Reckitt Benckiser under the cosh on baby food, says ALEX BRUMMER
- The board should have recognized that involvement in bottle feeding would be fraught
- When Reckitt switched to baby food, he entered more difficult territory
- Formula is considered a poor substitute for breast milk and divides opinion
The US pharmaceutical and healthcare market is vast, profit margins are generous, and any multinational that tries to ignore this might as well give up the ghost.
Yet the United States also exposes companies to banana peels in terms of regulation and litigation.
GSK shares are suffering from the overhang of Zantac, the stomach drug that is claimed – despite solid scientific evidence to the contrary – to have caused cancer.
The British Reckitt Benckiser is facing an even greater share price increase. For years, Reckitt defied gravity. It demonstrated the ability to transform underperforming hygiene and consumer health products such as Cillit Bang and Nurofen into superbrands. However, when the company moved into baby food, with a £13 billion takeover of Mead Johnson five years ago, it found itself in more difficult territory.
Baby food, while providing nutrition, has long been considered controversial and a poor substitute for breast milk, and has divided opinions.
Difficult terrain: Although baby food provides nutrition, it has long been seen as controversial and a poor substitute for breast milk, and opinions are divided
It is often the only food source available to premature babies in antenatal care units before mothers can produce their own milk. Plaintiffs allege that Mead Johnson (and Abbott’s baby formula) is responsible for causing the deaths of prenatal babies. The lawsuit brought by well-funded specialists was fueled by an Illinois jury. Earlier this year, it ordered Reckitt’s Mead Johnson arm to pay $60 million to the mother of a premature baby who died of intestinal disease after being given Enfamil formula.
The case has become a serious problem for Reckitt CEO Kris Licht. At a time when FTSE100 shares are on the rise, Reckitt shares are down 30 per cent in the past year.
Broker Barclays estimates that the cost of dealing with the lawsuit against Mead Johnson – which is still structured as a separate entity – could be between £500m and £2bn. Suffice it to say that US class action lawsuits are a notorious lottery and the outcome is unpredictable.
Reckitt has little to worry about. In most neonatal intensive care units, medical experts have no choice but to administer formula to supplement or replace breast or donor milk.
GSK’s fight over Zantac tells us that it doesn’t really matter what the underlying truth is. In jury cases, even if the evidence is fragmentary, the panel will always be more sympathetic to the plaintiff than large corporations. The emotional pull of a baby’s death will be difficult to overcome. It may not help that Reckitt has a case of carelessness, especially regarding the deaths in South Korea caused by a completely unrelated, malfunctioning humidifier disinfectant.
Reckitt’s management problem is the best way to deal with this and restore investor confidence. One proposed solution is to spin off Mead Johnson into a separate entity.
A proposal from analysts at Barclays would call for Reckitt to spin off a majority stake in Mead Johnson and relaunch it in the US. The figures suggest that such a move, with Mead Johnson taking on some of the debt, could solve the legal problem. The formula company generates sufficient cash flows and profits to meet potential obligations.
There are lessons to be learned from Reckitt’s demise. Transforming mergers rarely deliver the growth and dividends that the key players promise. A more politically aware Reckitt board should have recognized that involvement in baby food would be fraught and involve enormous lawsuits. The price is now being paid.