by four years of underperformance: Coca-Cola. That’s right, the $100 billion behemoth has been losing fizz for four years. It will take a transforming deal like a buy of Kraft to get back to generating the growth that the market expects of a company that lately feels like a helpless soda jerk. Think a KO-Kraft combo is far-fetched? Anyone who listened to the now-historic P&G-Gillette conference call heard longtime Gillette shareholder Warren Buffett praise both companies for recognizing the need to combine to compete in a business world gone global. Coke’s had a string of failed chieftains; if this new fellow, Neville Isdell, doesn’t break the tailspin, it’s safe to assume that the problem isn’t management, it’s the stalled business itself. A Kraft-Coke combo looks as made-to-order as the Pepsi buy of Quaker Oats, a deal that everyone now regards as shrewd.

If Coke can’t swing Kraft, Sara Lee or Heinz would also make a huge amount of sense: A Gillette-based valuation takes Heinz to $45 and Sara Lee to $34 (they were at $38 and $24, respectively, late last week). But unlike Kraft and Kimberly-Clark, neither SLE nor HNZ has the fundamentals going for it. They do, though, have viable dividends north of 3 percent, more than you can get from cash, so you’d get paid to wait until something develops. Sara Lee makes the most sense given its recent disappointing earnings report.There are other candidates in the consumer-products sector: Down-and-out Revlon would get you almost a double if a Gillette-style bid surfaced, and Avon would give you a 16 percent return at a Gillette valuation. But neither company’s CEO seems inclined to want to give up the job—Revlon’s Jack Stahl’s relatively new, and Avon’s Andrea Jung seems to be the CEO-for-life type. But, again, the P&G-Gillette deal makes them attractive enough to buy as specs. It wouldn’t shock me to see $100 billion Nestlé put a move on General Mills—“only” an $18 billion company. They’ve been partners in cereals worldwide, and it wouldn’t take much to make that union formal.

Then there’s Colgate. For six years, Colgate’s been stuck at about $55 as it’s battled both P&G and Gillette for supremacy in the health-and-beauty arena. The P&G-Gillette merger seems like a textbook pincer move against Reuben Mark’s beleaguered toothpaste-and-soap company. Of all the companies in the sector, it has the fewest options—too small to go it alone, and too expensive on an earnings basis to be acquired. No wonder its stock declined two bucks on the P&G-Gillette news. Colgate’s stock would have to fall 10 percent just to get to the valuation that Procter paid for Gillette. The most likely scenario: Colgate, too, goes on the acquisition hunt to spend the currency it has before it loses it, along with the shelf space it will most likely have to cede to a more-powerful-than-ever P&G.

Oh, and don’t forget Goldman Sachs and Lehman Brothers. Both stand to make so much money from all this M&A activity that they could end up being even bigger winners than the targets themselves. Given their mastery of the global takeover environment, Goldman under $110 and Lehman under $100 make huge sense. Who knows? In a world where brands matter more than ever, they too could succumb to the merger mania that 2005 seems to promise. Citigroup, are you listening?

James J. Cramer is co-founder of He often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions he takes may change at any time.

Mergers on the Verge