Over the weekend I wrote about Unilever's (NYSE:UL) recent acquisition activity, specifically the purchase of Dollar Shave Club and the potential buyout of The Honest Company, which would propel UL into an assortment of more eco-friendly/green household staples. In semi-agreement with Quinn Foley, I saw one goal of the purchase of Dollar Shave Club as a way to enter e-commerce, and felt Honest would complement these efforts. But I also noted that they were low-balling the bid for Jessica Alba's Honest at $1 billion, when it has been valued at $1.7 billion based on rounds of investment fund-raising.
But how quickly things can change, as UL announced yesterday its acquisition of 7th Generation (I want to personally thank an SA member, Argyll, for sending me a note about this as I had just awakened in Korea to find his message and see the news). This is a move I recommended Procter & Gamble (NYSE:PG) to consider several months ago as it would have moved PG into this line of gap-filling complementary eco-friendly/green products. 7th Generation is proven, with $200 million in annual sales, and has been profitable since 2002. It was once a publicly traded company beginning in 1993, but in 1999 bought back its shares and went private to avoid hostile takeovers. Thus with $200 million in sales which turn a profit through a very diverse and successful product line, it appears to be a good deal for a mere $700 million. And as a regular consumer of 7th Generation products (they have contracts with both AAFES and DECA for military Post Exchanges and Commissaries), it has me smiling.
But contrary to my expectations that UL would reach a deal with Honest, the 7th Generation acquisition significantly reduces the likelihood of such a buyout. Price will likely remain the primary sticking point from Honest's leaders and investors as they are almost certainly slighted by the low-ball bid. But that bid makes sense when one realizes that UL paid $700 million for a profitable competitor of Honest. Even under these circumstances, I still think a deal with Honest is possible for three reasons:
1. While both 7th Generation and Honest compete and have some overlapping clientele, they still have distinct markets to which they sell. They would not have experienced such success if they did not have separate and slightly dissimilar customers. And in this light, Honest has the key piece that UL is likely still seeking - an established e-commerce capability and client list, which if copied or combined with 7th Generation and/or Dollar Shave Club, could definitely help ring the register in the long run. But countering this argument is that most of 7th Generation's products are already subscription-available on Amazon.com at discount rates. However, acquiring Honest may help UL mitigate any risk of being held-up by Amazon through its own e-commerce solution, which would not leave it monopolized by Amazon's distribution system and prices.
2. The reported price paid for 7th Generation definitely gives UL leverage. Honest has ~$300 million in annual sales, but is not profitable - a situation I assess could be solved from less discount sales and switching from FedEx (NYSE:FDX) as its standard shipping provider. As previously mentioned, Honest is assessed as being worth $1.7 billion based upon investment fund-raising. But UL can leverage Honest's price with the fact that it just paid only $700 million for a profitable company with 2/3 of Honest's sales. UL has to assess how much a mature e-commerce system and $100 million more in annual sales is worth. With this in mind, I don't see UL as likely to stray over the $1.2 billion mark for this deal regardless of how much they feel they need Honest. The revenues without profit and an e-commerce system are likely only bringing the value to about the $1 billion range (if that), and the number of registered customers in its e-commerce system is likely not worth more than $200 million. The work needed to turn a profit as compared to developing a new 7th Generation e-commerce site with the help of Dollar Shave Club is likely not worth going above that price.
3. Honest now needs UL more than UL needs Honest. So let's just be honest (pun intended) - UL has now further encroached into enemy territory, but will compete directly with the big boys [PG, Kimberly-Clark (NYSE:KMB)] and Honest alike, especially in the diaper and cleaning product categories. UL provides 7th Generation products much more visibility overseas and the opportunity to grab international market share in the eco-friendly/green lines before Honest has even had a chance to expand. Outside discounts and shipping costs, Honest will need to keep growing, and the international market that UL can easily reach provides it much more opportunity than the U.S. market only. Add to this that the investors in Honest have displayed a recent proclivity to exit by selling the company, and a buyout from UL still remains a distinct possibility. Of course, Honest could do an IPO, but I see that causing much consternation in their moral/ethical mission as 7th Generation found out in the 1990s when shareholder pressures began to force them to sacrifice their values.
Overall, I see the deal with 7th Generation as very positive and helpful for UL in their current position. This opens product lines for UL in areas they lagged and puts some pressure on the likes of PG and KMB to take actions into uncharted territories, especially in the diaper market. As for the potential of a deal with The Honest Company, I think this reduces the chances of such an event, but it does not completely rule out the possibility. Regardless, I continue to buy UL on a weekly basis and will increase my amounts on any weakness as I see this company making the right acquisitions with the right strategy.
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Disclaimer: I am not a financial professional and accept no responsibility for any investment decisions a reader makes. This article is presented for information purposes only. Furthermore, the figures cited here are the product of the author's own research and may differ from those of other analysts. Always do your own due diligence when researching potential investments.
Disclosure: I am/we are long UL, KMB, PG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.