Selling its LU biscuits division would allow Danone to concentrate on its faster-growing bottled water and dairy product businesses. Buying Numico – known for its Milupa, Nutricia and Cow & Gate brands – would further strengthen Danone’s focus on ‘healthy food’.

Numico adds expertise in the specialised markets for baby food and clinical nutrition to Danone’s strength in mainstream food markets.

Danone’s chief executive Franck Riboud said the deal with Numico would create “the most powerful” health food company in the world. It combines the Dutch group’s expertise in the specialised markets for baby food and clinical nutrition – food for patients with specific dietary or medical requirements – with Danone’s strength in two more mainstream markets that have also benefited greatly from their associated health benefits. “The combination of the two groups will create a unique food company – the one with the clearest and most powerful health positioning in the world,” Riboud said on the day the deal was announced. “With this project, we are designing a new Danone, enhancing dramatically its growth profile and its growth potential for the years to come.” And the price tag reflected this, he stressed: “The price Danone is offering today is a reflection of the outstanding quality and positioning of Numico as one of the world’s leaders in healthy nutrition.”
But Danone’s eagerness to benefit from Numico’s healthy credentials prompted more than a few raised eyebrows among financial analysts, not least because the price of €55 per share offered by the French firm was at a premium of 44 per cent to Numico’s average share price over the three months before the offer was made. Moreover, analysts were concerned that the Numico deal could push Danone too far away from its core food business and into the niche market of nutritional products – Numico’s other main business line is clinical nutrition. But Riboud argues strongly that Danone is increasingly focused on healthy products – including its own line of baby food – and that its entire strategy in recent years has been based on strengthening that business.

It was then, and notwithstanding the continued presence in biscuits, that the group began its healthy products strategy, buoyed by the increasing amount of scientific evidence surrounding the benefits of dairy products. The sale of the biscuit business and the acquisition of Numico mark the culmination of a ten-year reworking of Danone into arguably the world’s biggest and best-known producer of mainstream ‘healthy’ brands – a strategy that has been phenomenally successful. In 2006, company sales increased by 9.7 per cent on a like-for-like basis to €14.1 billion, with the two main ‘healthy’ product lines leading the way: dairy product sales were up 9.2 per cent to €7.9 billion, while beverage sales increased by 14.8 per cent to €3.9 billion.

International expansion
Riboud’s decade at the helm of Danone has also seen a marked internationalisation by the company, with more than 40 acquisitions in Latin America, Asia and South Africa since 1997. The French group’s brands are sold in 120 countries worldwide. This increasing global presence has helped the company’s recent good performance. Sales in 2006 increased by a healthy 5.1 per cent in Europe, but it was a stunning performance in Asia – notably in China – with sales up 20.6 per cent that contributed to the main increase in sales in 2006. Yet this international expansion, which, somewhat unusually, has taken the form of acquisitions of stakes in both large and small market players rather than through the direct launch of existing Danone products, is not without its problems. Sales for 2007 – nine-month figures were released in mid-October – show a 2.7 per cent downturn in Asia sales compared to the same figures in 2006, due almost entirely to an increasingly bitter dispute with Danone’s Chinese partner, Wahaha.

Danone Net sales

Back in 1996, the French group showed considerable vision when it first decided to expand its Chinese operations through a partnership with this well-known local producer of beverages. However, it has in many ways become a victim of its own success. Buoyed by phenomenally successful sales from the joint venture, Wahaha has begun to expand its own range, a move that Danone claims violates the terms of their original agreement. The Chinese firm in turn claims that that agreement was not validated under Chinese law, leaving Danone facing not only the prospect of a lengthy and expensive legal battle but also, and more worryingly, the potential loss of one of its most successful businesses. Riboud put on a brave face, however, arguing that “the strength of our growth model is remarkable” and that he was confident of meeting the 6-8 per cent growth targets set at the start of the year. “This gives me additional confidence in our business prospects as we prepare to welcome Numico into the group by year-end,” he added.

Numico: saviour or sinker?
But will Numico help ease the pain of Danone’s current Asian crisis or merely add to its financial woes? Karel Zoete, analyst at the Dutch Rabobank, believes that the “nutrition business is a comfortable fit with Danone, given the growing link between food and health, and Danone already has a strong research and development pedigree in this area with its Actimel brand of functional dairy drink.” But, he stresses that “the two companies have made it quite clear that Numico’s business will not be consolidated into Danone, and will remain as a stand-alone unit in the Netherlands, so there will be no clear cost synergies generated by the takeover.”

