By Saabira Chaudhuri and Annie Gasparro 

Deal talks between Kraft Heinz Co. and Unilever PLC are dead, but both consumer-goods giants now find themselves under heightened pressure to make bold moves to accelerate growth.

Unilever shares fell 6.6% in London Monday after Kraft Heinz dropped its $143 billion bid for its rival -- partly reversing a 13% jump on Friday, when the offer became public.

Unilever made clear it didn't want to pursue a tie-up, but investors in recent years have encouraged the Anglo-Dutch maker of Ben & Jerry's ice cream, Dove soap and Axe deodorant to sell underperforming businesses or do a large acquisition to boost its shareholder returns, which have lagged behind other European home and personal-care companies. Chief Executive Paul Polman has so far danced to his own tune.

"It's a wake-up call for Unilever and they need to respond," Société Générale analyst Warren Ackerman said of the short-lived offer. Unilever declined to comment.

Kraft Heinz, meanwhile, has significantly improved its profitability since the 2015 deal that created the company, driven by the aggressive cost-cutting methods of Brazilian private-equity firm 3G Capital, its biggest shareholder. But it is now running out of costs to cut, leaving investors hungry for another deal.

Kraft Heinz shares soared by 11% on Friday, as shareholders cheered the prospect of a new acquisition. U.S. markets were closed on Monday in observance of Presidents Day. Barclays analyst Andrew Lazar said the offer served "as a reminder of Kraft Heinz's interest, capacity and commitment to pursuing large-scale M&A in a potentially near-term time horizon."

3G, which has raised at least $10 billion in new funds, declined to comment.

Analysts and investors expect Mondelez International Inc. to be a likely takeover target for Kraft Heinz, because it was part of Kraft before their 2012 breakup and has a strong presence in emerging markets where Kraft Heinz wants to expand. A Mondelez spokeswoman said "we don't comment on market rumors or speculation."

Kraft Heinz said buying rivals isn't the only way for it to produce strong returns. Chief Financial Officer Paulo Basilio, also a partner at 3G, said Wednesday that the company has decided to make additional investments in food-quality improvement and developing new products to boost sales.

"We don't need another acquisition to drive value," Mr. Basilio said.

Investors in companies led by 3G, including Anheuser-Busch InBev NV and Burger King operator Restaurant Brands International Inc., have come to expect rapid returns. When savings max out a few years after a merger, 3G has a habit of making another sizable deal, beginning the process over again.

At Heinz, which it bought in 2013 along with Warren Buffett, 3G managed to strip out $1 billion in annual costs before acquiring Kraft two years later. Last year, Kraft Heinz's operating-profit margin expanded 5 percentage points to 23% of sales.

The need for cost cuts is exacerbated by changing consumer tastes away from packaged goods and toward healthier offerings. Kraft Heinz, which logged $26.5 billion in sales last year, in 2015 said the deal would allow the combined conglomerate to revive the center aisles of supermarkets. But its comparable sales inched up 0.3% last year after falling 1.6% in 2015.

Unilever's food business has fared better than most of its rivals in recent years, thanks in part to the company's large footprint in emerging markets, where consumer preference for packaged goods remains strong. Unlike Kraft, the company's biggest revenue sources come from its higher-margin personal- and home-care businesses, which sell things like soaps and detergents.

But since Mr. Polman became CEO in January 2009, Unilever has posted a total shareholder return of 193%, according to Exane BNP Paribas data. The results underperform most of Unilever's European peers: 464% at Henkel AG, 290% at Reckitt Benckiser Group PLC and 215% at L'Oréal SA.

Unilever's profit margins also have lagged behind those of some of its U.S. and European rivals, and the company rarely buys back shares, a strategy analysts say Mr. Polman views as financial engineering. Unilever last repurchased its shares in 2007 and last paid a special dividend in 1999.

"Investors have been very patient yet have been given relatively mediocre financial reward," said Exane analyst Jeff Stent. "This should not be back to business as usual at Unilever."

Following Kraft Heinz's approach, Unilever could come under increased pressure to sell, spin off or strike a joint venture for its declining spreads business, which includes margarine brands such as Flora and Blue Band. "Just because it's declining doesn't mean you just sell it; you only sell it if the price you can get for it is better than if you keep it," Mr. Polman told reporters last year.

Analysts have also suggested Unilever could choose to divest certain local tea brands -- such as PG Tips in the U.K. -- and instead focus on launching premium tea brands more widely. Despite being the world's largest tea company, Unilever has turned in lackluster sales growth for years as consumers move away from mainstream black tea into areas such as green and herbal teas, to which it has less exposure.

Mr. Polman has stayed away from large acquisitions in recent years, instead opting for a series of deals up to $1 billion, including last year's purchase of Dollar Shave Club Inc. But Kraft's approach underscores Unilever's vulnerability as the pound has weakened sharply against the dollar while Unilever investors hoping for a big payout have been left disappointed. All this could propel Mr. Polman to look at bigger acquisitions as a pathway to growth.

The company has long been rumored to be interested in buying Colgate-Palmolive Co., which would significantly boost its exposure to high-growth personal-care products and deliver major cost savings. Analysts say now would be a good time for such a move given that a January profit warning has pressured the toothpaste maker's shares, borrowing costs are low and Unilever's balance sheet is in good health.

Exane BNP Paribas on Monday raised its target price on Colgate to $90 from $68 and upgraded its rating, saying "the likelihood of Unilever seeking to acquire Colgate has now increased materially." Colgate closed Friday at $71.98, giving it a market value of nearly $64 billion.

Unilever has also long been floated as a natural buyer for Edgewell Personal Care Co., which owns shaving brands such as Schick, Edge and Skintimate along with sun-care brands such as Banana Boat and Hawaiian Tropic. Edgewell has a market capitalization of $4.6 billion.

Edgewell and Colgate didn't respond to requests for comment.

Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com and Annie Gasparro at annie.gasparro@wsj.com

 

(END) Dow Jones Newswires

February 21, 2017 02:47 ET (07:47 GMT)

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