All of the financial world, and the food industry in particular, were stunned last Friday, when it emerged that Kraft-Heinz (KH) had made a stupendous US$143 billion offer for Anglo-Dutch FMCG giant Unilever. Combining the two companies, which will encompass brands that range from Dove soap to Philadelphia cheese to Heinz baked beans, will "create a leading consumer goods company with a mission of long-term growth and sustainable living," said Kraft in a statement.

A combination would be the third-biggest takeover in history and the largest acquisition of a Britain-based company, according to Thomson Reuters data. Unilever is the larger of the two companies by market valuation, worth $120.2bn against $106.2 for Kraft-Heinz.

The takeover attempt has been rejected, with a Unilever statement claiming that it fundamentally undervalues the company. “Unilever rejected the proposal as it sees no merit, either financial or strategic, for Unilevers shareholders,” the statement concluded. But these types of mega mergers are rarely ever over after a first attempt and this saga will likely run for months to come.

In fact on Sunday it emerged that Kraft Heinz is poised to defy opposition to its £115bn takeover bid by taking its proposal directly to the shareholders of the consumer goods giant. The American food goliath will meet some of Unilever’s biggest investors over the next few days to test their interest in its takeover effort.

A slow period

KH moved for Unilever at a time when the company is going through a slow period. Last month, Unilever reported that fourth-quarter underlying sales rose 2.2 percent, the worst result in two years and below the 2.6 percent gain seen by analysts. Growth at the company’s personal care business, its biggest unit, also hit a two-year low, as shipments declined for the second straight quarter.

Commenting on the results, Unilever CEO Paul Polman said: “Our priorities for 2017 continue to be volume growth ahead of our markets, a further increase in core operating margin and strong cash flow. The tough market conditions which made the end of the year particularly challenging are likely to continue in the first half of 2017. Against this background, we expect a slow start with growth improving as the year progresses.”

“Unilever, for some time, has been seen as underperforming, with difficulties in emerging markets, slow growth in Europe and problems with margins, despite its move away from food and household products towards the much higher returns in personal care and cosmetics,” notes Heather Johnston, a London-based analyst with Innova Market Insights. “Its chairman has been very open in acknowledging these sales problems, while reminding shareholders of the other side of why they may own Unilever – its social commitments. Unilever has been a leader in commitments such as responsible palm oil, water usage, sustainable business, and its approach to its employees across the globe,” she notes.

An Innova Market Insights analysis of new product activity from Unilever in 2016 (see chart) indicates that Sauces & Seasonings (26.6%), Desserts & Ice Cream (22.8%) and Soup (11.6%) are the areas wher the most recent work is being shifted towards. The move would certainly give Kraft-Heinz a immediate huge stake in the ice cream market.

A short history of cuts

The pursuer, Kraft-Heinz, was itself only formed in 2015 in a deal backed by Warren Buffetts investment company Berkshire Hathaway. It came after private investment group 3G Capital combined with Berkshire Hathaway four years ago – in a deal announced on Valentines Day – to acquire the iconic Pittsburgh company H.J. Heinz Co.

3G are financial engineers based in Brazil, who were formed in the 1990s. the group has a history of taking over companies and aggressively cutting costs. The buyout firms typical playbook has been to target companies with weak margins and then slash costs to boost profitability.

Bernardo Hees, a 3G partner, has slashed jobs and pursued other savings, some of them granular, as CEO of Kraft-Heinz. For example, in a 2015 memo to employees, Hees reminded them to print on both sides of the paper, reuse office supplies like binders and turn off computers before leaving the office to cut down on energy costs. The company even went as far as stopping the stocking of the corporate office with free Kraft snacks.

“Like private equity, 3G find companies which have higher costs or lower margins, or perhaps a large cash balance, and then restructure them by divestment, cost-cutting and loans, to give themselves and their investors (such as Warren Buffett, also mentioned in the Unilever deal) a large dividend pay-off,” says Johnston. “The rump company may continue but, like Kraft-Heinz, is often run for cash, not growth or development. The other company formed as part of the Kraft split was Mondelez, which has also concentrated on financial engineering and is currently cutting costs and brands severely but has not managed to regain growth.”

Partly as a result of that move, a tie-up between Kraft-Heinz and Unilever is likely to draw huge opposition in the UK, wher memories of Krafts takeover of iconic confectionery company Cadbury and the subsequent job cuts that followed are still raw. Unilever employs about 7,500 people in the UK and estimates its products are in 98 percent of the country’s households. The falling price of sterling in the wake of the Brexit vote is believed to be one of the reasons why major UK companies can be available "on the cheap."

