Why Nestle Paid $11.9 Billion for Pfizer (NYSE: PFE) Baby Food

By , Contributing Writer, Money Morning •

Nestlé SA, the world's largest food maker, has agreed to acquire Pfizer Inc.'s (NYSE: PFE) baby food business for a hefty $11.9 billion.

Nestlé outbid potential rivals like Danone SA and Mead Johnson Nutrition Co. (NYSE: MJN).

Chris Hogg, a spokesperson for Switzerland-based Nestlé, said the company will be funded entirely through debt, "namely through internal cash resources and through the bond markets."

In a statement, Nestlé CEO Paul Bulcke said, "Pfizer Nutrition is an excellent strategic fit and this acquisition underlines our commitment to be the world's leading nutrition, health and wellness company. Its strong brands and product portfolio, together with its geographic presence will compliment our existing infant nutrition business perfectly."

Nearly $12 billion for baby food sounds steep - that's nearly 20 times earnings before interest, tax, depreciation and amortization (EBITDA). Most analysts expected the deal to top out at $10 billion, according to The Wall Street Journal.

But Bulcke tried to assure investors that this was a growth move aimed at getting ahead of the game and snagging a leadership role in a market that will drive the company's earnings for years.

"At first look [Nestle's acquisition] is expensive, no doubt," Patrik Schwendimann, an analyst at Zuercher Kantonalbank, told The Journal. "On the other hand, the Pfizer deal is attractive for Nestlé in the long term. Its exposure to emerging markets is higher than expected, which is attractive, and the margins are also higher than expected."

Nestlé Gains Emerging Market Presence

The acquisition will help Nestlé , currently the No.1 seller of infant nutrition products, reclaim footing in the Chinese baby-food market, where it has lost market share since 2005.

The newly acquired Pfizer unit obtains roughly 85% of sales from emerging markets like Asia, Africa and the Middle East. Pfizer estimated 2012 sales in those regions would top $2 billion.

Nestlé says the acquisition will lead to annual cost benefits of $160 million and will enhance earnings per share in the first full year. The Pfizer unit will amplify Nestl'e's sales of infant formula by 40%.

What investors need to know is that the debt-funded acquisition may weigh on Nestlé. It could put pressure on its rating, as its debt could increase above management's target rate of $16.4 billion (15 billion francs), to $19.7 billion (18 billion francs) during this year and next, Fitch Rating points out.

Bloomberg reports Nestle has $8.1 billion (7.4 billion francs) of bonds outstanding, including $2 billion (1.8 billion francs) of securities due in 2012. The cost to insure Nestlé's debt against default did not increase much after the debt-heavy Pfizer deal was announced. Since the start of the year credit default swaps on Nestl'e have declined, showing that investor perception of the food maker's credit quality has improved.

Fitch currently ranks Nestl'e "AA+" along with Moody's Investors Service. Standard & Poor's currently maintains an "AA" rating on Nestl'e.

How Nestlé Deal Helps Pfizer (NYSE: PFE)

Pfizer expects the divestiture to be completed by the first half of 2013.

The pharmaceutical giant has been shedding businesses outside its core medicine franchise. Pfizer's nutrition unit is among its smallest, and it no longer fits in the drug maker's core focus of selling prescription medicine.

The question is how far will Pfizer go in its business spin-off strategy. It has already said it will look into selling its animal health unit - which could land an even bigger bid than the Nestlé deal.

While removing additional divisions could create a more streamlined, fast-growing drug company, the key to Pfizer's success will be its ability to bring new drugs to market.

Pfizer is currently working with Elan Corp. (NYSE ADR: ELN) and Johnson & Johnson (NYSE: JNJ) on a potential game-changing drug to treat Alzheimer's. The FDA will review the treatment in the second half of the year.

Pfizer also has two drugs coming up for approval: rheumatoid arthritis pill tofacitinib, and blood thinner Eliquis.

In afternoon trading Monday, with markets suffering a triple-digit sell-off, shares of Pfizer were little changed at $22.39, not far below its 52-week high of $22.80. Nestl'e lost about 0.64%, trading at $60.89.

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