Eat, drink and be merry?

Food and drink has never been the most glamorous sector in the private equity universe but it could be one that attracts an increasing amount of attention in coming months. The business tensions that have resulted from the terrorist attacks in the US on September 11 mean venture capitalists will be concentrating on defensive investments in the near-term and the sector, which has traditionally been the preserve of a small number of private equity houses, can now expect attention from across the board. “Food is the ultimate defensive sector,” says Quintin Barry, partner in the private equity group at Deloitte and Touche in London. “People will always eat.” But there is one slight problem: where are the deals going to come from?

Consolidation in the food and drink sector is seen as largely complete in the UK and many feel UK-based venture capitalists will now have to look more to Europe for opportunities. This is nothing new. “It is a truism of the private equity industry as much as it is a feature of the food and drink sector,” says Guy Weldon, director at London-based Bridgepoint Capital.

One of the largest private equity deals in the food sector so far this year has been the Candover-backed MBO of French frozen food chain Picard Surgeles from Carrefour. The euro920 million deal was once of the largest buyouts ever seen in the French market and has raised the profile of private equity in the country. Candover took a euro138 million equity stake in the company along with Chevrillon & Associes (euro35 million), HSBC Private Equity (euro53 million) and Astorg Management (euro27 million). A tranche of euro573 million senior and mezzanine debt was underwritten by UBS. Picard Surgeles aside, however, 2001 has not, so far, been the year of the mega-deal. This may be a result of the fact that two huge deals took place last year in the UK: the GBP1.4 billion LBO of United Biscuits and the GBP1.2 billion sale of RHM. But with appetite for the sector bound to be on the increase, more large deals can be expected, particularly in Europe, in the future.

As far as private equity investors are concerned opportunities in the sector are strongly focused on prepared and chilled foods. The most obvious reason for this is better margins, but there are a number of other factors at play. Foremost among these is the negotiating strength of the supermarkets themselves.

This varies widely across Europe but is at its most intense in the UK due to its higher level of grocery market penetration by retailers. High profile price competition between the largest supermarket chains of Sainsbury’s, Safeway, Tesco and Asda has placed extreme pressure on their suppliers competing for shelf space. The result has been to underscore the mantra of many private equity firms active in the sector: only go for the number one brand.

“The problem in the UK is that opportunities to buy into the number one brand in the sector are now few and far between,” says Michael O’Donnell, director at Legal & General Ventures in London. “People will have to look further down the brand ladder.” But just such an opportunity might arise with the anticipated sale by Legal & General Ventures of its 79 per cent stake in Youngs Bluecrest, the Grimsby-based fish products group. Legal & General Ventures, which acquired United Biscuits’ 44 per cent stake in the business in March this year, has invested heavily in the brand to turn the company around. “It was difficult as we had to put two businesses that weren’t performing together but this has been done successfully and it is now growing strongly,” says O’Donnell.

Youngs Bluecrest has been growing by over 20 per cent year-on-year and recorded a profit of GBP11.3 million last year.

It has a 30 per cent market share ahead of rival Birds Eye.

All of which begs the question why exit? “The business is at a crossroads and we have to make the decision to either stay in for another 18 months or to sell,” says O’Donnell. But given that Legal & General Ventures could get as much as GBP150 million for the stake the attraction of the latter is obvious. Deutsche Bank is advising on the sale.

O’Donnell explains the tactic of investing in the brand was the key to Youngs Bluecrest’s success in climbing to the number one position in its sector. Legal & General Ventures invested GBP5 million in advertising the brand more than has ever been invested in seafood advertising in the UK before. But taking an underperforming brand and hoping to turn it around is now probably riskier than ever in the food and drink sector. “Our experience has shown that it is very difficult to do this as you are squeezed between the spend needed and the power of the supermarkets,” says Clare Cotton, business development manager at Deloitte and Touche.

