Unilever is breaking some of the basic rules of corporate finance. Investors, being keen on financial logic, aren't impressed.
The Anglo-Dutch consumer goods giant is offering to pay $5.4 billion for a 22 per cent stake in Hindustan Unilever, lifting its holding in its Indian subsidiary to 75 per cent. The first rule violation is to offer a premium for additional shares in a majority-owned business. But Unilever had no real choice, since Indian stock market rules mandate a minimum price in such situations.
The high price exacerbates the second violation - buying expensive shares in another company rather than buying back its own cheaper stock. Unilever trades on a forward price-earnings multiple of 20. Its bid for Hindustan Unilever values the stock at 34 times forecast earnings.
There's more. Here is a multi-billion dollar transaction with no synergies. And, the deal isn't even a route to 100 per cent ownership. Unilever wants to keep the subsidiary's listing, to protect the profile that goes with being one of the top Indian blue chips.
Unilever's market capitalisation is $127 billion. It could probably spend only about $4.7 billion to buy back and retire 110 million shares without hurting its credit rating. After taking the cost of debt into account, the financial engineering would boost per share earnings more than the Hindustan Unilever transaction.
For Unilever, the difference is small - added accretion of maybe a percentage point or so. But corporate managers have previously danced to the tune of share buyback vigilantes, who have no patience with any amount of financial inefficiency.
Common sense is less precise but more helpful. Unilever has no better way to buy structural growth in emerging markets. Sure, in theory Unilever shareholders could buy that growth themselves by using the proceeds of a buyback to purchase Hindustan. But they would not get the closer ties and goodwill created in this important market. Those synergies are probably worth the $1 billion premium. Let common sense prevail.
