Has the feeding frenzy caused some indigestion?

With the failed auctions of Prize Foods, Beeck-Homann and Findus in the wake of the aborted IPOs of Ranks Hovis McDougall, United Biscuits and the Irish drinks group Cantrell & Cochrane; the trolley dash among private equity houses to load-up on European food and drink companies and head for the checkout has lately begun to weave off-course. Joanna Gant reports.

Cantrell & Cochrane (C&C), backed by BC Partners in a €730m buyout from Allied Domecq in 1999, was due to float in mid 2002 valued at some €1bn. United Biscuits, the manufacturer of McVities and Oreo biscuits taken private in a £1.3bn deal backed by Cinven and PAI Management in 2000, abandoned its plans for a £2.4bn float in 2002.

Ranks Hovis McDougall (RHM), the owner of assets as diversified as Mr Kipling cakes to Saxa Salt group, pulled its proposed €1.5bn float at the beginning of last year due to ongoing stock market volatility. RHM was bought out of Tomkins in a €1.1bn deal backed by Doughty Hanson in 2000. Tomkins had initially sought, unsuccessfully, to demerge the business onto the London stock market in 1999. Having installed a new chairman and chief executive and with trade buyers likely to be deterred by RHM’s pension fund commitments, the company is expected to revive its float plans at the earliest opportunity.

“With scant competition from trade buyers, getting into the food sector is relatively easy. The difficult thing is getting out again,” observes Michael O’Donnell, a director of Legal & General Ventures (LGV). “But even though trade bidders have not been out in force, target pricing has still been on the high side and some of these businesses have simply not delivered growth,” he says.

But it’s not all doom and gloom. The sector has seen some successful exits through secondary buyouts: LGV realised its investment in Golden Wonder through a £157m secondary buyout to Bridgepoint in July 2000. Having bought Golden Wonder from Dalgety for £68m in 1995, the exit produced an equity return approaching five times LGV’s original investment. “As a co-investor in the original buyout we knew the business and its management team and so were comfortable leading the secondary deal,” says Guy Weldon, a director of Bridgepoint.

LGV also sold its 79% stake in Young’s Bluecrest in a €195m secondary buyout to CapVest in 2002, reaping 2.9 times its money on an IRR of 39%. “Trade buyers were in the ring on both occasions but the PE houses could move quickly and we put a value on that,” says O’Donnell.

Some firms have also used devices such as the split sale, whereby they parcel off a business to several buyers, to achieve realisations. Bridgepoint’s own exit from Golden Wonder in 2002 saw the Wotsits branded portion of the business sold to Pepsi Co to combine with its Walkers business while the rest of the business went to The Snack Factory. Although the price was not disclosed, Bridgepoint is thought to have doubled its money. “The Wotsits brand was the jewel in the Golden Wonder crown. It was where the real value in the company lay. And we had to sell it to PepsiCo separately. Competition issues would not have allowed PepsiCo to buy the whole business. But while we were able to get much more value out of the business by breaking it up, getting a split-sale to run seamlessly is quite challenging from a transaction perspective and it can be a lengthy process,” Weldon says.

With its wealth of brands and reputation as a recession-proof, non-cyclical sector, the food and drink industry has some key attractions for PE investors. It is a reliably old economy business, can be highly cash generative, its companies often come with strong asset backing and there is scope for expansion in high growth niche markets such as chilled, convenience and ‘healthy’ snack foods. “You have to look at the food sector’s fundamentals. It is a stable, non-cyclical industry and while it delivers low top line growth it has very positive cash flows which support leveraged capital structures,” says Robert Darwent, principal of Hicks Muse Tate & Furst (HMTF).

“There are also opportunities to unlock value from the various ownership structures, from the multinationals which have unloved brands within vast portfolios to family-owned businesses where we can grow value through operational change and further investment,” says Darwent.

The majority of PE deals were in the UK last year with HMTF’s €776m buyout of Weetabix, the €147m management-led acquisition of Cirio Del Monte Foods UK and Montagu Private Equity’s (MPE) €97m buyout of Marlow Foods all helping to swell the figures. Elsewhere in Europe, 3i acquired Refresco, a Dutch soft drinks maker, for €240m while Arca Impresa Gestioni and Barclays Private Equity paid €100m for a 33% stake in Marr, the food distribution business owned by the Italian food group Cremonini. Last year also saw the €60m buyout in Greece of Nikas, a producer of sausage and meat products.

Due to on-going asset shuffling by the global food giants and fall-out from the M&A binge in the food sector in 2000 when Philip Morris and Kraft bought Nabisco for $15bn and Unilever took over Bestfoods for $20bn, PE firms will continue to be tempted by a steady stream of opportunities. There are also interesting possibilities in continental Europe, particularly southern Europe, where the food sector remains highly fragmented and the supply chain less efficient.

