Dan Loeb's Third Point, which has more than doubled the S&P 500's return the last two decades, just made its largest investment ever with a multibillion-dollar bet on Swiss food giant Nestle.
Loeb's hedge fund firm owns around 40 million shares of Nestle, according to an investor letter published Sunday. The position totals over $3.5 billion and includes options. It is held in Third Point's hedge funds and a special purpose vehicle specifically raised for the investment, according to the manager.
A Third Point spokesperson said the SPV is "close to $1 billion."
"Third Point invested in Nestlé because we recognized a familiar set of conditions that make it ripe for improvement and change: a conglomerate with unrealized potential for margin improvement and innovation in its core businesses, an unoptimized balance sheet, a number of non-core assets, and a recent history of meaningful under-performance versus peers," Loeb wrote in the note to clients. "It is rare to find a business of Nestlé's quality with so many avenues for improvement."
Meetings between Nestle and Third Point have been going on for a while, according to CNBC's David Faber.
The hedge fund manager believes the stock has the most upside, versus downside, he's seen in almost anything, according to sources close to the fund who talked to CNBC's Scott Wapner.
Nestle is a Swiss packaged foods company and owns brands such as KitKat, Nespresso and Butterfinger. It is the largest food company in the world with a market value of more than $270 billion, according to FactSet.
The manager shared more details on his proposal for Nestle in the letter:
1. "Improving Productivity: We believe Nestlé should adopt a formal margin target … Nestlé's CY16 EBIT margin 15.3% (16% ex-items) is at the low end of its peers, nearly all of which are now targeting high-teens to low 20's margins. Our work suggests Nestlé should be able to improve margins by as much as 400 basis points over the next several years."
2. "Capital Return: We believe capital return in conjunction with a formal leverage target makes sense as well … Share repurchase is a particularly attractive option at the moment since the company has the potential to grow earnings considerably over the next few years as sales growth reaccelerates and margins expand."
3. "Re-Shaping the Portfolio: It is past time for Nestlé to undergo a comprehensive portfolio review. The company operates today with over 2,000 brands in Food & Beverage and Health Science. Management must determine which of these businesses are key pillars of growth for the future and then strategically reduce exposure to those that are not."
4. "Monetizing the L'Oréal Stake: It is also time for Nestlé to sell its stake in L'Oréal … having L'Oréal in the portfolio is not strategic and shareholders should be free to choose whether they want to invest in Nestlé or some combination of Nestlé and L'Oréal."
During a meeting with CEO Mark Schneider a couple weeks ago in Switzerland, nothing led Loeb to believe the CEO is averse to doing many of the suggestions laid out by Third Point, according to sources who spoke to CNBC's Wapner.
Loeb estimates Nestle earnings-per-share will rise more than 50 percent by 2020 versus last year if his plans are implemented.
"We believe our recommendations to Nestlé management, if taken together, would dramatically improve both the growth profile and earnings power of the company," he wrote. The shares then will "command a premium not just to the market but also to the broader staples group, generating attractive returns for shareholders."
To be sure, not everyone on Wall Street is optimistic on Loeb's proposals.
"We counsel caution from here, reflecting our view that Third Point's targets will be non-trivial to achieve … their influence is relatively dilute," Jefferies analyst Martin Deboo wrote in a note to clients Monday entitled "Counselling Caution on Third Point."
Deboo reiterated his hold rating on the shares and also noted Nestle's valuation is "already anticipating a healthy degree of change."
Loeb's hedge fund Third Point Offshore is up 9.9 percent through the end of May this year compared with the S&P 500's 8.7 percent return in the same time period, according to an investor report. From inception in June 1995 to May the fund generated annual returns of 15.9 percent versus the market's 7.8 percent.
In regard to Loeb's investment strategy, Third Point materials describe its philosophy as "event-driven, value-oriented," with an "emphasis on special situation equities." The firm "seeks to identify situations where we anticipate a catalyst will unlock value."
The firm currently has $18 billion of assets under management, according to a Third Point spokesperson.
L'Oreal did not immediately respond to a request for comment. Third Point declined to comment on the Nestle investment.
A Nestle spokesperson sent the following statement: "As always, we keep an open dialogue with all of our shareholders and we remain committed to executing our strategy and creating long-term shareholder value. Beyond that, we have no specific comment."
Nestle shares rose more than 4 percent in Europe after Dan Loeb's investment news was released. An ADR trades in the U.S. in the over-the-counter market under the ticker NSRGY.
— With reporting from CNBC's Leslie Picker, David Faber and Scott Wapner.
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