Shared from the 2017-07-01 Financial Times (Europe) eEdition

Nestlé talk gives L’Oréal stock a healthy glow

When hedge fund Third Point revealed stake move and urged action on the cosmetics group, the shares promptly rose

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When Jean-Paul Agon, chief executive of L’Oréal, met his counterpart at Nestlé, Mark Schneider, for the first time at a summit in Berlin a week ago, it proved to be a timely encounter.

Just days later, hedge fund Third Point revealed it had taken a stake in Nestlé and urged the Swiss consumer goods company to offload its 23 per cent holding in L’Oréal, an investment stretching back more than 40 years. L’Oréal’s shares rose almost 4 per cent as speculation returned that it could sell its 9 per cent stake in pharmaceuticals company Sanofi to buy out Nestlé.

For L’Oréal, whose best-known brands include Maybelline, Lancôme and Yves Saint Laurent, the Sanofi stake is a pure financial play. “We have clearly said that it is not a strategic investment,” Mr Agon told the Financial Times in May. “If Nestlé wanted to sell, we might consider selling our Sanofi stake to buy their shares, but for the moment no one wants to move,” he added. Mr Agon declined to comment on the Nestlé or Sanofi stakes this week.

The partnership between L’Oréal and Nestlé began in 1974 when L’Oréal’s founding Bettencourt family sought an outside investor because they feared nationalisation.

The most recent change in the shareholder structure came in 2014, when Nestlé sold 8 per cent of its holding. That was part of a deal for Nestlé to gain full control of the Galderma skincare joint venture that reduced its position in L’Oréal from 29.4 per cent to 23.3 per cent, and raised the Bettencourt holding from 30.6 per cent to 33 per cent.

For Nestlé, its investment in the world’s largest beauty group by sales has been a lucrative one: L’Oréal’s share price has increased 128 per cent over the past 10 years. The French group’s total shareholder return has outpaced that of Nestlé fivefold since 1977.

L’Oréal’s story is one of steady growth. Annual sales dropped for the first, and only, time in 2009 but it has bounced back strongly since, boosted by investment in digital and successful acquisitions, such as brands Urban Decay, NYX and IT Cosmetics. Its professional products — mainly shampoos sold to hairdressers — have had a tough time recently, although L’Oréal has benefited from strong demand for luxury products, such as Lancôme.

Like-for-like sales growth of 4.7 per cent last year, which took revenues to €25.8bn, was higher than Nestlé and Unilever. But it was below that of rival Estée Lauder, which had growth of 6.6 per cent, on half the revenues of L’Oréal.

Pinar Ergun, analyst at UBS, says L’Oréal “has been one of the most agile firms of its size in the sector. It has invested in digital, acquired and globalised successful brands and invested in groundbreaking research and development, for example, 3D skin printing [for use in product testing].”

It is also more profitable than its rivals: L’Oréal’s operating profit margin of 17.6 per cent last year was higher than Nestlé, Unilever and Estée Lauder, which were in the region of 15-16 per cent.

However, analysts at Berenberg point to “a fairly crazy” first quarter this year. Growth of 12 per cent in luxury was “fantastic”, but L’Oréal’s consumer, professional and active units had “their lowest quarters of growth since 2014, 2009 and 2011 respectively”. They also expect margins to increase more slowly than before, reflecting “incremental investments in response to elevated industry competitive intensity”.

The stable backing of the Bettencourt family and Nestlé meant L’Oréal could increase its investment during the financial crisis where other brands were forced to pull back, says Mr Agon.

Mr Agon was also early to spot the effect of digital on the industry: “I understood that a big tsunami was coming that would completely change the way we work with consumers, the way we communicate, the way we create products, the way we sell them.”

Since 2010, L’Oréal has hired 1,600 digital experts, and ecommerce sales rose by a third last year to 6.5 per cent of group revenues, while the target is to reach 20 per cent. Digital has removed barriers to entry and L’Oréal has sought to tap into start-up innovation through joint initiatives with venture capital firm Partech Ventures in Paris, and start-up platform Founders Factory in London. Mr Agon wants to add similar joint ventures in China and the US.

L’Oréal’s own innovations include a virtual cosmetics app, Makeup Genius, and “the world’s first smart hairbrush”, which analyses hair quality. The group’s broad portfolio of products has helped cushion it as consumer tastes have evolved: when skincare sales began to slow, it ramped up sales of make-up, which have been boosted by the ubiquity of selfies and social networks.

“L’Oréal is the global leader in make-up, which is growing at twice the industry rate at 8 per cent, versus 4 per cent,” says Chas Manso, analyst at Société Générale.

It is likely to face stiffer competition in the future from Coty, which bought Procter & Gamble’s beauty lines to become the world’s third-biggest beauty group by sales.

While brands such as Kiehl’s, which L’Oréal bought in 2000, epitomise the group’s success in buying smaller brands and ramping up distribution to turn them into a global hit, other acquisitions have been less successful.

For example, last year L’Oréal booked a €234m impairment on Clarisonic, a beauty device; and a €213m impairment on Magic Holdings, a Chinese skincare masks company. And then there’s the Body Shop, the British brand, which L’Oréal announced this week it has sold for an enterprise value of €1bn to Brazilian group Natura Cosméticos.

When L’Oréal bought the retailer a decade ago it decided to “ringfence the Body Shop brand within the L’Oréal portfolio because the culture was too different”, says Mr Agon. In the end this meant that the Body Shop did not fully benefit from the L’Oréal machine.

By using the proceeds from the Body Shop sale, the stake in Sanofi and raising some debt, L’Oréal could theoretically buy back the entire Nestlé stake — should the Swiss group decide to sell.

Nestlé has stayed tight-lipped so far but Mr Schneider, who took over as chief executive in January, is the first outsider to lead the group in 95 years and so could be open-minded about the company’s options.

L’Oréal is unlikely to buy back the entire Nestlé stake and cancel the shares. One issue is that doing so would push the Bettencourt family’s holding above the level at which it must launch a mandatory takeover. This could mean applying to the French regulator for a special exemption so it did not have to do so, or selling shares to take it below the mandatory takeover threshold.

Selling down its position would be an unprecedented move: the Bettencourt family has not sold a single share in L’Oréal since the 1974 Nestlé deal. Third Point, for its part, has suggested that Nestlé’s L’Oréal stake could be divested via an exchange offer for Nestlé shares.

And while Third Point is pushing Nestlé to sell out of L’Oréal, in the past the Swiss group was seen as a possible buyer for the entire company. For now, this is a moot point because Nestlé is prevented from making a full takeover of L’Oréal until six months after the death of the family’s 94-year-old matriarch, Liliane Bettencourt.

Would Mr Agon resist such a takeover? Ever diplomatic, he responds: “Liliane is alive and healthy and I thank God for that so there is no question today.”

See Person in the News

‘I understood that a big tsunami was coming that would change the way we work with consumers’

€25.8bn

L’Oréal revenues last year, with like-for-like sales growth of 4.7%

17.6% Operating profit margin, higher than Nestlé, Unilever and Estée Lauder

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