But, while Danone sold its Italian cheese and salami business Galbani to BC Partners for £610m in 2002, food sector M&A activity and interest waned in Italy last year in the wake of the bankruptcy of Cirio Del Monte and Parmalat scandal. Now, however, PE firms including HMTF and PAI are believed to be circling the stricken Parmalat, evaluating which of its brands to be sold as part of a debt for equity restructuring plan might yield most value. Under the terms of the restructuring, the food group intends to focus on 30 core brands, six of which currently account for around 80% of group sales. This leaves around 90 under-performing brands ripe for turnaround.

Another exciting area of the market for deal hunters is convenience foods, particularly the chilled ready-meal variety. Thanks to a variety of socio-economic trends and general changes in eating habits, this is the fastest growing segment of the food manufacturing industry. It also offers scope for higher margin, product innovations with suppliers often capitalising on the increasing obsession with healthy eating. The distribution requirements of chilled convenience foods make it a capital intensive industry so the benefits of scale are more pronounced here than elsewhere in the food sector. Yet the market remains fragmented with the top ten chilled foods suppliers commanding just over 50% of the market.

This is due, in part, to the market being dominated, particularly in the UK, by private label products. “Chilled recipe dishes are very important to the supermarkets which, led by Marks & Spencer (M&S), see them as a real point of differentiation. But because they are likely to be own-label, the large multinationals have not been interested in penetrating this market,” says Guy Weldon. “Chilled food does offer considerable scope for brand development but, for smaller firms, developing a brand from scratch is enormously expensive,” he points out.

In the chilled convenience foods sector Bridgepoint backed the €206m PTP of WT Foods, a manufacturer and distributor of ethnic foods, in 2001. “The dynamics of the ethnic food market continue to be very attractive with strong and consistent growth rates,” Weldon explains. “It is one of the fastest growing sub-sectors within the fast expanding chilled sector,” he says. Since the acquisition Bridgepoint has set about reshaping the business; disposing of non-core divisions such as WT’s bakery business and Bart’s spices, and pursuing selective acquisitions with the purchase of Marston Valley Foods, another manufacturer of chilled ethnic foods, in August last year.

Also in the chilled cabinet is MPE-backed Marlow Foods, which produces Quorn, the leading vegetarian brand of substitute meat products, and incorporates it into a range of branded chilled and frozen foods. Says Simon Pooler of MPE in Manchester: “Quorn is well-positioned in the food market providing a meat alternative product. It operates in the convenience/chilled food sector and is part of the healthy eating trend. It is also a big retail brand name which is well-positioned in the UK and now expanding internationally.”

In the 1990s, PE firms tended to direct their efforts primarily at own-label manufacturers where they could grow sales without large marketing expenditure. Recently, however, with the need for leverage over the all-powerful supermarkets, brands have made a comeback. “Brands are attractive because they carry more negotiating weight with the multiples and are generally higher margin. On the downside, however, they require a high marketing spend. In the UK it is important to have a balance between the two,” says Robert Darwent of HMTF, which is one of Europe’s most active PE investors in the food manufacturing sector.

Over the last five years HMTF has splashed out over £2bn on food businesses. These include: Hillsdown Holdings, which was bought for more than £900m in 1999; Burton’s Biscuits, acquired from Associated British Foods for £130m in 2000; Nestle’s ambient grocery brands bought out for £135m in 2002; and Unilever’s Ambrosia creamed rice business, acquired for an undisclosed sum last year alongside Weetabix, the UK’s second-largest cereal maker, for £642m. All HMFT’s European food interests are in the ambient or shelf-stable category with no interests in chilled, frozen or fresh groupings.

Faced with a highly competitive marketplace dominated by a small number of big food retailers, HMTF’s strategy is to create a food business centred on a cluster of iconic brands supported by a string of smaller ones. Through its Premier Foods unit, HMTF’s best-known UK brands include Branston pickle, Sarson’s vinegar, Typhoo tea and Hartley’s jam with Chiver’s marmalade, Sun-Pat peanut butter, Gale’s honey and Rowntree’s jelly in the second tier. Including Weetabix, the firm’s food interests now generate annualised sales of some £1.75bn.

“Our focus has been on classic British brands and we are prepared to put the proper investment behind them. And, whether they are formerly integrated or not, food assets have certain benefits of common ownership in terms of purchasing, manufacturing and logistics. These days it is difficult to rely on buying assets cheaply up-front. Once brands have been acquired investors have to genuinely work hard to build a cohesive and focused group,” Darwent says.

HMTF’s strategy at Premier Foods has been to acquire under-managed assets. This contrasts with its approach to Weetabix, which it sees as a business with an extraordinary quality. “But, because it was family-owned and controlled, we believe we can inject a new element of pace and urgency to the business and really provide an impetus for change. We also see major opportunities to take the Weetabix brands and leverage them further through new product innovations both within and outside the core breakfast cereal market,” says Darwent.

