Will Nelson Peltz Break Up P&G?
Procter & Gamble is already reinventing itself by largely following the activist investors’ playlist. So will Nelson Peltz seek even more reinvention––by demanding the breakup of the world’s consumer-goods colossus?
No activist investor can match Peltz’s record of energizing famous but flagging brands. The veteran co-founder of private equity firm Trian Partners (with Peter May and Ed Garden) has energized Heinz, Cadbury, Kraft, PepsiCo, and Family Dollar, and reaped billions in value for his investors in the process. Peltz calls his approach “operational activism.” After taking a position, Trian typically petitions its targets’ boards with highly detailed “white papers” outlining strategies for both paring costs and streamlining scattered product portfolios to focus on a single core business. For example, Peltz helped orchestrate the successful 2012 split of Kraft Foods into grocery (Heinz) and snack businesses (Mondelez).
Peltz seeks to work alongside management in a super-consulting capacity. But he’ll go to war if faced with stubborn resistance, as he did at DuPont, where he helped shepherd its merger with Dow Chemical.
The P&G gambit could well be the most ambitious undertaking of Peltz’s career. On February 14, press reports revealed that Trian had taken a $3.5 billion stake in P&G, the largest investment in its history. While that represents only about 1% of the company’s shares, the move still generated excitement among investors. P&G’s stock (PG) jumped 3.4% on the news, extending a strong run in the first two months of 2017. Still, its longer-term performance is underwhelming. Since the start of 2014, P&G shares have risen just 16%, half the increase in the S&P 500.
P&G suffers from the twin burdens afflicting the great consumer brands: weak growth and declining profitability. During the great recession, consumers switched from pricey household names to bargain generic products in everything from detergents to shampoo, and many aren’t going back. Young consumers aren’t nearly as attached to aging brands as their parents are, and competing offerings as varied as razors from the Dollar Shave Club (recently acquired by Unilever) and body lotions from the Honest Company are poaching sales from P&G perennials.
Still, P&G is mounting a surprisingly nimble campaign to regain momentum. CEO David Taylor is making many of the moves an ardent activist would applaud. Over the past two-and-a-half years, the maker of Tide detergent, Pampers diapers and Gillette razors and blades has shed over 100 brands, selling Duracell batteries to Berkshire Hathaway for $4.7 billion and a sprawling beauty portfolio to Coty for $12.5 billion.
The program has brought an impressive improvement in a crucial measure of efficiency: the cash flow P&G generates on all the money invested in its businesses. The yardstick, developed by Jack Ciesielski, author of the Analyst’s Accounting Observer, is called COROA, for “cash operating return on assets.” COROA is the ratio of all the cash a company generates in a year, after adding back cash taxes and interest to remove the influence of leverage and fluctuating levies on corporate income, divided by what the company has paid for all assets over its history. Hence, COROA provides a pure measure on how well a company is running its business.
Surprisingly, P&G is doing pretty well. From fiscal 2014 to 2016 (ended June 30), P&G has shrunk total dollars it has plowed into capex, measured by total assets plus accumulated depreciation, by $18.5 billion, to $147.5 billion, or 11%. But in that two-year period, it increased its cash flow from operations, exclusive of cash interest and taxes, by $1.7 billion, to $19.7 billion, a 9.4% gain. That’s a textbook case of improving what really matters, return on capital, through the axing of underperforming brands and raising cash flow on the products that remain.
Since P&G is already slashing costs and streamlining its portfolio, it isn’t a fat, flailing target where the solutions are obvious. So what improvements will Peltz demand, if any? Peltz isn’t commenting on his plans for P&G. Even after all its rationalization, P&G still has ten major product groups that it calls core, most of which, like beauty and homecare, are barely plodding forward, while others such as healthcare are expanding briskly. Peltz may argue that splitting P&G into separate businesses, each specializing in a single category, could be the key to unlocking value.
Of course, Peltz may well decide to endorse P&G’s current course, simply improving its prospects with his formidable guidance. Whatever the outcome, Nelson Peltz is now turning to one of the biggest challenges in the business world, assessing whether the big, varied portfolios of brands that used to be so successful can thrive in the future, or whether a new paradigm is needed. His next move will be one of the most intriguing spectacles of the year to come.