Spotlight: Deals, Results and Management

Charlie Huggins (CFA) - Fund Manager

17 February 2017

It's the Oscars next Saturday so we're running with the film theme to bring you a trilogy of fund related news in today's blog. Late last week one of our biggest holdings, Reckitt Benckiser, announced it had sealed a $17.9 billion deal to buy Mead Johnson Nutrition. On Monday, Fidessa, released full year numbers and the previous Friday, Just Eat, fell by over 6% on news that its CEO is stepping down. Plenty to talk about then, so we'll take each in turn.

Part 1: Reckitt Benckiser - the deal thesis

What we like:

MJN claim global leadership in the baby formula milk market and RB are buying when MJN shares were trading close to a five year low. Whilst MJN has had some tough trading conditions lately, RB has serious form in rejuvenating brands.

Financially, RB are talking about some pretty meaningful earnings benefits from the deal, not least from an identified £200m of synergies they expect over the next few years.

MJN will also lift RB's exposure to emerging markets and the United States, both areas with great long term potential. Exposure to Consumer Healthcare, which we've long viewed as the most attractive part of their brand portfolio, will also double.

What we don't like:

RB is taking a lot of debt on board to make the deal happen and that flashes a warning light to us. But with RB generating £2bn of free cash last year, they should be able to pay the debt down quite swiftly. We wouldn't be too surprised to see them look to sell off slower growing brands from their portfolio to accelerate this.

Chief Exec Rakesh Kapoor has an eye-watering remuneration package, and part of his payout is determined by growth in earnings per share. Buying MJN pushes earnings ahead, but is not expected to deliver returns in excess of cost of capital for up to five years. So the deal could end up working better for RK than it does for RB.

Our verdict:

For now, we're backing RB to make a success of the deal. The company has done very well historically from buying brands that were in need of more pizazz and boosting their growth through better marketing, taking them into new countries and broadening the brands' ranges. Although there are no guarantees they will be able to repeat their past successes.

With debts now running at high levels, our focus will very much be on levels of cash generation because RB needs to put as much effort into reducing those debts as it does into reinvigorating MJN's performance.

Part 2: Fidessa - robust performance

Fidessa, our financial services software provider, reported a 12% increase in revenue and a 25% rise in profit before tax in 2016, although this was significantly boosted by sterling weakness (around three quarters of sales are earned in foreign currencies).

Stripping out currency effects, sales grew by 3% and profits by 1%. That may seem pedestrian, but we view it as a resilient performance against a backdrop of closures and consolidations amongst some of Fidessa's customer base, many of which are investment banks. In 2016 this reduced revenue growth by some 4% but the good news is this headwind is expected to ease in 2017, although this isn't guaranteed.

In the medium to long run there are a number of initiatives that could accelerate growth. New regulations such as MiFID II, due to come into force from January 2018, could drive increased demand for Fidessa's solutions, while extension into other asset classes like derivatives and fixed income could create new sources of demand for the group's technology; to name just two.

Fidessa is enormously cash generative. This has enabled it to pay a special dividend, on top of ordinary dividends, in each of the last 8 years. The total dividend for 2016 (including specials) was raised by 11%, so the shares offer a yield approaching 4% (yields are variable and not a reliable indicator of future income). This means we are being paid to wait for our long term investment case to play out .

Part 3: Just Eat - are the concerns justified?

Just Eat has been our weakest performing holding since launch, falling by around 11% since 1 December. We maintain a positive long term view, and have been adding to our position.

The full year trading update in January highlighted a slowdown in UK order growth from 48% in 2015 to 31% in 2016 heightening concerns over the competitive threat from Deliveroo. Sentiment took a further knock last Friday when the highly regarded Chief Exec, David Buttress, announced he was stepping down due to urgent family matters.

The law of large numbers (analysts estimate that Just Eat executes c.8.5 million orders per month in the UK) means that c. 50% UK order growth was never going to be sustained for long. 31% growth is still exceptional and the long term growth opportunity still looks very good to us, with around half of UK takeaway orders still done over the phone.

Losing David Buttress (CEO) could hold back the company's ability to strike new M&A deals, an area where the group has made strong progress in the past. But we doubt that Just Eat's core customers, the takeaway owners, let alone their own hungry clientele, will notice at all. With growth driven primarily by the ongoing shift toward consuming meals that have been prepared outside of the home, Just Eat's commanding market position still appears highly attractive to us.

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