PE Firms Scarf Down Food Deals: But Will Some Investments Bite Back? –

The branded food industry has seen a significant increase in activity as of late. With deals ranging from franchise restaurants to packaged supermarket foods, private equity firms have been taking advantage of the steady cash flow stemming from a strong consumer market.

After Parthenon Capital, which acquired Atkins Nutritionals Inc. at the height of the no-carb craze in October 2003, lost big when the company was forced to file for bankruptcy in early August, many investors became somewhat wary of a similar situation. That’s why, in an industry where investors are constantly making bets on which companies they think will flourish, executives are trying to focus more of their efforts on doing deals with companies that have proven brands and a relatively long history. There is virtually no risk that any of the products offered by TB Corp. (Taco Bueno), which has been around since 1967, Papa John’s International Inc., which was founded in 1985 or Hill & Valley Inc. baked goods, which was founded in 1987, can be mistaken for fads. Palladium Capital Partners, Milestone Capital Management LLC and Circle Peak Capital LLC acquired these companies, respectively, in late August.

Regardless of the risks involved, the food sector is a good market right now. Consumers are spending, and given the fact that there are more two-income households than ever before, people have more money to eat out, as well as less time to prepare food in their homes.

Branded Packaged Foods

Private equity investors have often turned to branded food products, ranging from staple supermarket items like Tropicana orange juice to diet conscious products like Gardenburgers because of the level of stability they can provide.

“It’s a sector that offers some protection over a broad economic cycle, and there have been some very successful investments in the food sector that haven’t been trendy concepts that involve more traditional buyout characteristics-decent purchase price, management possibilities, and expanding distribution and branding,” said R. Adam Smith, a managing partner at Circle Peak.

Circle Peak plans to focus on branding and distribution expansion as it attempts to grow its newly acquired platform company, Hill & Valley Inc.-a manufacturer of sugar free and no-sugar-added baked goods sold in supermarkets nationwide under the Hill & Valley brand name and other private labels.

According to Scott Becker, a founder and managing partner of Northstar Capital LLC who served in the M&A division of General Mills Inc. during the 1980s, profits can often be made in the sector over time even without needing considerable growth of the brand name. “Traditionally levering up food companies has proven to be successful because of the consistency that you can expect in margin over time, especially if it’s a branded established product,” Becker said. “There is a degree of comfort in terms of the amount of leverage put on a food transaction that can be sustained without much growth on a debt pay-down platform because of the stability of cash flow.”

Still, investment opportunities within the sector come with changing trends, and, as evidenced by the Atkins collapse, the fine line between a new trend and a fleeting fad can often be hard to decipher.

“There is a continuous evolution of food consumer trends and product development that offer investors different entry points into the food sector, so there are always a lot of opportunities that occur as trends change,” Smith said.

Neal Aronson, managing director of Roark Capital LLC, maintained that the often trendy diet food industry typically goes through five-to-six-year cycles, which allows more than enough time for some investments, like Invus Group’s Weight Watchers International Inc. deal, to be fully realized. New York-based Invus bought Weight Watchers, which distributes branded frozen food products and snack foods, in addition to providing weight loss services, in 1999 from H.J. Heinz Co. for $735 million. The buyout shop, which is the U.S. extension of Artal Luxembourg SA, took the company public with the help of Credit Suisse First Boston on Nov. 15, 2001 in one of the most profitable IPOs of the year. Invus netted a 13x equity return on its investment.

Despite American consumers’ obsession with healthy trends and fads, packaged food deals are taking place in other niches as well. Monomoy Capital Partners LLC recently completed its first investment since the firm’s founding in March, 2005 with its purchase of Awrey Bakeries Inc. Monomoy completed the deal alongside Hilco Equity Managaement LLC. Awrey, which filed for Chapter 11 bankruptcy in February, produces and sells frozen pastries, doughnuts, cakes and other sweets and breads to distributors and retail outlets in the U.S. and Canada.

In other packaged food news, Cadbury Schweppe’s is rumored to be considering a sale of its European soft drink division, which includes products like Orangina and Schweppe’s ginger ale, tonic water, seltzer and club soda. Cadbury hired Goldman Sachs to auction off the division, and a number of Private Equity firms including the Carlyle Group are rumored to be interested.

Restaurants and Franchises

Many private equity executives who have invested in the restaurant/franchise sector are not surprised by the recent upturn in restaurant deals-mainly because many of them recognize that this aspect of the food industry is driven by a cyclical interest.

According to Aronson, whose firm specializes in franchise investments, namely Carvel, Cinnabon, and most recently McAlister’s Deli, the excitement over restaurant deals “comes in waves.”

“There are periods of one, two or three years when private equity investors have been very excited about the restaurant industry, and then there will be a period of three or fours years when many investors hate the restaurant industry,” said Aronson. “There has been an increased level of activity in the restaurant industry in the last 12 to 24 months, and that’s exciting.”

Lawrence Golub, founder and president of Golub Capital, which has just completed its eighth restaurant investment in the past two years, said that around 2002, in particular, few people would touch a restaurant deal.

“I think that today you are seeing a significant number of sellers who either acquired restaurant businesses in the 1999-2000 time frame, rode them through the downturn in the restaurant industry in 2001- 2002 and see the current environment with good performance as an opportunity to sell,” said Golub.

In fact, Buyouts only recorded a total of two successfully completed restaurant transactions in 2002. Morton’s Chicago Steakhouses was acquired by Castle Harlan Inc. in the third quarter of that year for $171.9 million, and, on a much larger scale, Burger King was acquired by Texas Pacific Group and Goldman Sachs in the fourth quarter for $1.5 billion. Though other food deals took place during 2002, the restaurant sector saw little activity.

Many factors have led to the upturns and downturns in this sector, an important one being the overall economic and consumer trends that tend to pave the way to success in this sector. This was most evident in 2001 with the economic situation following Sept. 11, 2001.

“In 2001 and 2002 there was a confluence of factors. The recession led to reductions in consumer spending and that combined with post 9/11 travel contractions, which had a particular impact on restaurant concepts tied to tourist destinations,” said Golub. “That double whammy led to an industry-wide profit contraction.”

Now that the economy has bounced back and a period of relatively consistent growth in the restaurant/ franchise sector has surfaced, many investors have started to regain their once muted interest in the sector.

But even though this resurrected interest has begun take hold of the private equity world, there are still concerns that go along with this, according to Aronson.

“There is a difference between a trend and a fad,” said Aronson. “What attracts people to the food and restaurant industries is intellectually making a bet that a certain trend will continue.”

Aronson added that in cases where what is thought to be a trend turns into a fad, you can end up with a disastrous situation, like the one Parthenon found themselves in with the Atkins deal.

“There is a reason why investors have fallen in and out of love with the restaurant industry over time, and that is because sometimes these consumer trends people have bet on through a restaurant chain have worked and some have not,” said Aronson.