One way in which this power has manifested itself over the last year is the emergence of Internet auctions for supply contracts by the larger retailers. Under these schemes, suppliers are forced to re-bid for contracts online on a regular basis squeezing already tight margins even further. “At the moment these tend to be limited to tertiary products the low value low quality lines,” explains Guy Weldon at Bridgepoint Capital. “They are not doing it yet for own label goods.” But it is a worrying development for the industry. “It can only go so far,” says Matthew Turner at PPM Ventures in London. “It will force consolidation by need rather than want.”

Own label goods are the way forward for investors in an industry where the opportunities to buy top brands are diminishing.

Ninety-five per cent of the prepared and chilled food sector is own brand. “Food and drink is not an easy sector and you have to go for quality.” Weldon says: “The prepared and chilled food sector is still growing very fast in the UK and own label brands are a very important part of that. Supermarkets are prepared to tolerate higher prices in this sector where they are not in others.”

Another recent supermarket innovation that is placing pressure on food companies is the “takeaway”. All of the large retailers are actively developing own label takeaway products, which should be resistant to any downturn. The logic is: you cut back on eating out by getting a takeaway; you can cut back on takeaway costs by buying the “takeaway” from the supermarket. “Supermarkets are looking to add value through pseudo-takeaway,” says Cotton at Deloitte and Touche. “They are doing this to set themselves apart and are devoting more and more shelf space to this. The result? Less space for everything else.” The recent growth in this type of product and the domination of own label could soon spell the end of second tier brands in many lines. “Supermarkets are increasingly asking themselves, Do we really need ten different brands of coffee that all taste the same?'” says Cotton.

Not all venture capitalists share the bleak outlook for brands. Legal & General Ventures successfully acquired and exited from UK snack firm Golden Wonder in 2000, selling it to Bridgepoint Capital for GBP156.5 million. “We knew that in this sector we were simply not going to be able to get the number one brand,” says O’Donnell at Legal & General Ventures. “Golden Wonder is the number three brand (behind Walkers and KP) but we made five times our equity investment [on exit].” O’Donnell does caution, however, that he would be “very nervous about going below the number three brand.”

Despite the constraints on the food and drink sector, there are still good, strong brands coming up for sale. The most high profile current example of this in the UK is Pepsico’s potential sale of soft drinks business Britvic. This could be a GBP600 million deal, and has attracted a raft of players from the private equity market. The business is being sold by majority shareholders Six Continents (formerly Bass), Whitbread, Allied Domecq and Pepsico and the sale is being advised by Schroder Salomon Smith Barney. The bidding list for Britvic reads like a telephone directory of the venture capital industry: BC Partners, Carlyle, Cinven, CVC Capital Partners, Doughty Hanson, Hicks Muse, Paribas Affaires Industrielles, PPM Ventures, and 3i is understood to have teamed up with AG Barr for a trade sale. The fact that the list includes players not usually active in the food and drink sector is an indication of the new focus on the sector.

“We have found that food and drink businesses have more first class managers than many other sectors which is the most important thing for private equity,” says a spokeswoman for CVC Capital Partners when contacted by evcj about its bid for Britvic. CVC has not been particularly active in the sector to date but is bidding for Britvic in tangent with former Whitbread executive Miles Templeman and Lehman Brothers.

But despite the huge interest in Britvic, several private equity firms have declined to bid on the deal over worries about the role of Pepsico. The US drinks giant is bidding for the business via its 42 per cent owned bottling concern Pepsi Bottling Group (PBG). As it is already a majority shareholder in the business there is concern that the venture capitalists are simply being used to flush out offers against which PBG can bid. “The problem with Britvic is that you have to get Pepsico on board,” says one London-based venture capitalist who declined to bid. “They have to be happy that you are the right partner for them and would drive an extremely hard bargain on any exit.”

