Procter & Gamble Just Says No

Just say no to drugs.

That was the message shareholders sent to Procter & Gamble (PG), and the company listened, saying Monday it had cut off talks with Warner-Lambert (WLA) and American Home Products (AHP) about buying the two drugmakers.

P&G, in a statement, took a passive-aggressive tone, blaming "leaks and resulting speculation" for sinking the deal. But analysts say the real problem was the more than 17% dive P&G shares had taken since news of the talks mysteriously showed up in The Wall Street Journal last Wednesday (something P&G and its bankers surely had nothing to do with).

"Nobody wanted it," says Andrew Shore, consumer products analyst with PaineWebber. "And the company isn't fiscally irresponsible. They've always been one of the more shareholder-conscious companies." (Shore rates P&G shares attractive and his firm has done recent banking for P&G.) P&G spokesman Simon Denegri wouldn't comment on whether it spoke to shareholders about the proposed purchase.

Now, the problem is that P&G, which under CEO Durk Jager was striving to shake away its sluggish ways, seems hemmed in. Shareholders apparently want the Cincinnati-based company to stick to its knitting, which ultimately might mean slow growth. After P&G backed off Monday, its stock rallied.

On paper, at least, the Warner-Lambert and American Home acquisitions in question fit the criteria that P&G has set out for itself in eyeing prospective purchases: large global markets with opportunities to leverage technology across its lineup of products (which include Tide, Charmin and Cover Girl) and a chance to apply its marketing muscle.

And as part of its futuristic-sounding program, Organization 2005, P&G is committed to deriving between 1% and 2% of its targeted 6% to 8% annual sales growth from acquisitions. P&G has already made a big purchase in the last year, the $2.3 billion acquisition of hoity-toity pet food maker Iams.

"By going into pharmaceuticals, they'd drive margins and also drive unit sales," says Burt Flickinger III, managing director of Reach Marketing and a former P&G exec. (Flickinger's firm has done consulting for P&G.) P&G already has a small pharma unit, but it hasn't produced any blockbuster drugs.

But analysts said investors weren't too thrilled about the prospect of P&G hitching its wagons to the bucking broncos of pharma rather than the steady, nag-like consumer products industry. Sure, drugs would have boosted growth. But then, "buying Cisco (CSCO) would be a better growth opportunity, too," says Shore.

An acquisition would have likely hit earnings in the first year or two, particularly if P&G got caught in a bidding war with Pfizer (PFE) over Warner-Lambert.

Besides, P&G has been doing well lately: Its new product lineup, including the Swiffer dust assassin and Dryel home dry-cleaning kit, are performing nicely and its cost-cutting and cost cuts are kicking in benefits. The company is set to report quarterly earnings on Tuesday, and analysts expect it will report earnings per share of 88 cents, up 13% from 78 cents last year.

"It'll be the best quarter they've had in two years," says William Steele, an analyst with Banc of America Securities. (He rates P&G shares a buy and his firm hasn't done recent banking for the company.)

Now that it's stepped out of the drug wars, the company may turn its sights to Gillette (G), says Shore. As TheStreet.com wrote in November, Gillette might make a good addition to P&G's or Colgate's (CL) consumer products businesses, and The Wall Street Journal reported Monday that P&G had approached Gillette a few weeks before pursuing the pharma deals. (P&G wouldn't comment on whether it's held, or is holding, talks with Gillette.)

Gillette, whose shares are about 34% off their 52-week high, has been a consumer products malingerer ever since Latin American and Asian economies took a dive. The company is now weighing the sale of its small household appliance and stationery units and trying to beef up its capital management. But its Mach 3 razor and Duracell battery businesses may make a tempting target. Gillette spokesman Eric Kraus says as a matter of policy the company doesn't comment on speculation or on potential merger or acquisition activity.

"Gillette is absolute bait," says Shore. And after Monday's announcement, P&G may be ready to keep fishing. Of course, the most crucial question may be whether investors will bite.

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