Why Unilever Could Bid for Colgate and Why Now

Unilever (NYSE:UL) aims to double its revenue within a decade, ^[1] and Colgate-Palmolive (NYSE: CL) might help it get there. Under current CEO, Paul Polman, the consumer giant has been on an acquisition spree with the recent acquisitions of Sara Lee’s European shower gel and detergents business and of Alberto Culver that added premium hair care brands TRESemme and Nexxus to its portfolio of leading hair care brands, Dove and Sunsilk. Unilever is the second largest consumer goods company in the world after Procter & Gamble (NYSE:PG) and sells everything from soap and deodorant to salad dressing and ice cream, pitting it against other consumer companies like Kimberly Clark (NYSE:KMB) and Colgate-Palmolive (NYSE:CP).

While food and beverage items made up over half of the total sales in 2010 with detergents and household cleaning products making up around 17%, Polman has identified the personal care segment as the focus area for Unilever going forward. ^[1] This makes Colgate an ideal candidate for Unilever’s ambitious growth plans.

Colgate’s Portfolio a Good Fit for Unilever

Colgate is the global leader in oral care with close to a third of the market share in the $20 billion market for toothpaste, toothbrush, dental floss and mouthwash. A merger with Colgate would immediately strengthen Unilever’s position in the oral care market from its current market share of around 6% made up by Signal and Closeup brands.

Among other benefits, Colgate’s Suavitel and Soupaline brands of fabric conditioners would strengthen Unilever’s fabric care offering that includes the Surf and Omo detergents brands. The merger would also expand Unilever’s soaps, shampoos and deodorants portfolio of brands.

Unilever Could Improve Profit Margins

Unilever’s overall EBITDA margin, a measure of profitability, has fluctuated around 15% between 2005 and 2010. Below we include a chart showing the margin trend for its hair and skin care products, which carry a slightly higher profit margin than for many of its other products. This compares to Colgate-Palmolive’s EBITDA margin in excess of 25% over the same period and highlights that adding Colgate would likely improve the operating margins for Unilever. Further cost savings and synergies in areas such as selling, general and administrative and savings on marketing expenses would also benefit the profit margins.

Healthy Balance Sheets at Both Unilever and Colgate

Unilever has reduced leverage over the past five years from a debt to equity ratio of 1.6 in 2005 to 0.73 in 2010. The debt coverage ratio (EBITDA/interest payments on debt) has increased from 9.3 in 2005 to as high as 17.4 in 2010. This implies that Unilever has room to expand its balance sheet by taking on debt if it wanted to make a bid for Colgate. The current low interest rate environment is ideally suited for Unilever to take advantage of cheap credit available.

Unilever has made recent acquisitions to grow its portfolio while not straining its balance sheet including the recent $3.7 billion all-cash acquisition of Alberto Culver (Unilever’s Alberto Culver Acquisition Adds Shine to Stock?, Trefis,  Jan 20′ 2011) and the $1.9 billion acquisition of Sara Lee’s personal care and European laundry business (Unilever’s European Expansion Lifts Stock, Trefis, Dec 21′ 2010).

Colgate too has reduced its debt to equity ratio of 2.5 in 2005 to below 1 by 2009. The corresponding increase in debt coverage has climbed from around 19 to 53 over the same period. Colgate has an impressive cash conversion ratio (free cash flows as a % of sales) of close to 14%. We highlighted this in a recent article (Investing in Beauty and Personal Care? Look for Cash!, Trefis,  Feb 11′ 2011) and included a table below with some of our findings.

Colgate’s strong balance sheet could allow Unilever or another suitor to raise debt against Colgate’s assets in the event of a takeover. This could increase the number of potential bidders that might look at Colgate thereby bidding up its shares if the market starts to consider it is an acquisition target. However this flexibility also gives Colgate more options to defend itself, for example by raising debt to pursue non-strategic acquisitions in an attempt to avoid takeover bids and lever up its balance sheet to make it less attractive.

Colgate standing alone has considerable overlap with PG and Unilever in its core product categories and may find it difficult to maintain its profit margins and market share if the two larger companies start competing on price and growing aggressively though acquisitions.

You can see a detailed analysis of our $35.14 Trefis price estimate of Unilever’s stock and $85.26 Trefis price estimate of Colgate-Palmolive’s stock here.

1. Unilever aims to double revenue, Unilever [↩] [↩]