- The board should have recognized that participation in baby formula would be complicated
- When Reckitt moved into baby formula, it entered more complicated territory
- Formula considered a poor substitute for breast milk and divides opinion
The US market for pharmaceutical and healthcare products is expansive, the profit margins are generous and any multinational that tries to ignore it might well give up.
However, the United States also exposes corporations to regulation and litigation.
GSK shares are hit by a glut of Zantac, the stomach drug that, despite strong scientific evidence to the contrary, has been claimed to cause cancer.
Britain’s Reckitt Benckiser faces an even bigger premium. For many years Reckitt defied gravity. Demonstrated ability to turn underperforming consumer health and hygiene assets, such as Cillit Bang and Nurofen, into super brands. However, when it moved into baby formula, with the £13bn acquisition of Mead Johnson five years ago, it entered more complicated territory.
Infant formula, while providing nutrition, has long been considered a controversial topic and a poor substitute for breast milk, dividing opinion.
Tricky territory: Baby formula, while providing nutrition, has long been considered a controversial topic and a poor substitute for breast milk, dividing opinion.
It is often the only food source available to premature babies in prenatal care units before mothers can produce their own milk. The plaintiffs claim that Mead Johnson (and Abbott’s baby formula) is responsible for causing the deaths of prenatal babies. Litigation brought by well-funded specialists got a boost from an Illinois jury. Earlier this year it ordered Reckitt’s Mead Johnson subsidiary to pay $60 million to the mother of a premature baby who died of an intestinal disease after being fed Enfamil formula.
The case has become a serious problem for Reckitt CEO Kris Licht. At a time when FTSE100 shares have been rising, Reckitt shares have fallen 30 per cent over the last year.
Broker Barclays estimates that the cost of dealing with the litigation launched against Mead Johnson (still structured as a separate entity) could be between £500m and £2bn. Suffice it to say that class action lawsuits in the United States are a notorious lottery and the outcome is unpredictable.
Reckitt should have 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 battle for Zantac tells us that the underlying truth doesn’t really matter. 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 the death of a baby will be difficult to overcome. It may not help that Reckitt has been somewhat sloppy, particularly regarding the deaths in South Korea caused by a completely unrelated humidifier disinfectant malfunction.
Reckitt’s management problem is how best to address it and restore investor confidence. One discussed solution is to split Mead Johnson into a separate entity.
A proposal put forward by Barclays analysts would require Reckitt to spin off a majority stake in Mead Johnson and relist it in the United States. The figures suggest that such a move, in which Mead Johnson would assume a portion of the debt, could resolve the legal problem. The formula company generates sufficient cash flows and profits to meet potential liabilities.
There are lessons to be learned from Reckitt’s downfall. Transformative mergers rarely deliver the growth and dividends their protagonists promise. A more politically aware Reckitt board should have recognized that involvement in baby formula would be complicated and carry enormous litigation risks. The price is already being paid.