Food & drink: loss of appetite?

Food and drink transactions over the last 20 years have been slow and steady and certainly haven't followed the boom and bust of the dot.com. Private equity houses see the sector as a reliable source of investment opportunities, but deal flow has slowed over the last year with an increasing pressure on exiting these businesses. Is the private equity industry's appetite for food and drink businesses waning?

Food and drink is part of the backbone of the European economy. It represents 13 per cent of total production and 12 per cent of employment in the manufacturing sector. With over EURO600 billion of production and EURO145 billion of added value it is the EU's third largest industrial employer with over 2.6 million employees in almost 26,000 companies, according to the Confederation of the Food and Drink Industries of the EU (CIAA). It is also a leading exporting sector with a total of EURO45 billion and a positive trade balance.

The disposal of non-strategic brands from food giants such as Danone, Nestle, Procter & Gamble and Unilever has been a major source of deal flow. Across the board these multinationals built up diverse international portfolios and then discovered they can't manage multiple businesses in different categories and in different countries. This has resulted in a frenzy of mass divestments, throwing up opportunities for private equity houses. But the question is what growth potential do these businesses offer a private equity player?

"The food sector is not going to reveal much volume growth unless the population grows or we start eating more, which is unlikely. It will only really grow by value," says Marc Mathenz, principal at Henderson Global Investors. Private equity players need to find a business that allows you to add extra value layers to the product. "No one really invents new food, you either reinvent an existing food type or product or make it more convenient; that's the value-added. This is also the only way the market can grow," he says. He uses bread sales as an example.

Sales of bread remained stable and did not show significant growth until part-baked products such as ciabatta and French bread came onto the market. The only way a private equity firm can succeed in this business s by acquiring a business where there is a corporate culture of creating value-added products. The more products you have that lend themselves to re-invention, the more successful your business will be, says Mathenz.

"People still need to eat and will pay more for convenience. It does not take a lot of R&D to re-invent a food product but rather a good understanding of the changing consumer habits and preferences," says Mathenz.

Food V Drink

Food and drink is a fragmented industry so there is plenty of room for consolidation, particularly buy-and-build opportunities. Food and drink manufacturers can be divided into various sub-sectors; meat and beverages alone account for one third of the total production value of the food industry. The beverage sector is the top performer with an increase of exports for the first half of 2002 up 38 per cent compared to 1998, according to the CIAA. Sales increases were particularly high for beer (up 142 per cent), mineral water (up 60 per cent) and fermented drinks such as cider (up 80 per cent). Beverages are also the main sector of export with close to 30 per cent of total food and drink export. However, as a source of deal flow for private equity houses, the drinks sector actually offers limited opportunities.

Drinks manufacturing, in particular alcoholic beverages, is a game for the multinationals such as Diageo and not a game often frequented by private equity players. There are a few opportunities but the mega deals in this sector, such as Snapple, are few and far between. The Snapple Beverage Group is a prime example of value recreation. US firm Thomas Lee's 1992 leveraged buyout of Snapple Beverage Corp led to nearly $1.6 billion in value creation over a 30-month period after the company was sold to Quaker Oats in 1994. Triarc Companies $300 million acquisition of the group in 1997 and subsequent $1.45 billion sale to Cadbury Schweppes demonstrated further the potential for value re-creation in a relatively stable sector. In the soft drink sector there is more opportunity in private label businesses. Rupert Bell, partner at Sand Aire Private Equity, says: "On the drinks side we are seeing a lot of activity in the non-alcoholic arena and at the smaller end of the spectrum such as smoothie businesses."

Charles St John, partner at Electra Partners Europe, whose most recent acquisition in the sector was last year when it completed the buyout of Irish and UK wholesale distribution business BWG from Pernod Ricard for EURO220 million, admits deals are few and far between: "There aren't so many opportunities in the drink sector, partly as the sector is already relatively consolidated and partly as there is less you can do to a drink [compared to food] and the value is more likely to be in the brand than the process." For this reason there are few alcoholic beverage businesses owned by private equity houses, with niche exceptions such as Bridgepoint's EURO109 million buyout of Spanish wine producer Arco Bodegas.

UK leads the way

European companies are widely represented in the world's top 15 food companies with Swiss manufacturer Nestle ranking second with sales of EURO52.6 billionfollowing US leader grain products manufacturer Cargill, which boasts sales of EURO54.9 billion. Also ranking in the top ten are Dutch/British Unilever, UK-based Diageo and French Danone.

France, Germany and the UK combined represent 60 per cent of European food and drink production, according to the CIAA. Small- and medium-sized companies dominate the sector and small family-run companies are a key source of deal flow. This is especially so in Southern Europe where over 80 per cent of food companies in Italy and Spain have less than 50 employees.

But the UK reigns supreme. There are over 7,700 food and drink businesses in the UK and the industry is the largest manufacturing sector with a turnover of GBP66.2 billion, accounting for 14.2 per cent of the total manufacturing sector, according to the Food & Drink Federation.

