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In an era of record high stock prices and cheap money, big deals are bound to happen. The latest major deal to hit the M&A landscape was Unilever’s (NYSE: UL) acquisition of consumer products start-up Dollar Shave Club for a cool $1 billion.
The danger today is that companies are paying huge sums of money for companies that have revenue but little to no earnings. In a low-growth world, large companies are starved for growth. This could backfire, but Unilever has a history of doing things differently, and it hasn’t hurt the company yet.
A $1 billion price tag for the Unilever acquisition might give investors nausea, but there is a reason why Unilever feels comfortable paying so much money: Dollar Shave Club could be the first true disruptor to come along in the consumer staples industry in years. As a result, Unilever is taking the fight directly to the doorstep of industry juggernaut Procter & Gamble (NYSE: PG).
Unilever Takes Aim
Unilever often flies under the shadow of its much bigger competitor P&G, but Unilever has a long track record of excellent performance. Unilever was founded all the way back in 1885, and has several strong brands of its own, including Dove, Axe, Comfort, Ben & Jerry’s, and many more. Thanks to these premium brands, as well as its strategic investment in the emerging markets, the company generates strong profits every year and achieves growth rates significantly ahead of P&G.
For example, last year Unilever grew its total revenue by 10% from the previous year. This in itself is a notable achievement; very few global consumer staples companies are achieving double-digit revenue growth in this climate. Unilever’s earnings increased 14% in 2015, and its strong results have continued in 2016.
Unilever grew organic revenue, which excludes currency fluctuations, by 5.4% over the first half of 2016.
Compare this to P&G, which is standing still in relation to Unilever. P&G recently concluded its fiscal year, and the results were underwhelming. P&G saw its organic revenue increase just 1% for the fiscal year. And, P&G’s results could get even worse if its flagship Gillette brand of razors and shaving products gets disrupted by a certain start-up, called Dollar Shave Club.
Unilever has a wide portfolio of brands, but no presence in the large shaving products category. Since Unilever has a diverse product portfolio across food and beverages, it makes sense to diversify into another category, especially when the leader in that category is the company’s closest competitor.
Unilever Acquisition: Is It Madness?
Financially, Unilever’s $1 billion deal to buy Dollar Shave Club looks crazy on the surface. But the financial implications of the Unilever acquisition are actually much better than they appear. The reason is that Unilever can raise extremely cheap capital right now, thanks to historically low interest rates. Earlier this year, Unilever raised approximately $1.7 billion of bonds, including approximately $339 million of notes maturing in 2020 that carried a 0% interest rate.
You read that right: Unilever essentially raised free money. That capital can be used to invest in strategic growth initiatives to expand the business, such as mergers and acquisitions activity. This is important to note. Because Unilever raised such cheap capital, if it derives any growth whatsoever from Dollar Shave Club, it will be worth the price tag, because the growth generated from the acquisition would exceed the cost of capital used to finance the acquisition.
Also consider that Unilever has enough cash on hand to buy Dollar Shave Club and still have plenty left over. At the end of last quarter, Unilever held $3.5 billion in cash on the balance sheet. Again, because interest rates are so low, this money is burning a hole in the company’s pocket. It is earning nothing for shareholders, and might as well be deployed to purchase a productive asset.
Deal Could Make Sense
Some might call Unilever crazy for spending $1 billion on a tiny company with a small footprint, but that footprint is likely to grow.
Razor blades are an industry ripe for disruption—as most consumers can attest to, brand-name razors from the likes of Gillette are very expensive. Dollar Shave Club might have just invented a better mouse trap, and with such cheap money, it made great sense from both an operational and financial perspective for Unilever to make this deal.