The lemon in HMTF’s portfolio is Burton’s biscuits. Along with United Biscuits, it has had a tough time of late hit by a fierce price war, a sharp rise in raw material costs and last year’s hot summer. Robert Schofield, chief executive of HMTF-owned Premier Foods, was last year parachuted in to hire a new senior management team to turn the business around. While an IPO of HMTF’s combined food interests (excluding Burton’s) has been muted in the press, Darwent would not be drawn on HMTF’s exit strategy for Premier Foods/Weetabix. “Because of the groups of assets that we have, the portfolios we could bring together and their strategic appeal, we have flexibility and a number of different options,” he says. “In the public markets cash as opposed to out-and-out growth is now being appreciated more readily and food businesses fit well into that cash generative profile. But there are also recapitalisations and secondary buyouts, which, while not necessarily our preferred exit routes, are also possibilities,” he says.

Follow-on investment and extensive change management is often necessary to add value to food sector companies with quick turnarounds a thing of the past. LGV successfully restructured, refocused and transformed Golden Wonder into one of the most successful low-cost, brand-focused snack businesses in Europe. Key elements in the process included redirecting the business towards higher margin snack products, tighter working capital management, extensive advertising expenditure, particularly behind the growth brands, committed capital investment, factory rationalisations and new product development.

Merger appeal

LGV-backed Young’s Bluecrest emerged as the UK’s largest specialist seafood business in July 1999 from the merger of Bluecrest, bought from Booker for £59m in 1998, with Young’s, which was then owned by UB. The businesses were highly compatible, with Young’s expertise in branded products complementing Bluecrest’s pre-eminence in private label and food service operations. Both also benefited from strong relationships with the major UK supermarket groups.

“It was a challenge to merge an own-label with a branded business and both companies were significantly under-performing,” recalls Michael O’Donnell. “But, because they were based in the same town and used the same raw material there were clear synergies and significant efficiencies to be made,” he says. With rising fish prices, the merger allowed considerable savings in processing, buying, distribution and manufacturing. LGV also invested heavily in relaunching the Young’s brand, achieving 20% growth in the first year alone. The deal also illustrates another trend in the food sector; for corporates to retain stakes in units being sold or to form joint ventures with PE investors. According to LGV, two-thirds of its deals involve working alongside trade partners or founders. The Young’s Bluecrest merger was structured as a leveraged joint venture with LGV and UB taking equal shareholdings of 44% each with management holding the balance. LGV acquired UB’s shareholding in March 2001 with UB achieving an IRR of 35%. For UB the joint venture provided a managed exit from an under-performing business that was non-core and which would have realised a low price if sold outright.

However, such alliances can sometimes hamper a company’s development and exit options. The consortium of investors that backed United Biscuit’s £1.8bn public-to-private included Nabisco. (United Biscuits (UB) also acquired Nabisco’s European biscuit activities). But, under the terms of the shareholders agreement, UB needed approval from Nabisco for any M&A activity worth more than £25m. The agreement also stipulated that UB’s shareholders could not transfer their shares to a third party before March 2003 and that Nabisco and UB’s holding company retained the right to refuse an offer from a third party after that.

The last two years have also seen the emergence of several new investment partnerships, created with the aim of linking traditional growth capital with trade partners to provide sector expertise and strengths in areas such as technology, R&D and marketing. Unilever has got together with Holland’s Rabobank International to create Langholm Capital Partners, for example. The fund aimed to raise a total of €300m by mid 2003 to invest in mid-sized, European, consumer-related businesses. Unilever and Rabobank contributed €100m and €75m, respectively.

A new vehicle for retail and consumer buyouts is Change Capital Partners. Put together by M&S chairman Luc Vandevelde last year, it has €300m to invest on behalf of the Halley family, who founded Promodes, the French retail giant and an additional €700m to co-invest in bigger deals. Advertising gurus Maurice and Charles Saatchi launched SAATCHiNVEST to acquire under-utilised consumer product brands from divesting multinationals. It made its first acquisition during 2002 by entering into a joint venture with Heinz for its Complan and Casilan trademarks in Europe and the Americas. However, Andrew Leek, who was recruited from Alchemy to head up the venture in 2002, returned to the firm last year.

Food is a mature industry in which it is often hard to deliver sales growth. There is also constant pressure on margins, not helped in the UK by the continuing consolidation among the major food retailers. Meanwhile, exits for PE investors in the sector have generally proved more challenging than anticipated. After a dismal few years, however, stock markets are beginning to become more conducive to IPOs; Intercontinental Hotel Group is set to spin-off its stake in Britvic through a float expected to value the soft drinks business at up to £1bn, for example. But still it is an open question as to whether the financial buyers who enthusiastically outbid their rivals to acquire prime food assets will ultimately reap healthy returns or find that such a high intake has impaired their overall performance.