"The UK is still the most popular target sector in terms of food," says Neil Sutton of PricewaterhouseCoopers. "Private equity houses are very comfortable buying food businesses [in the UK] and you can get exits that are successful." The secondary buyout route is particularly popular. Legal & General Ventures'
(LGV) long-anticipated exit from Youngs Bluecrest Seafood in a secondary buyout to CapVest is recent proof. As is Bridgepoint's sale of crisps and snacks manufacturer Golden Wonder to Longulf for an undisclosed sum last year.

Golden Wonder was the subject of a secondary buyout in July 2000 from LGV for GBP156.5 million. LGV was the lead investor in the original buyout from Dalgety in October 1995. Bridgepoint's commitment to the sector is also illustrated by its public-to-private purchase of WT Foods, a UK manufacturer and distributor of ethnic and specialty foods, which needed substantial capital to pursue its growth strategy. The firm completed the GBP128.5 million buyout and de-listing of the company last year, having received acceptances in excess of 90 per cent from WT Foods' shareholders for its 47 pence per share offer. The years 2000 and 2001 were landmark years for private equity deals in the food sector. Private equity houses managed to capture self-standing, strong brands such as BC Partners' acquisition of Italian cheese and salami producer Galbani from French food giant Danone and B&S Private Equity's buyout of olive oil producer Carapelli from French group Cereol. But Antonio Perricone of B&S Private Equity says this type of deal has dried up in the Italian market. Potential targets include Italian group Cirio Finanziaria, the largest buyer of tomatoes in Italy, which is currently under possible receivership. The ailing group is looking to sell its Del Monte fruit juice division.

Italian dairy giant Parmalat Finanziaria is rumoured to be selling its baked goods unit and pasta manufacturer Barilla is said to be looking for potential buyers for its bread division, Panem. Perricone thinks this business is more likely to go to an industrial buyer rather than a private equity business and is doubtful as to how successful this type of stand-alone business in Italy would be. "The consumption of this sort of processed bread in Italy is low because Italians normally buy fresh bread once a day, rather than the long-lasting sliced variety." Another strong brand on the sales block is Italian beer manufacturer Peroni, which again Perricone thinks will go to an industrial buyer due to the nature of the brewery industry. And Kraft is currently auctioning processed cheese brand Invernizzi. Again, its appeal to private equity buyers is debateable as the product is incomplete as a self-standing business, says Perricone.

M&A activity in the sector has been increasing steadily across Europe with the most marked increase in France where 54 deals were completed last year compared to 17 in 1998, according to figures from PricewaterhouseCoopers. Spain also shows a dramatic increase from 23 in 1998 to 52 in 2002. France has always been strong in the food and drink sector, says Christopher Masek of Industri Kapital, which last year acquired French foie gras and smoked salmon manufacturer Labeyrie. "The French market is a good source of deals. It is very brand-orientated and there is strong support from large mass retailers." PAI Management is a prominent player in the French food industry boasting deals such as French dairy specialist Yoplait and Panzani, the pasta, sauce and rice manufacturer. The firm recently acquired Lustucru as an add-on acquisition to help strengthen Panzani's position in the pasta and rice market.

A market that has been steadily increasing in terms of volume is Central & Eastern Europe, but by size transactions are still small. Gyuri Karady of Baring Private Equity Partners says: "In Central Europe the food and drink industry is driven by Western brands and more progressive products being introduced to the market as an extension of products that already exist." Danone has introduced flavoured yoghurts, custards, rice pudding and other dairy-related products to the market. Products already familiar in Western Europe, but completely new to Polish and Hungarian tastes, says Karady.

Baring celebrated a partial exit from its Central and Eastern European regional fund when it sold a division of Topway, a Romanian margarine and condiments producer last year to Norwegian food industry group Orkla. Baring sold the margarine, ketchup and mustard manufacturing plants but still holds a stake in the oil business of Topway. The time may now be right to put together an exit for the rest of the business, says Karady. The edible oils business is having a good year in the region due to a combination of seed prices and a fruitful harvest last year.

Brand or own-label?

There are three main categories a private equity firm will consider when looking at food and drink manufacturing; top performing brands, own label products and niche products. Marc Mathenz says: "If you're not a national brand, a low-cost own label brand or an innovator in a niche, you're going to have a problem exiting in the current climate. You have to make sure your company will fit a particular strategy."

In the food sector there are actually very few brands that are internationally recognised. The drinks sector is more of an international business by nature with global brands such as Pepsi, Coca Cola and Schweppes. Food on the other hand is nationalistic as a brand with each country harbouring its own characteristics and culture. In this respect there are opportunities for investors to pick up brands that the multinationals don't see part of their core strategy, says Simon Holmes at SJ Berwin. "Just because it is not a leading global brand, it doesn't mean that's the case in its domestic market." For example, brands such as Campbell's soup and Knorrs are leading in the UK, but not recognised globally.

