Analysis: Reckitt, GSK balance risk-reward in high-stakes Pfizer fight

By Martinne Geller and Ben Hirschler

LONDON (Reuters) - The leaders of GlaxoSmithKline and Reckitt Benckiser -- two of Britain's best-known but underperforming companies -- are in a high-stakes battle for a dose of Advil to ease their pain.

The drugmaker and consumer goods group, both under investor pressure to improve operations, face a tricky risk-reward balance in a potential $20 billion auction for Pfizer's consumer healthcare unit.

Pfizer's cabinet of strong brands such as painkiller Advil, Centrum vitamins and Chapstick lip balm present a great opportunity for both Reckitt and GSK to build all-important scale in the still fragmented over-the-counter (OTC) market.

 

OTC remedies are durable brands with loyal customers, and buying the Pfizer business would cement either Reckitt and GSK in a market-leading position.

The acquisition would be a financial stretch for both, however, and the growing threat from Amazon.com in the OTC space is a further uncertainty.

Both CEOs have expressed interest in the Pfizer auction, though neither company has confirmed its participation. But people familiar with the matter say they are in the running.

"Neither of them have to do this deal," said Hargreaves Lansdown portfolio manager Steve Clayton, who owns shares in both companies across funds worth 500 million pounds ($695 million).

"The value of our investment is dependent most on the stuff that they already own. That has to be management's No. 1 priority."

With Reckitt and GSK shares having underperformed their respective European sectors by 13 and 14 percent in the past year, both bosses already have their work cut out.

Reckitt has grappled with a slowing market and ongoing fallout from a South Korean safety scandal, a failed product launch and a cyberattack. GSK has struggled with a scarcity of promising new drugs in its pipeline at a time of mounting competition in its core respiratory and HIV divisions.

CONVINCING INVESTORS

Rakesh Kapoor, Reckitt's CEO since 2011, has a reputation for savvy deal-making and financial rigour in his quest to turn Reckitt from a stodgy British maker of cleaning products into a consumer healthcare powerhouse.

Yet he came under pressure last year for his high pay, which was slashed, and the $16.6 billion acquisition of struggling baby formula maker Mead Johnson, its biggest ever. GSK's Emma Walmsley, who took over in April, has yet to convince some investors that her background selling shampoo at L'Oreal has prepared her for running one of the world's biggest drug operations. Doubling down in consumer products risks increasing that scepticism.

She must also ensure buying Pfizer does not endanger the dividend or derail existing priorities to invest in pharmaceutical research and have resources to buy out Novartis's minority stake in their consumer health joint venture, if the Swiss company decides to sell from next month.

Both companies must also evaluate how far they are prepared to let credit ratings slip for a big acquisition, at a time when global interest rates look to be on the rise.

Reckitt has said it would be willing to temporarily let its rating slide to BBB for a "spectacular" deal.

"A short-term downgrade in debt rating for what is a once-in-a-generation opportunity makes sense," said Reckitt shareholder Harold Thompson, a partner at consumer goods-focused investment firm Ash Park Capital.

GSK is currently rated A2 and Moody's Investors Service analyst Knut Slatten said its credit quality in 2018 would hinge on the company's appetite for deals.

Yet Morgan Stanley analysts said downgrades may not be necessary, given a range of available financing options aside from just taking on debt or issuing equity, which would dilute shareholder returns. Examples include bridge loans secured by asset sales or partnering with a financial investor.

GSK could do the deal through its joint venture, and in Reckitt's case, the home and hygiene business could be a fertile ground for disposals, especially since it now operates as a separate business from health, as of this year. "They've been presented with an opportunity in Pfizer that really pushes them to decide the next decade of their destiny," Jefferies analyst Martin Deboo said of Reckitt.

Reckitt will report full-year results on Feb. 19, and another improvement in Mead Johnson could warm more investors to a Pfizer bid if it signals that deal's integration is on track.

($1 = 0.7193 pounds)

(Reporting by Martinne Geller; Editing by Catherine Evans)