The year of the deal starts off with a bang

published 31 October 2005

Mergers and acquisitions (M&A) are back with a bang in 2005. The latest is Procter & Gamble's deal to buy Gillette for $57bn.This caps the biggest four months of takeovers since the days of the tech boom in 2000.

This may be good news: it suggests buyers are seeing good value all over the market. Or it may be bad news, in that it tells us America's big firms can't see much in the way of organic growth on the horizon, so they're having to buy it in instead. Either way, it seems to be telling us that the many predictions that 2005 would be the year of the deal were right.

But the P&G deal should also remind us of something else. Household goods companies such as Gillette shouldn't be ignored. They might look boring compared to internet firms, but try telling that to Warren Buffett, who one day after the announcement of the deal was sitting on a windfall profit of $300m - his Berkshire Hathaway group is the razor maker's largest shareholder, with 9% of the outstanding shares. Not that he is taking any money off the table. On the contrary, he is promising to spend a further $350m on boosting his stake in the new consumer products behemoth.

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Investing in such a huge firm does makes some sense, says Edward Helmore in The Observer. There have been massive changes in the household goods sector in the last few years. P&G-Gillette is going to be a behemoth of a company: the combined firm will have annual sales of $60.7bn. But it needs this size. In the age of giant retailers, such as Wal-Mart and Tesco, suppliers need all the clout they can get to protect their margins. Before the deal, P&G was hardly small, says The Sunday Times, but even so, along with its rivals, including Britain's Unilever, it has watched its power wane as global retailers demand ever lower prices from suppliers (and get them) and launch "copy-cat products" that eat away at branded sales. Once they were able to hold the supermarkets to ransom, but suppliers have increasingly found the boot is on the other foot. Hence this merger: the bigger the supplier, the more it can fight back.

This all sounds like bad news for the sector, and to a degree it is. But there is "happier news" for the investor, says Nils Pratley in The Guardian. Mature consumer goods companies, such as P&G and Gillette, and even Unilever, are inherently cash generative. If they cut back on advertising, cash comes gushing out, at least for a while. In short, these companies' balance sheets are strong enough for them to go deal crazy. Nobody, for example, would go bust by buying Reckitt Benckiser at its current valuation.

All this, along with the need for size, rather suggests that the P&G-Gillette deal is highly likely to trigger imitations. And as Simon Nixon points out on Breakingviews.com, next up could well be Unilever. The Anglo-Dutch group has "long struggled" to keep up with P&G. Now P&G will pull even further ahead, putting pressure on Unilever to come up with a deal of its own, perhaps with Reckitt Benckiser. The P&G deal is unlikely to be the last in this sector in 2005.