Gillette Acquisition May Be Hurting P&G

Earnings Numbers Indicate Weaker Organic Growth

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CINCINNATI ( -- After reporting some of its weakest quarterly top and bottom-line numbers in three years, Procter & Gamble Co. is feeding the doubts of people who thought it might be biting off more than it could chew with its $57 billion acquisition of Gillette Co. last year.
A confluence of events could cause P&G to pull back on its advertising spending plans ahead of the TV upfront.
A confluence of events could cause P&G to pull back on its advertising spending plans ahead of the TV upfront.

And a more conservative outlook for sales and earnings in the coming quarter and year -- as well as marketing mix models and growing experimentation with other media -- could also lead P&G to pull back on TV spending plans ahead of the U.S. upfront.

Beat average estimates
P&G didn't disappoint when it released earnings numbers for its fiscal third quarter, ended March 31, today. In fact, it came in at the top end of its revised 5% to 6% organic sales growth range it forecast in March and beat average analyst earnings estimates by 2 cents.

But surprising weakness in the top line of newly acquired Gillette's blade-and-razor business globally -- combined with weak organic sales growth in most of P&G's businesses -- helped send its stock down 3.25% to $56.22 today (though it rebounded from a drop of more than 5% earlier in the day).

The most likely reason for the market's reaction was "lackluster growth from Gillette, increasing acquisition risk fear and emboldening those who decry big [mergers and acquisitions] or claim that the deal was done to cover up organic weakness," Deutsche Bank Analyst William Schmitz said in a research note.

He isn't one of those people, having maintained a buy rating on the stock, adding that "time will prove the [deal doubters] wrong" and that continued strength of the base business disproves the weakness cover-up.

Possible difficulties in 2007
While P&G's guidance for the fiscal fourth quarter and its indications for fiscal 2007 were weaker than some analysts had hoped, Mr. Schmitz chalked it up to conservatism in the face of a "potentially difficult" fiscal 2007 as P&G consolidates Gillette and faces competitors such as Colgate-Palmolive Co., Kimberly-Clark Corp. and Unilever. Those companies are all using restructuring savings to market more aggressively.

Though P&G has never failed to deliver promised bottom-line results from acquisitions, the company has seen disappointing top-line results in the years following most of its acquisitions, including Tampax, Clairol and Wella.

Gillette, at least for this quarter, has followed suit. Global sales of the all-important blades-and-razor business rose only 1%, P&G said, though Gillette executives and others close to the company say the closely watched February launch of the six-bladed Fusion razor has performed well ahead of plan in the U.S.

When P&G announced the Gillette acquisition in January 2005, it said Gillette's stronger growth prospects and ability to combine complementary businesses in various parts of the world would add a percentage point to its long-term organic growth target, which it raised to 5%-7%.

But P&G today blamed the overall weak quarterly results for Gillette blades and razors on inventory draw-downs associated with consolidating P&G and Gillette distribution in Asia.

The Wal-Mart factor
In March, P&G had cited Wal-Mart Stores' efforts to trim inventory as a factor behind its pullback in organic sales growth forecasts, but Chairman-CEO A.G. Lafley played down the Wal-Mart factor somewhat in a conference call with analysts today. He said inventory reductions are "something we deal with all the time" and that Wal-Mart's current effort, which P&G began planning for last year, could ultimately help P&G because it will tend to reduce the shelf presence of smaller competitive brands.

P&G's more conservative outlook comes ahead of the U.S. TV upfront and could signal another year of retrenchment in TV spending for the nation's biggest advertiser, which last year pulled money off the table across network, cable and syndication.

P&G reduced advertising spending last quarter globally, the company said in a statement, because of a less-aggressive new-product effort compared to the year-ago quarter. But Mr. Lafley said P&G's "innovation program" for the full year is stronger than a year ago, and Chief Financial Officer Clayton Daley indicated ad spending as a percent of sales would remain in the 10% to 11% for the quarter and year.

Out of TV?
P&G's use of marketing mix modeling, now covering 80%-85% of its biggest brands, may be playing a role in moving some marketing funds out of TV, Mr. Lafley said, but he said the company's overall TV spending globally has increased every year for the past several years and will continue to do so this year.

Experimentation in new media and marketing approaches could also pull P&G funds away from TV, he said.

Mr. Lafley noted that P&G has taken money out of TV in Japan in favor of putting pet-health nutritionists in stores. He said that move resulted in "a huge bump in business."

"At Cannes the past couple of years, we got recognized for our alternatives to television," he said. He also cited online programs such as for feminine care and Home Made Simple in home care as examples of P&G shifting somewhat out of its traditional reliance on TV.

"We are experimenting with almost anything that will reach our consumer target," Mr. Lafley said, "And that means over time we're going to be moving out of some of the television."
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