Kraft Heinz

and listing to the Netherlands. As I remarked at the time, it is not a good way to manage relationships to ignore people until you need their support. Once contact had been established with Unilever we then tried to make some points about what we saw as problems with the performance of the business and the focus of the management, which were duly ignored. This is a business making a return on capital in the mid to low teens, below the market average, where you could measure annual growth if you could only count to three, and which missed every target it set out when it summarily rejected the Kraft Heinz bid approach. So it’s not like there weren’t some questions to answer. Then came the near-death experience with the abortive GSK Consumer bid. I don’t know how long Trian held its stake before Mr Peltz was invited to join the board or how big that stake was, but I would guess that they held it for far fewer months than we have held it in terms of years. We have no objection to Mr Peltz’s involvement. He at least seems to have the sense to become involved in good businesses which need some improvement, whereas some activists pick on poor businesses and all they can hope to achieve is a better-run bad business.

£60m of additional expenditure, two thirds of which is on product development. The other main corporate engagement outside the run of the mill AGM proxies and remuneration consultations in 2018 concerned Unilever, which announced a plan to unify its Anglo Dutch dual share structure and centre the headquarters and listing in the Netherlands. This was to be subject to a shareholder vote in the UK PLC which never occurred, presumably because the board could see it was about to be defeated. Unlike some investors, the switch of listing would not have affected our ability to continue as shareholders. Our engagement with the Chairman centred around the motivation for the move which was portrayed as a desirable simplification that would make it easier for Unilever to engage in acquisitions involving share issues, particularly in the United States. We were rather sceptical about the stated reasons for the change. The previous year Unilever had a near death experience with a takeover approach from Kraft Heinz. Add to this the episode in which the US chemical company PPG Industries had bid for the Dutch paint maker Akzo Nobel and a subsequent freedom of information request had revealed collusive activity between Akzo Nobel’s management and Dutch politicians to thwart the bid and you did not need to be the fictional Dutch detective Van der Valk to figure out that there might be some other motivations for the proposed move.

As you will be able to tell if you read our annual letter last year, we are far from enthusiastic about most shareholder activism nor are we shareholders in or fans of the Kraft Heinz business model. But we thought that Unilever’s management had a case to answer and we think that the ability to mount a hostile takeover is an important discipline in ensuring that our assets are properly managed. When the Chairman told us that he was never in favour of such actions, though he concurred that some companies were poorly managed, we were at best a bit confused about what mechanism he thought might be applied if such a change became necessary. Harsh language maybe? We did not take part in any public commentary about our voting intentions had the Unilever changes come to a vote and please note that we have not revealed that here, we have merely commented on the process. In our view achieving good stewardship of a business is not always a process best conducted through the media.

Quite a lot happened to affect our portfolio companies and we have seen some takeover activity in the past year. In addition to the bid for CR Bard and the bid approach from Kraft Heinz for Unilever, activists became involved in ADP and Nestlé, which we own, and P&G, which we had already sold, but which remains in our Investable Universe of stocks we would own given certain conditions. I thought it might therefore be helpful to investors if I described our reaction to each of these in turn, since we may not be very active in the sense of changing portfolio positions but we are often engaged in thinking about situations such as these. Automatic Data Processing (‘ADP’) / Pershing Square Payroll and HR services company ADP was approached by activist fund Pershing Square, led by Bill Ackman, who had ‘bought’ an 8.3% stake. The inverted commas are because this stake involved 36.8m shares, 28.0m of which were in fact call options and not actual shares. This did not amount to true ownership in our view since Pershing Square had no right to vote the shares covered by those call options and neither had they expended the cash to purchase the shares. Pershing Square’s approach to ADP became a public row and proxy contest with Pershing Square delivering a 168 page presentation, several letters suggesting ways to improve operating efficiency, which might be summarized as ‘cut costs quickly’, and demanding three board seats. The reaction of the ADP management was interesting.

Unilever / Kraft Heinz On 17th February, the story broke that Unilever had received a bid approach from Kraft Heinz, the listed food products company controlled by 3G, the Brazilian entrepreneurs who also control AB InBev, the world’s largest brewer, and Burger King, together with Warren Buffett’s Berkshire Hathaway. On 22nd February, Unilever put out two releases by way of immediate response. The first was entitled, ‘Unilever guidance update’ which said that Unilever ‘now expects core operating margin improvement for 2017 to be at the upper end of its 40–80bps guidance’. The second release said, ‘Unilever is conducting a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders. The events of the last week have highlighted the need to capture more quickly the value we see in Unilever. We expect the review to be completed by early April, after which we will communicate further.’ On 6th April, Unilever announced the results of this review.

The company said it was: • ‘Accelerating its ‘Connected 4 Growth’ programme and targeting a 20% underlying operating margin, before restructuring, by 2020’ • Combining the foods and refreshment units into one unit, ‘unlocking future growth and faster margin progression’ • Establishing a net debt/EBITDA target of 2x • Launching a €5bn share buyback program • Raising the dividend by 12%—about double the recent rate of increase This approach clearly falls foul of our scepticism when management produces rabbits from a hat when an activist or takeover comes into view. We think we should already have seen the rabbits or at least been told about their existence. To hopefully be clear, we are not fans of Kraft Heinz. We have never owned any shares in Kraft Heinz or its constituent parts. Although 3G has managed to operate the business with efficiency as they have AB InBev, to produce great cost savings leading to operating profit margins of 23% in 2016 and strong gains for owners, well certainly for 3G and Berkshire Hathaway, we have never found a business which can cut its way to growth. Although the Kraft Heinz management are certainly handicapped in this regard by the nature of the company’s brands, which are mostly not in growing areas of the market, the sort of people and approaches you need to grow businesses tend not to flourish in cultures in which the emphasis is on cost cutting.

However, the contrast between their approach and that of Unilever does raise some questions for Unilever’s management which remain unanswered. To give you a simple illustration of this, in 2016 Unilever had €52.7bn of revenues and an average of 169,000 employees, thus revenue per employee of about €312,000. Kraft Heinz had €23.8bn of sales and an average of 41,500 employees, and so revenue per employee of about €574,000. Kraft Heinz has slightly less than half the sales of Unilever but manages to achieve this with less than a quarter of the number of the employees. You don’t have to be a fan of brutal cost cutting to see that Unilever has a case to answer here.

Unfortunately we never got to hear Unilever justify its rather interesting sales/employee ratios because Kraft Heinz withdrew as soon as it became evident that Unilever was hostile to the approach. Warren Buffett is notoriously opposed to hostile takeovers. I hope that has given you all some insight into how we think about and interact with the companies in our portfolio and those we are interested in, and other shareholders, activists and bidders. Finally, I wish you a happy New Year and thank you for your continued support for our Fund. My colleagues and I look forward to seeing many of you at our Annual Shareholders’ Meeting on 27th February 2018 and to trying to answer any questions you may have. Please see the enclosed invitation for details. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: An English language prospectus for the Fundsmith Equity Fund is available on request and via the Fundsmith website and investors should consult this document before purchasing shares in the Fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product.

Icahn's 2007-2008 campaign against RJR Nabisco's successor, Kraft, and his earlier 1980s assault on RJR itself, displayed his long-run consistency: he argued that consumer conglomerates trading at discounts to their parts should be split or sold. He proposed disposals and buybacks, won partial concessions, and kept returning to the theme across decades whenever the valuation gap reopened.