(Adds detail from sources on why Unilever feared a merger with Kraft, link to Breakingviews column)
By Carl O'Donnell
NEW YORK, Feb 19 (Reuters) - U.S. food company Kraft Heinz Co withdrew its proposal for a $143-billion merger with larger rival Unilever Plc, the companies said on Sunday, raising questions about whether Kraft will turn its focus to another target.
Kraft had made a surprise offer for Unilever to build a global consumer goods behemoth that was flatly rejected on Friday by Unilever, the maker of Lipton tea and Dove soap.
Kraft withdrew its offer because it felt it was too difficult to negotiate a deal following the public disclosure of its bid so soon after its approach to Unilever, according to people familiar with the matter who requested anonymity to discuss confidential deliberations.
Kraft had not expected to encounter the resistance it received from Unilever, one of the people said. Some key concerns raised during talks included potential UK government scrutiny, as well as differences between the companies' cultures and business models, the person added.
“Kraft Heinz’s interest was made public at an extremely early stage," Kraft Heinz spokesman Michael Mullen said in a statement. "Our intention was to proceed on a friendly basis, but it was made clear Unilever did not wish to pursue a transaction. It is best to step away early so both companies can focus on their own independent plans to generate value.”
Kraft was forced to publicly disclose its offer on Friday to comply with Britain's takeover regulations, after rumors of its approach to Unilever circulated among stock traders.
Under UK takeover rules, Kraft's public withdrawal of its offer precludes it from reviving takeover talks with Unilever for six months.
A combination would be the third-biggest takeover in history and the largest acquisition of a UK-based company, according to Thomson Reuters data. The combined entity would have $82 billion in sales.
The premature exposure of Kraft's bid left the aggressive acquisition machine scrambling to craft an appetizing message for shareholders, the press, Unilever's rank and file, and British and Dutch leaders.
Prime Minister Theresa May ordered top officials to investigate if the proposed deal posed potential threats to British economic interests, the Financial Times reported.
May has been adamant the government should be more active in vetting proposed foreign acquisitions of UK companies. She had previously singled out Kraft's 2010 acquisition of another British household name, Cadbury Plc, as an example of a deal that should have been blocked.
A deal for Unilever would have marked the next installment of Brazilian private equity firm 3G Capital Management Inc's longstanding strategy of buying food companies and slashing costs.
In 2013, 3G teamed up with billionaire investor Warren Buffett to acquire Heinz and then purchased Kraft two years later. It is now the second-largest shareholder in Kraft, behind Buffett's Berkshire Hathaway Inc.
Unilever feared that a merger with Kraft, under 3G Capital's relentless cost-cutting, risked eroding the value of its brands and could impede its expansion in emerging markets, which requires more investment, according to people familiar with the company's thinking.
Unilever also saw its household products and consumer care divisions as too distinct from Kraft's food business, the people added.
3G made its name in corporate America by orchestrating large debt-laden acquisitions and then slashing costs dramatically to juice profits. Using a strategy called zero-based budgeting, its managers must justify all expenses, from pencils to forklifts.
KRAFT STILL HUNGRY?
The breakdown in deal talks sparked speculation among analysts and investors about whether Kraft might attempt to purchase another large consumer goods company as a backup plan.
"We believe this announcement serves as a reminder – if needed – of (Kraft's) interest, capacity, and commitment to pursuing large-scale M&A in a potentially near-term time horizon," said Barclays analyst Andrew Lazar in a note.
Its bid for Unilever, where more than 60 percent of sales come from home and personal care products, signals a willingness to make big buys outside of its historic area of focus - food - said Sanford Bernstein analyst Ali Dibadj.
He cited Colgate-Palmolive Co as one potential target, noting that its stock popped 4 percent Friday on news that Kraft was eyeing Unilever.
However, the breakdown of the Unilever talks means that some food companies that have long been speculated as potential targets for Kraft, such as Mondelez, are still very much on the table, said an industry banker, who declined to be named because he was not authorized to speak to the press.
Low interest rates and cheap debt have fueled big cross-border deals, marking the busiest start to the year for M&A activity on record. The bid also reflected a broader interest in UK companies as acquisition targets, in part due to the British pound, which has been under pressure since Britain announced plans to withdraw from the European Union.
Labor union representatives expressed relief that the deal talks broke down, citing concern about its potential effect on jobs and consumers.
"How many scares must the government put UK workers through before they actually do as they have promised, which is to make the takeover process socially responsible?" said Len McCluskey, general secretary at Unite, Britain's largest union.
(Reporting by Ismail Shakil in Bengaluru, Pamela Barbaglia in London, Lauren Hirsch and Greg Roumeliotis in New York; Editing by Nick Zieminski and Phil Berlowitz)