Will a $10 Billion Skincare Buyout Leave a Rash?

(Bloomberg Opinion) -- $10 billion leveraged buyouts don’t come round often and, when they do, the U.S. private equity goliaths tend to nab them. Nestle SA’s auction of its skin health unit has ended with a surprise European winner: Swedish private equity firm EQT Partners.

It’s a pricey transaction that will test the received wisdom that orphan assets in big conglomerates can be turbocharged by private equity. Securing such a high-profile target should also help to burnish EQT’s credentials as it weighs its own initial public offering.

EQT’s latest buyout fund totals 11 billion euros ($12 billion), and it’s unlikely to want the deal to absorb more than a fifth of that. Hence the firm has assembled a group of co-investors, among them the Abu Dhabi Investment Authority.

Nestle’s skin health business ranges from moisturizer to acne treatments. It accounts for only a small fraction of group sales. The operation’s history suggests another parent would be beneficial. It began as a joint venture with L’Oreal SA before the Swiss company took full control. Writedowns followed, and the division was put up for sale last year.

Will a $10 Billion Skincare Buyout Leave a Rash?

Under pressure from activist investor Dan Loeb, Nestle has been trying hard to improve things, and says the business achieved double-digit revenue growth in the first quarter. Still, the price EQT is paying is a wager things could get a lot better. Assume the business made a little more than 550 million francs of Ebitda on 2.8 billion francs of sales last year, in line with Nestle’s group margin. The price paid by EQT is some 18 times that Ebitda. That's the same multiple as Nestle trades at, but the parent also owns many better performing businesses.

Now assume the deal is funded with 5.1 billion francs of equity and the same in debt. To hit a 20% internal rate of return over five years would mean growing the value of the equity to more than 12 billion francs. One way to achieve that would be to increase Ebitda to almost 1 billion francs and sell at nearly the same multiple EQT is paying here. If debt is cut to 4 billion francs along the way, EQT would clear the hurdle.

Such an outcome isn’t totally outlandish. It would mean expanding sales by roughly 5% a year and lifting Ebitda margins to 25% from 20%. Skincare margins are generally higher than that. Nestle may have revived sales, but there is ample scope to boost the business’s profitability.

Success cannot be taken for granted. The price is full, and the Swedish private equity firm’s ambition has seen it best U.S. rivals like KKR & Co. that are unafraid of paying up for big deals – witness the latter’s $8 billion buyout of Unilever NV’s spreads business last year. EQT will have to work hard to prove the beauty of this deal is more than skin deep.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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