After $16.7bn Mead Johnson bid, is Reckitt Benckiser Group plc a buy?

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Burning Question proper size

Shares of Reckitt Benckiser(LSE: RB) shot to the top of the leader board this morning after it confirmed it was in talks to acquire US baby foods group Mead Johnson Nutrition, whose brands include Enfamil infant formula.

Is Mead Johnson a good buy for Reckitt? Will the deal happen? And should you snap up shares of the FTSE 100 consumer goods powerhouse?

A good buy?

Reckitt is looking to buy Mead Johnson for $90 a share in cash, valuing the US firm at $16.7bn. This is affordable for Reckitt, whose market cap is £50bn at a current share price of 7,100p (up 4% on the day). It expects to finance the deal with a combination of cash and debt "whilst retaining a strong investment grade credit rating".

As well as being affordable, the valuation looks attractive. The proposed $90 a share represents 17 times Mead Johnson's forecast 2017 earnings before interest, tax, depreciation and amortisation (EBITDA), which compares favourably with the 20 times forecast EBITDA Danone is paying for WhiteWave Foods.

Mead Johnson could also be a good buy for Reckitt because it further diversifies its range of consumer categories, which are currently best represented by Lysol cleaning, Durex condoms, Nurofen painkillers and Scholl footcare. Mead Johnson's strength in Asia, particularly China, would also usefully increase Reckitt's exposure to higher-growth emerging markets.

Will the deal happen?

Reckitt's announcement contained the usual disclaimer that there's "no certainty that any transaction will ultimately be agreed, nor as to the terms on which any transaction might occur". However, there looks to be a good chance of it going ahead for a number of reasons.

Reckitt said today that it's in "advanced negotiations" and at the stage of "due diligence and contract discussion". Another positive for a go-ahead is that the acquisition would present no antitrust obstacles to Reckitt, something that can't be said of Nestlé, which has been seen as a potential bidder for Mead Johnson. Meanwhile Danone, another touted bidder, is busy completing its WhiteWave Foods deal.

Should you snap up the shares?

After the rise in its shares today, Reckitt is trading on 21 times forecast 2017 earnings. That may look a bit pricey but there are a number of reasons why I believe the stock is still worth buying.

  • I reckon there's a good chance the deal will go ahead and if so, it will be earnings-enhancing.
  • While this would be Reckitt's biggest deal to date, it's previously done a fine job of integrating some other pretty sizeable companies.
  • There are always analysts who question the advisability of an acquisition but the market's initial reaction to the news -- favourable in Reckitt's case -- is often a better guide to the longer-term direction the shares will take if the deal does complete.
  • If the deal were to collapse and the share price fall back, I don't think it would be too long before Reckitt sought out another prize asset for an earnings-enhancing acquisition. Pfizer's consumer-health unit, for example.

For these four reasons, I wouldn't be put off buying Reckitt's shares today.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Reckitt Benckiser. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.