Inside the move

Discussing the rationale for the deal, Johnston notes that 3Gs Kraft-Heinz is a US company selling low margin, mass market US groceries. While Unilever has a US operation, notably Lipton and an ice cream business (“Heart” brand), the US only accounts for €8bn in sales out of €53bn globally (2015 finals), so there would be few synergies across the whole business. Globally, Unilevers foods (spreads and some regional brands) have fallen to 24% of turnover, “refreshment,” which includes ice cream and tea is stable at 19%, household cleaners are 19% and personal care is 38%. Kraft-Heinz has no personal care or household cleaners interests.

But if 3G are not buying sales, or development potential for KH (its split into KH and Mondelez explicitly got out of all non-US markets) then what is the attraction? “The answer is likely to be purely financial, and short-term. The 3G modus operandi is to cut workforces sharply, reduce investment, divest and move to zero-base budgeting. KHs sales are dropping even if its short term profits are rising,” notes Johnston.

If KH is buying Unilever to become a diversified non-US based corporation, this would be a huge about-turn in strategy and can therefore be dismissed. “This is not about brands or expansion, but purely about getting the money out. In which context, it is worth mentioning that Unilever, being long-established, has a very large pension fund, which is also a major shareholder,” notes Johnston.

No company has a divine right to exist, she stresses, even companies that make a point of being good neighbors and good citizens, but shareholders and other stakeholders now have a decision to make: what sort of companies do they want? Is the extra expense of being a “good citizen” going to be rewarded with loyalty, or not? Is short-term financial return the only measure which matters? “once the jobs are lost, the research establishments and the sustainability commitments are gone, and the brands are declining from lack of support, it will be too late to think again,” says Johnston.

A relatively quiet period

The mega tie-up between Unilever and Kraft-Heinz would come after a relatively quiet period in M&A in the food industry, with Danone’s purchase of WhiteWave the most notable major acquisition of 2016. The Food Institute recorded 256 deals in the first six months of 2016, after a relatively slow 2015, a 24.3% increase and only three deals lower than 2014, which was a high-activity year.

But 3G has been linked with several acquisition moves in recent months, including Kellogg’s. In fact the purchase of Heinz was mainly perceived to be a matter of gaining an initial foothold in the food industry, to serve as a stepping stone.

One of the initial responses to Friday’s news was that shares of packaged goods companies that had been speculated as potential 3G targets tumbled on news the private equity firm was going in a different direction. Shares of Mondelez International Inc., General Mills Inc., Kellogg Co. and Campbell Soup Co. all fell on Friday, adding to declines they sustained last Thursday, amid reports that 3G was looking beyond packaged food for its next target.

Inside M&A trends

In general, it can be said that M&A activity is a reflection of general economic activity, but also cyclical, because it depends very heavily on the financial context. Put simply, if the economy is growing, then companies become more ambitious. But if you can’t borrow money to buy a company, you may not be able to expand by acquisition. And if companies can’t borrow, then selling unwanted divisions also becomes difficult.

2016 and the beginning of 2017 have seen slow economic revival, but the financial context is most unusual. Around the world, short-term interest rates are at historically low levels – down to zero in Europe. Money has been injected into the system through “quantitative easing.” But that does not mean that banks or funds are eager to lend: they are under pressure to maintain their capital, and the quality of their lending, by international regulation. Loans might be cheap, but you have to find one first.

Normally, if money was only “costing” a few percent, this would be a trigger for widespread activity. The ability to ‘buy’ sales growth of 4-5% a year for a “cost” which is significantly lower would make buying growth and brands significantly cheaper and much lower-risk than developing them internally. But today’s special conditions are reducing the ability to make approaches to takeover targets.

Some business sectors are highly active in M&A, wher companies buy out technologies, patents or distribution networks. This can be seen in hi-tech and telecoms companies, but also in areas such as biotech. A large biotech group will buy out a one-product specialist developer; the developer sells because it does not have the resources or sales team to develop the property further, and the buyer gets a product already part of the way through the difficult and expensive development process.

Megadeals are becoming more popular as companies find the only way to keep their share of the market is to merge with the competition. However, activity is limited by anti-competition regulation in many jurisdictions. “In nearly a third of industries, most US companies compete in markets that would be considered highly concentrated under current federal antitrust standards, up from about a quarter in 1996,” according to The Wall Street Journal.

This is less often the case in foods, although buying brands or sector entry is still a major reason for using M&A to expand. Large-scale restructuring purchases are uncommon, but have a big impact: notably Kraft-Heinz, Mondelez-Jacobs and in 2016, Danone-White Wave.

The Tetris complications

In a recent Innova Market Insights report entitled “Mergers and Acquisitions in 2016: The Tempo Rises,” Johnston assessed the complexity of the Kraft-Heinz-Mondelez-Cadbury-Jacobs-Keurig situation, indicating just how even more complex this will become if an even larger company like Unilever were thrown into the mix.

