Here’s Why Procter & Gamble Should Not Break Up

Procter & Gamble’s (NYSE:PG) underwhelming performance in the last few quarters has prompted increasingly insistent calls for a breakup of the consumer processed goods behemoth. The proponents of a breakup claim that Procter & Gamble is “just too big” and has failed to demonstrate the benefits it claims to gain from its massive scale. ^[1] To the contrary, the gigantic size of the company has led to slow and bureaucratic decision-making, which is hurting the company’s growth. However, we believe that the time, costs and other resources required for breaking up a company of the size of P&G would be counter-productive. This is especially true since Procter & Gamble is currently going through a transformational phase, which we believe to be a step in the right direction. (Read: Can Procter & Gamble Return to Growth?)

On parallel timelines, breaking up P&G and completion of the ongoing restructuring would take roughly the same amount of time, that is, one to two years. But while the current restructuring is already underway, a break up would involve significant additional costs towards achieving the same goal – revival of growth. Therefore, we believe that a break up would be inadvisable for Procter & Gamble and it should continue with its present strategy.

In this report, we look into some of the key points mentioned by the advocates of a break up and why such a radical measure is still not justified.

Our price estimate of $76 for Procter & Gamble is nearly the same as its current market price.

See our complete analysis for Procter & Gamble here

A Question of Agility

The primary issue raised by those clamoring for a break up of P&G is that the company has become too big to run efficiently. It is losing ground to smaller, more agile competitors and has lost the entrepreneurial culture that fosters growth in innovation, revenue, and earnings. ^[2] Based on P&G’s performance over the last two years, these claims appear to be true. However, it is worth noting that P&G’s ongoing brand consolidation program is designed to address this very shortcoming.

The culling of 100 under-performing or non-core brands is a textbook case of the Pareto Principle. The divestment of these brands will result in a loss of just 14% of the company’s total revenues and 6% of its total pre-tax profits. In the process, P&G could potentially transform into a much leaner organization since the bureaucracy associated with 60% of its brands will be eliminated. ^[3]

Revival of Sluggish Growth Rate

Another cause of concern for not just the advocates of a break up, but all stakeholders is P&G’s flailing revenue growth rate. In the latest quarter, the company’s top line slumped by 12% year on year. For once the company could not hide behind currency headwinds also, since even revenues contracted by 1% year on year even in constant currency terms. (Read: A Deeper Look at P&G’s Q1 Results: Focus On The Bottom-Line Is Fine, But At What Cost?)

The need for a turnaround of top-line growth is a valid concern that needs to be addressed. By breaking up the company, proponents claim, the lack of innovation and entrepreneurship currently ailing the company could be reversed.

However, P&G’s brand consolidation program has shrewdly identified and retained the company’s best performing brands. These brands are concentrated across just 10 product categories. P&G is the leader in 7 of these 10 categories, and number two in the remaining three. ^[3] In other words, the ongoing restructuring is designed to free the company of all the deadweight that had been dragging down top-line expansion and profitability.

Granted, revenue growth is not guaranteed solely on the basis of market leadership. While a hefty market share does provide tangible benefits, consistent product innovation is necessary to maintain and grow that market share. P&G has already shown that it is taking steps to revive the culture of constant innovation. It stepped up its R&D investments over the last year and funneled a chunk of this year’s cost savings into R&D. (Read: Can Procter & Gamble Return to Growth?) While the success or failure of its new products cannot be ascertained in advance, these measures still address the concerns around the hitherto lack of innovation.

Value Accretion for Shareholders Remains the Paramount Priority

Even as Procter & Gamble struggled with sluggish volume growth further beleaguered by strong currency headwinds, protection and accretion of shareholder value has remained the management’s top priority. This is evident in the structuring of the $12.5 billion sale of P&G’s beauty brands. Despite a loss of 7% of its revenues due to the sale, the non-GAAP EPS is expected to remain unaffected due to retirement of shares and reduction in overhead costs. (Read: The $12.5 Billion Sale of Beauty Brands Could be the Herald of a New Era for P&G) Additionally, the company also plans to return a mammoth $70 billion to shareholders via dividends and share buybacks over the next four fiscal years. Notably, this will be accomplished without any impact on credit ratings by utilizing the cash realized from the Coty and Duracell transactions. This sufficiently demonstrates P&G’s capability to take care of its shareholders even amidst non-existent revenue growth and difficult macroeconomic environment.

Given this priority, it would be paradoxical for P&G to embark upon a corporate break up, given the costs involved in such an endeavor. It would not only eat into the impressive cost savings that P&G has generated in the last two quarters, but would also put further pressure on revenue growth by distracting the management for an extended period. While addressing the matter of a potential break up, CFO Jon Mueller stated the example of Duracell, which was sold to Berkshire Hathaway last year. The company added 450 employees to the Duracell unit for it to be able to operate independently. ^[4] Thus, a corporate break up of the size of P&G would generate massive incremental costs that would pile on to the costs of the ongoing restructuring.

In summary, we believe that a break up would not be the best move for Procter & Gamble because of the associated cost, and since the brand consolidation program addresses most of the concerns involved.

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More Trefis Research

1. P&G should be broken up – Bernstein’s Dibadj, Reuters, October 23, 2015 [↩]
2. Procter & Gamble: Time for a Split, Barron’s, November 21, 2015 [↩]
3. P&G Consumer Analyst Group of New York Conference Call, February 19, 2015 [↩] [↩]
4. Procter & Gamble CFO: We’re Not Averse to Looking at a Breakup, WCPO Insider, November 19, 2015 [↩]