The Guide to Investing in Stocks and Shares

P Z Cussons

Dan Tebbutt - A Shareworld Contributor

Recently I took a look at Unilever and was put off by the risk that management might splurge on some over-priced acquisitions. My thoughts naturally turned, therefore, to whether I could invest in one of those soon-to-be-over-priced companies, and reap a tidy profit.

Unilever's 10-year financial history provides a couple of clues as to the direction the firm is evolving in, and therefore the sort of company they might like to buy:

• Asia/Africa has grown from 26% of their turnover to 38% . Unilever are desperate for growth, and emerging markets provide exactly that.
• The 3 sectors that Unilever operate in are Home care, Personal care and nutrition/food. Personal care is growing fastest, and has the best margins.

P Z Cussons (PZC) ticks a lot of boxes as an acquisition target, but has one major drawback. Let's start with the positives. It has:

• A strong business in Africa, with £325m of revenue (42% of total revenues) and £42m of operating profit.
• A small but growing presence in Asia, with £165m of revenue (21%) and £13m operating profit.
• A number of brands in personal care, home care and nutrition: Imperial Leather is the number one UK soap brand, Morning Fresh is the number one Australian washing up liquid.
• Average operating profit growth of 14% per year over the last 4 years. That is mostly down to increased turnover, which grew at more than 12% per year.
• No net debt
• Market capitalization of £1.5bn (easily digested by Unilever, but big enough to be worth their while).

Sounds perfect doesn't it? But maybe too perfect. Unilever already has a number of soap / shower gel products: Radox, Dove, Pears', Lux, Lifebuoy. Adding Imperial Leather to their stable might raise the eyebrows of competition regulators. Unilever would probably have to dispose of one or more other brands (or indeed Imperial Leather itself) in order to satisfy such concerns.

Assuming that hurdle could be overcome, what sort of price might Unilever pay for P Z Cussons? Unilever can borrow money at a rate of about 4-5%. PZC made £101m pre-tax last year. So Unilever could borrow £2bn at 5% and pay the interest entirely out of PZC's earnings. There would be no hit to Unilever's earnings, even if they couldn't squeeze any cost-savings out of the merger.

But PZC has a massive overlap in costs with Unilever. Merging their distribution networks could save a lot of money. PZC had £210m of selling, distribution and administrative costs on revenues of £771m. If we assume that 25% of that could be saved by merging with Unilever, that would boost pre-tax profits by 50%, and give Unilever a good return on their investment.

PZC currently have a market cap of £1.5bn. Adding a premium of 40% (the minimum that would be likely to be necessary to get the agreement of PZC shareholders) gives £2.1bn. That seems like a price that both parties would be happy with. I therefore think a takeover is a possibility at around the 500p mark (vs. the current share price of 350p).

Of course, all of this is highly speculative. I haven't seen anything to suggest that Unilever have an interest in PZC, and there could be any number of other factors that make it unworkable. At a P/E ratio of 21, PZC is not exactly cheap, so it's difficult to justify on that basis alone. I certainly don't think this is one to bet the farm on, but it might be worth a small punt.