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Executive summary:

  • Nestle has agreed to sell part of its stake in L'Oreal, reducing its stake from 29.8% to 23.3%, for a cash amount of $4.6 billion

  • Nestle is a great income investment given its long history of dividend payments and very good cash flow generation, leading to a sustainable dividend over the long term

  • With cash proceeds from this disposal, Nestle can enhance considerably its shareholder remuneration through a special dividend and share buyback program making it even more attractive for income investors

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Nestle (OTCPK:NSRGY) and L'Oreal (OTCPK:LRLCY) have announced today a strategic transaction for both companies under which L'Oréal will buy 48.5 million of its own shares (8% of its share capital) from Nestle. Nestle is currently L'Oreal's largest shareholder with an equity stake of 29.8%, which at its current stock price is worth about $33 billion. Nestle has owned this stake in L'Oreal since 1974, which will now be reduced to 23.29%. The rest of the L'Oreal stake is strategic according to Nestle's chairman. Nevertheless, under French law only 10% can be bought back in a single year, so if both companies decide to reduce even further Nestle's stake it can take three years to dispose it entirely.

According to the companies, the deal will be financed through:

Partially through the disposal by L'Oréal to Nestle of its 50% stake in Swiss dermatology pharmaceuticals company Galderma (a 50/50 joint venture between L'Oréal and Nestle) for an enterprise value of 3.1 billion euros (2.6 billion euros of equity value), paid by Nestle in L'Oréal shares (21.2 million shares);

For the remainder, corresponding to 27.3 million L'Oréal shares held by Nestlé, in cash for an amount of 3.4 billion euros ($4.6 billion).

The transaction is expected to close before the end of the first half. With this transaction, Nestle is creating a new unit called Nestle Skin Health, using Galderma as a basis, enlarging even more its business portfolio.

With this proposed acquisition of 50% of Galderma, Nestlé will pursue its strategic development in Nutrition, Health, and Wellness, by expanding its activities to medical skin treatments. In this respect, Nestlé will create a new centre of activities in this area, through a new entity: Nestlé Skin Health SA. Galderma will be the foundation of this entity which will be run by Galderma's management.

L'Oreal is a French beauty company offering products mainly for women, such as cosmetics and perfumes. Therefore, this stake is not a core holding for Nestle and the decision to monetize it was expected, as cosmetics don't fit its long-term nutrition and health strategy. For Nestle, this deal will reduce slightly its net income from lower contribution in the associates line of L'Oreal profit. This can be offset through share repurchases, which will most likely be one of the ways the company decides to use this cash.

As I discussed in my previous article, Nestle is a great income investment due to its long history of dividend payments and its dividend sustainability over the long term. Nestle has an impressive track record given that it has paid annual dividends since at least 1959, and has paid a rising dividend since 1995. Moreover, as the company has a strong balance sheet it does not need to retain cash proceeds from this deal, so a special dividend and share buybacks are expected over the coming months.

Its last dividend payment was CHF 2.05 ($2.29) per share related to 2012 earnings, amounting to a cash distribution of nearly $7 billion. Nestle only makes one payment per year, so the next dividend payment related to 2013 earnings should occur in next April/May. The company's free cash flow was about $4.7 billion in 2012, thus it can easily increase its dividend organically. Therefore, Nestle's $4.6 billion cash proceeds from this L'Oreal transaction should be completely allocated to enhance its shareholder remuneration policy both from a special dividend and perform share buybacks to offset dilution, which is clearly another positive factor for income investors.

Conclusion

Nestle is a quality company, with a resilient business model and a remarkable dividend history. Although its dividend is not among the highest in the stock market, it is clearly safe and has very good growth prospects. Moreover, with the sale of its non-core stake in L'Oreal it will most likely improve substantially its shareholder remuneration policy, as Nestle does not need to retain this cash on its balance sheet making it even more attractive for income investors.

Source: Nestle: Expect A Special Dividend And Share Buyback Soon