Danone sales by region

Nonetheless, Zoete says that the longer-term benefits for Danone could be considerable, and potentially worth the hefty price tag. “Numico is very advanced in terms of R&D into nutritional products that can be used to treat diseases, and this is not too far away from what Danone is also doing in the dairy products sector. For example, Numico’s R&D arm has developed products for people who are allergic to cow’s milk, which is likely to be of obvious interest to a company that specialises in dairy products. Some of Numico’s nutritional products are very close to pharmaceuticals, targeted at specific diseases. For example, one product, for treating Alzheimer’s disease using amino acids and vitamins, is currently undergoing phase two clinical trials. This sort of R&D knowledge could have great potential for Danone if it were to be developed into a more mainstream food – added to yoghurts, for example. All it needs is for Numico’s R&D to come up with one or two ‘blockbusters’ like this and then the synergies with Danone become much clearer. Numico in itself is a great business for Danone to buy but if it can come up with these blockbusters as well, then the investment looks well worth it.”
But not everyone is so convinced. Charlie Mills, an analyst with Credit Suisse in London, says that there is no getting round the fact that Danone has paid too much for Numico, potentially hindering its chances of further expansion. “What Danone offered was a very full price, and the company hasn’t really justified it. There are always two rationales behind any acquisition: the commercial and the financial. On the commercial side, the Numico business is complementary to that of Danone, and fits well with a long-term acquisition strategy. But on the financial side, the reasoning is less clear. Usually a company justifies a high premium on the grounds of cost savings or growth acceleration, and Danone’s cost savings [the group has suggested €60 million] just don’t seem to add up in this case. As for accelerating growth at Numico, it is hard to see how that could be greatly improved by Danone, giving the pace at which it is already happening. Any suggestion that Danone could somehow justify the price offered by suggesting that Numico’s R&D could lead to a blockbuster product any time soon is rubbish.”

A bold acquisition

“We are designing a new Danone, enhancing dramatically its growth profile and its growth potential for the years to come.”

Danone has obliquely acknowledged the long-term nature of its investment in Numico, with chief financial officer Antoine Giscard d’Estaing admitting that it would be likely to be six or seven years before it saw real financial benefits from the deal. Riboud also stressed that Danone had a history of cautious, but profitable, investment and that the company had not been afraid in the past to step back from acquisitions it considered to be too expensive – an indication that this was not the case this time around. Even so, the acquisition appears to be a somewhat bolder step than Danone is usually prepared to make, with Riboud himself admitting that the company’s strategy has tended to focus on building up sales in a new market from a relatively small base. “We can start out with nothing, or buy the number three or number four business, as we did in Egypt, where our market share jumped from nil to over 12 per cent in only a year. Buying the local leader isn’t the only path to success,” Riboud said earlier this year.
That said, there are some ‘local leaders’ that could be considered at least as interesting as Numico and offering potentially greater cost savings. “There was considerable speculation that Danone would bid for the Russian dairy group Wimm-Bill-Dann, or Japanese functional food firm Yakult, both of which could have been seen as offering more obvious immediate synergies,” says Zoete. “Indeed, both these companies could still have a strategic fit with Danone.” Mills agrees that Wimm-Bill-Dann and Yakult would also have been good fits for Danone but warns that Danone’s chances of investing in either of these groups in the foreseeable future has probably been scuppered by the excessive price paid for Numico. “The Numico acquisition shouldn’t stop Danone investing completely, spending say €300-500 million a year on increasing stakes in minority shareholdings or moving into new regions, for example. But substantial investments of the size of Wimm-Bill-Dann or Yakult are unlikely.”

What next?
So is Danone putting all its eggs into one basket, counting on a major blockbuster discovery from Numico that will revolutionise the dairy market and restore the company’s now slightly tarnished image? Such a narrow vision does not fit easily with Riboud’s strategy for Danone, although there is no doubt that the company will be working towards developing just such a blockbuster product as a matter of urgency. Yet the company will continue to do far more than that. “We must provide vigorous support for our brands, set up new production facilities, make major investments in research, accelerate geographical expansion and open up new frontiers,” Riboud said in the annual report, stressing in particular the potential for moving into new countries with strong brands such as Activia, the group’s flagship live culture yoghurt brand. “Activia is a magnificent success, with sales running at €1.3 billion and showing strong growth even on mature markets such as France and Spain. But if you set your sights a little higher, you see that Activia is present in only 30 countries and only a small part of its potential has been realised. If we can double the number of countries where the Activia brand is sold and maintain the pace of organic growth, you’re looking at annual sales of €5 billion a few years from now.”
He makes it clear that Danone’s long-term expansion plan is likely to be geographical above all – a move made all the more likely following the sale of the biscuit business and the even tighter focus on healthy products. “Danone is now firmly established in only about 40 countries. I think we should be able to double the number in years ahead. We have the financial resources to make several acquisitions every year, especially because our potential partners are generally small to medium-sized operations serving local markets.” Recent pre-Numico deals included investments in Algeria, Egypt, Thailand and Colombia, and it is these ‘developing’ markets that are likely to remain the focus of the company’s strategy in the future.
However, the high price paid for Numico and the sharp deterioration in the relationship with Wahaha, in many ways Danone’s flagship foreign investment, have exposed the precariousness of Danone’s strategy: too tight a focus on certain types of products means it has less room for manoeuvre on price and fewer choices of stable, reliable partners. Neither problem is insurmountable – if Numico helps Danone create more innovative dairy products, no-one will remember how much it cost. Furthermore, the French group has many other investments in China that could yet prove just as successful as Wahaha – but they have taken some of the shine off a company whose performance under Franck Riboud has been exemplary. Both he and the company will undoubtedly bounce back but investors and shareholders will be a little more wary in the future.