A sale of Danones waters division could be more likely in the coming months

A sale of Danone's waters division could be more likely in the coming months

For a company which claims to have water in its ‘DNA’, Danone has to fend off rumours that it is ready to sell its water business with remarkable regularity. The speculation arose last week that the French company had been approached by Japanese drinks group Suntory. The rumours were fuelled further on Friday by reports in Japan that the two companies would begin negotiations next month.

Danone has dismissed the rumours, as it did last November, telling just-drinks that water remains strategic to the company. A Suntory spokesperson said it was not formally in negotiations with Danone.

However, there are two key differences between the takeover speculation last November and this year. 

First, there appears to be a clearer rationale for such a move on Danone’s part. Analysts maintain that Danone wants to sell its water business to finance a takeover bid for Pfizer’s baby nutrition business. In other words, its keenness to develop its baby nutrition activities now outweighs its longstanding commitment to bottled water. Last year, analysts said Danone would only move out of water to fund a move into something else, but there was little indication of what that acquisition target might be.

Secondly, the rumours last year were considerably vaguer, with insiders quoted as saying that both Kirin and Asahi were talking to Danone. This time, the speculation is centred specifically on Suntory.

The deal would certainly be transformative for Suntory. With a saturated soft drinks market in Japan and the prospect of declining juices and ready-to-drink tea and coffee categories, the move would provide Suntory not only with acquisitive expansion but with much-needed organic growth going forward. “Suntory is looking to expand outside of its home market, particularly in Asia, to help drive sales,” Datamonitor analyst Michael Hughes tells just-drinks.

However, with a valuation of US$6bn to $7bn for the entire Danone water business, the size of the deal could deter Suntory, which may prefer simply to buy Danone’s Asian water operations.

If Danone does want to sell, it is likely to want to offload the entire division in one fell swoop. Being left with a business stripped of what could be higher-growth elements and still seen as less synergetic with its core dairy and baby nutrition activities, is unlikely to be an alluring prospect. “The sheer size of the deal could prove a stumbling block," says Hughes, "particularly as Danone wants to sell its entire water division.”

The question therefore remains whether a rival bidder would have the wherewithal to move in with an offer for the whole operation. Japanese firms Kirin and Asahi were both linked with bids last year, with The Coca-Cola Co and PepsiCo also mentioned. However, as yet. none of these names have been linked with counter-bids this time round. 

In fact, Hughes believes the size of Danone’s total water business would make such an acquisition a difficult proposition for any company, so the sale of its Asian operations to Suntory remains “a very real possibility”.

In addition to the steep price-tag on a total acquisition, it is easy to see why Suntory is focusing on the Asian businesses. The company already has some presence in bottled water: It markets its own Suntory Natural Mineral Water range and, interestingly, entered a deal to distribute three Nestle bottled water brands in Japan back in 2005. However, the addition of brands such as Evian and Volvic to its portfolio would appeal to consumers in the emerging Asian markets that Suntory is aiming at by dint of their international, and western, cachet.

Danone itself reported recently that its bottled water volumes have shown strong growth in Asian markets on the back of rising sales to younger, urban consumers looking for premium brands.

Datamonitor forecasts that, between 2010 and 2015, the Asia Pacific bottled water sector will grow by 69%. The Chinese market is set to more than double to US$24.1bn, while India will almost double to $1.8bn. The bottled water segment in Indonesia, a country where Suntory is apredy present in the soft drinks sector, is also forecast to show strong growth over the next four years.

While Danone is thought to be motivated to sell because bottled water offers less synergy with its other operations and the need to raise cash, it has also been noted that the water businesses are delivering growth below Danone’s group average. The water division also has the lowest operating profit margins out of the company's four business units. That Suntory is a private company may mean that its growth requirements would be a little less exacting and it will be prepared to take a longer-term view on bottled water. 

A further twist came at the weekend with a report in the FT that Mengniu Dairy, China's largest dairy firm, is considering making a bid for Pfizer’s baby nutrition arm. Mengniu played down the report but did not deny its interest. Danone is clearly not the only company likely to be interested should Pfizer decide to offload its infant nutrition business. Nestle, Mead Johnson and Heinz have also been suggested as possible bidders.

This could impact on Suntory’s supposed plans either negatively or positively. The idea that Danone is facing competition in its pursuit of Pfizer’s baby food arm may concentrate the French company’s mind somewhat and leave any company putting money on the table for its water business in a reasonably strong position.

On the other hand, if Danone were to see the Pfizer deal snatched by a rival suitor, its immediate need for acquisition funds disappears, which could weaken the position of any company bidding for its bottled water business.