Founded by a family in 1869, Heinz is a major brand in processed foods such as soup and condiments, based in the US but with foreign sales. However, faced with stagnating sales, in 2013 they sold themselves to financial group Berkshire Hathaway and 3G.

Cadbury was a company founded in the UK by a charitable Quaker family, with a dominant position in UK confectionery, and international sales. After a fierce takeover battle it was bought by Kraft Foods in 2009.

Sara Lee was a US conglomerate across a range of markets from cooked meats to clothing, deodorants, frozen cake and coffee. It operated in the US but also in Europe. In 2012, Sara Lee Corporation was split in two. North American operations became Hillshire Brands (though the Sara Lee name continued on bakery and deli products). International beverage and bakery businesses became D.E Master Blenders 1753 (for Douwe Egberts, the European coffee brand bought in 1978, plus the US Master Blenders coffee brand).

Kraft in its modern form is the descendent of a series of mergers and demergers going back to Philip Morris, the tobacco company, who bought it in 1988 to merge with the General Foods division. In 1990 Kraft bought Jacobs Suchard, a European coffee and confectionery group, and Nabisco’s cereals unit. Philip Morris spun off the Kraft foods division as a separate public company in 2007, to focus on tobacco.

Berkshire Hathaway became an investor in Kraft in 2008. Kraft bought confectionery company Cadbury in 2009. but sales disappointed and the cost of merger and integration was high. In 2012, Kraft split its non-US confectionery and coffee interests out into Mondelez, leaving Kraft as a US-focussed grocery and coffee business.

The first move in the recent sequence of company sales and acquisitions was the Heinz-Kraft merger, facilitated by Berkshire Hathaway and 3G, the Brazilian private equity group. This was a financial move rather than brand- or sales-led.

Last week, Kraft-Heinz reported its fourth quarter and full year 2016 financial results that show how its cost savings have led to significant gains with more savings expected by the year-end. Following its merger in 2015, Kraft-Heinz has been cutting back on expenses and on Wednesday it announced that it now expects to achieve US$1.7 billion in savings. General and administrative expenses fell back 21.3%, while during the fourth quarter the cost of products sold declined 6.8%.

The company now expects its multi-year Integration Program to deliver US$1.7 billion in cumulative, pre-tax savings by the end of 2017, up from US$1.5 billion previously. The program is now forecast to result in US$2.0 billion of pre-tax costs, up from US$1.9 billion previously, and US$1.3 billion of capital expenditures, up from US$1.1 billion previously.

Coffee group D.E Master Blenders 1753 was floated by Sara Lee in 2012, and bought by private investors JAB Holdings in 2013. DEMB was merged with the coffee division of Mondelez International in 2015 to form Jacobs Douwe Egberts, Mondelez retaining a minority stake in the new group.

Jacobs Douwe Egberts is now majority owned by Acorn Holdings, a subsidiary of JAB Holding Company, the holding company for the Reimann family (the German owners of Benckiser and other consumer companies). In 2015, JDE bought Keurig Green Mountain of the US (and Krispy Kreme doughnuts).

Mondelez sales have been affected by divestments but in 2013, revenues were $35.3 bn, and in 2016 they are $29.6 bn. Sales by all product categories fell in 2015, (excluding the beverages division which was affected by the sale of the coffee brands). Some of this is currency-related, and raw materials prices had an impact, but some is simply lost sales; “Unfavorable volume/mix was driven by declines in refreshment beverages, cheese & grocery, chocolate and biscuits, partially offset by gains in gum & candy.”

In 2016, Mondelez made an offer for private confectionery company Hershey, although activist investor Nelson Peltz is suggesting that the confectionery interest – a large part of which is Cadbury – should be split into a separate company. The company currently carries $15.5 bn in long-term debt.

One problem with this game of Company Tetris is that it is now quite impossible to track the financial performance of any of these groupings: they have changed shape too often. (The London Stock Exchange does not permit companies to list if, over the last three years, they have significantly altered their businesses, precisely because of this. If these were new companies, it might be hard to get a listing for some of them. )

While brands have been parcelled out to divisions, which have then changed company parent (some several times) the real damage may well have been in company systems.

Integrating one large corporation with another is tough enough: all the IT and financial systems have to communicate. To retain a clear vision of the performance of a division which has been reorganised several times in a few years is a tough ask. Maintaining a clear brand vision must be as hard.

The evidence above is that while M&A in mature companies may improve reportable profits, it does not necessarily have a good impact on sales.

A tie-up between Kraft-Heinz and Unilever will face numerous challenges, including shareholder resistance and likely competition concerns. But should KH succeed and a regulatory green light follow, it would create a mega FMCG player and an even more complex tapestry to the existing Kraft-Heinz structure.