Multinationals don't want these businesses as they can't see where they fit in their core strategy and so the private equity industry is able to mop up these deals. Further opportunities may spin out of Danone, which is refocusing on its dairy products, and Nestle, which is disposing of those brands that don't have the ability to be international. Nestle recently sold its Avidesa ice cream plant in Spain to the chief executive of that operation, Guillermo Lamsfus. The move came shortly after its main global rival in the ice cream industry, Unilever, announced it was cutting back on production of its Frigo ice cream brand in Spain.

But the acquisition of a branded business can be complex, says Charles St John of Electra. "The top [food] brands are rarely owned by private equity houses. They are owned by the giants such as Unilever and Nestle leaving the private equity houses to focus on the secondary and tertiary brands. The challenge with purchasing some of these businesses is finding one you can extract from a large corporation while being comfortable having to rely on the previous owner for certain functions such as manufacturing of the product, IT and even sales," he says.

The dynamics of an own-label business on the other hand are very different. Private label has a different meaning across Europe. In the UK, private label is a premium quality product to the point that certain products have even acquired brand-status. For example offerings such as Tesco's Finest or Sainsbury's Be Good to Yourself ranges have replaced the number three and four brands on the supermarket shelves. On the continent however private label targets a completely different customer. Germany, for example, is less of a branded market and is driven by what you can buy at the cheapest price with discounters such as Aldi and Lidl selling low price, value-beaters.

Charles St John of Electra sees significant opportunities within the private label sector across Europe. He says: "The key attributes for us are innovation, scale with customers and a market segment where supply and demand are in broad equilibrium. When these are present, our experience is that reliance on a few large customers and a constant need to keep capital investment high can be better managed and there is the opportunity to develop a profitable and growing business model."

Food manufacturing is a retailer-driven market and the consolidated nature of supermarkets in the UK is making life difficult for food and drink manufacturers of both brand and own-label products. The UK has a high level of supermarket penetration with high profile price competition and pressure on suppliers competing for shelf space.

Retailers are all powerful in this business. You are practically investing alongside retailers and you either keep their business or lose it, says Marc Mathenz. Contracts for supermarkets in the UK are nationwide, whereas in continental Europe they are regionally focused. So if a manufacturer in the UK loses its contract to another supplier you could be looking at losing as much as 20 per cent of your business."As far as contracts are concerned, it is important to understand which food segment retailers are committed to and make sure your key customers have commitment to your segment. The way for a food manufacturer to grow is if his key customers are growing in the particular segment," he says.

Neil Sutton of PricewaterhouseCoopers predicts a drag on private equity activity in the UK due to uncertainty surrounding the Safeway takeover bid. "Certainly there are plenty of food companies in a position to sell, but a lot are waiting for the Safeway saga to come to a head and a lot of potential purchasers may take a more pessimistic view than they need to," he says.

Bell, who looks predominantly at UK mid-market deals, is cautious when it comes to deals in this sector: "At the moment it is a brave man who backs a business that is in the supply chain for Safeway. As a generalist investor we ask where the lowest hanging fruit is and we are tending to see better opportunities in other sectors." Despite dampened enthusiasm and an overall slowdown in investment activity, there are still funds chasing deals. New investment vehicles launched last year included Luc Vandervelde's Change Capital Partners and Unilever's investment vehicle dedicated to the sector.

Unilever has allocated EURO170 million to three different funds to invest in its core interests in foods and personal care. For the largest of its three ventures, Unilever has taken the position as lead investor committing EURO100 million to Langholm Capital Partners Fund, which has reached a first closing at EURO225 million. Rabobank International, also a specialist in the global food and consumer goods sectors, has committed EURO75 million to Langholm and is the co-sponsor. The fund will focus on acquiring majority or influential minority stakes in European companies valued at between EURO20 million and EURO200 million.

Marks & Spencer chairman Luc Vandevelde also made his first foray into private equity this year with a new fund called Change Capital Partners. Vandevelde's background is in the consumer industry, where he has worked all over Europe for Kraft Foods and Carrefour, prior to his position at M&S. The fund has secured EURO300 million from cornerstone investors, the Halley family, founders of the Promodes supermarket chain and who hold a 10 per cent to 11 per cent stake in Carrefour. The fund will focus on small- to mid-sized buyouts in consumer and manufacturing food industries, which is where Vandevelde's skills lie and where the Halley family is knowledgeable.

Sutton says there is optimism in the sector despite a tough business climate. "Clearly you can't say it's dropped off a cliff when there were 19 exits in 2000, which was classified as a good year, and last year there were 18 exits in the sector."

The ever-present positive of this sector is that even in the economic downturn, food is still a stable business and in a down market you will not be hit, unless you lose a major contract.