While there has been widespread consolidation at the larger end of the market, Weldon at Bridgepoint reckons there is still a lot to come at the sub-GBP100 million level. A Bridgepoint Capital-backed MBO made a bid for ethnic food maker WT Foods at the beginning of June this year, valuing the company at around GBP79 million. The public to private transaction is being driven by frustration at the company’s share price, which fell from a high of 60 pence in 1999 to a low of 27.5 pence in November 2000. The firm, which is 13 per cent owned by management, is one of the largest manufacturers of ethnic food in Europe. The Bridgepoint-backed bid valued the company at 52 pence a share and was recommended to shareholders. Rabobank is providing debt financing. Everything was due to be tied up by the end of September but negotiations were upset by the slump in share values following the terrorist attacks in the US. As a result the offer was revised downwards from 52 pence a share to 47 pence a share on September 28. But it was emphasised that there was no change in the assessment of the underlying business and the revised offer has, therefore, been recommended.

The continuing slump in equity markets may prompt more public to private transactions in this sector. One firm that has been the subject of persistent rumours is Uniq (formerly Unigate), the troubled chilled food manufacturer. Both Hicks Muse and Candover are understood to have made approaches to the firm over the last 18 months but any deal presents a challenge. “The poisoned pill in this transaction is the Malton pigmeat division,” says Weldon at Bridgepoint. “It is losing money hand over fist and will be an impediment to any bidder.” The division turned a GBP15.3 million profit into a GBP11.4 million loss last year a victim of the foot and mouth outbreak. Management has said that it is in negotiations with “four or five” European buyers to sell the business. “Management still has the capacity to sort it out but it has the potential to turn into a, perhaps hostile, venture capital deal,” says Barry at Deloitte and Touche.

Although the long-term outlook for food deals is relatively healthy, investors remain understandably cautious in the short-term. “I expect to see a number of transactions suspended,” says Turner at PPM Ventures. “Activity will fall as there is simply no visibility on earnings. There will be a flight to quality.” But the downturn could give venture capitalists an advantage over their trade competitors for those deals that do come to market. A private equity firm that has recently completed a fund raising will look attractive compared with a trade buyer that will have to raise the capital to finance a bid. But while this may knock the smaller trade buyers, the larger ones will always stand as very tough competition for venture capital. “A large manufacturer will always be in a good position to output a VC,” says Barry at Deloitte and Touche. But there is room in this sector for both.

Pernod Ricard announced at the end of September it will sell its soft drinks businesses in Europe, North America and Australia to Cadbury Schweppes for E700 million. But the French drinks company is also in negotiations with two private equity houses over the sale of its wholesale distribution business BWG. This business was put up for sale in March this year as part of Pernod’s joint $8.1 billion bid (with Diageo) for Seagrams. Pernod Ricard is believed to have received four offers from private equity firms for the business, which operates 80 cash-and-carry warehouses. At the beginning of September two bidders Electra Partners and ABN AMRO Capital were shortlisted for the GBP200 million deal. The deal is being advised by Hambros. Pernod Ricard is also talking to another VC, Butler Capital Partners, over the sale of its fruit processing business SIAS.

If interest in food and drink investment increases as expected, the volume of deals across Europe could increase over the next year. The fragmentation of the European market means there is an overpopulation of brands and it is likely that these brands will now face tougher competition as US food companies seek to increase their distribution in Europe. The take-overs of Nabisco and Keebler by Phillip Morris and Kelloggs means these brands are now likely to be marketed far more aggressively in Europe.

The resultant shake-out could provide rich pickings for venture capitalists: food industry deals already form a significant percentage of the French market five per cent over the last three years. But in the UK where the potential for consolidation is lower, VCs will be looking for niche sectors. Cotton at Deloitte and Touche reckons the catering sector should be the logical next step for investment. “The margins are much better and there isn’t the same level of competition,” she says. But she warns that aside from the large operators, such as Brake Bros, many of these firms are small, family-owned businesses that are not coming up for sale. “The problem for private equity is going to be finding a deal that is large enough to be worth doing,” says Cotton.