Absense of mid sized deals

Unsurprisingly, food & drink companies have been impacted by the financial crisis that started more than 18 months ago. In terms of M&A activity, there has been a relatively modest decline in deal volume. Between 2008 and 2009, the number of deals in the food & drink industry went from 3036 to 2949, a drop of only 3 percent, according to Zephyr ‘Annual M&A report 2009’. Comparatively, global deal volume in the transport sector fell by 6 percent, while it dropped by 7 percent in the construction industry. Only the chemicals and the insurance sectors saw the number of deals increase between 2008 and 2009. But in terms of deal value, the drop in the food & drink sector was severe. In 2009, the global deal value for such transactions reached just $127.4bn, 52 percent lower than the previous year. This reduced activity mainly comprised of smaller deals and a few large transactions, as mid-sized deals were relatively absent due to the unavailability of financing, which hampered the ability of many companies to conduct transactions.

Among the larger transactions conducted in 2009 and the beginning of 2010 was the acquisition of brewer Anheuser-Busch Inbev’s Central European operations by CVC Capital Partners Group, a UK-based private equity firm, for $3bn. Also in 2009, US-based Pinnacle Foods Group announced it would buy frozen food provider Birds Eye for $1.3bn. Two months later, in January 2010, Dutch brewer Heineken NV said it had agreed to buy the beer division of Fomento Economico Mexicano SAB (FEMSA), producer of Dos Equis and Mexico’s second-biggest brewer, in an all-stock deal valued at €5.3bn ($7.7bn), to tap faster sales growth in Latin America.

 

But one of the sector’s largest deals in years was the Cadbury/Kraft transaction. On 19 January 2010, it was announced that Cadburyand Kraft Foods had reached an agreement, and that the largest confectionary, food and beverage company based in the US would purchase the British confectioner for £8.40 per share, valuing Cadbury at £11.5bn ($18.9bn). Kraft, which issued a statement saying that the deal will create a “global confectionery leader”, has had to borrow £7bn ($11.5bn) in order to fi nance the acquisition. “The food & drink sector had several high-profi le transactions that changed the landscape in some segments of the industry,” explains Steven Ellcessor, a partner at Frost Brown Todd. “The Kraft/Cadbury deal is a demonstration of the more global landscape of the industry and of the continuing drive by the major players for growth. Elsewhere, the acquisition by Pinnacle Foods of the Birds Eye’s frozen foods business refl ects its ongoing attempts to bundle its strengths across several parts of the retailstore.”

 

Large deals are also a sign of confi dence returning to the markets. Companies with strong performance and healthy balance sheets in 2009 are expected to contribute to a rebound in the

number of transactions through 2010. Indeed, with valuations for struggling companies at historical lows, many healthy companies may pursue growth-oriented acquisitions. “We’re seeing considerable interest from both strategic and fi nancial buyers,” says Pete Mulvey, a managing director at RSM McGladrey. “Many food companies have been delivering strong fi nancial results, enabling them to reduce debt loads and enhance their cash positions. They’re now actively investigating strategic acquisitions. Meanwhile, private equity firms, which are drawn to this sector for its consistency, are demonstrating a strong appetite for investment,” he adds. Opportunities in the current climate also lie in the underperforming dollar and sterling, encouraging foreign fi rms to target food & drink companies in the US and UK. In addition, the next few months should see an increasing number of consolidations, according to Willy Kruh, Chairman of KPMG’s Global Consumer Markets practice.

 

“Financially stronger firms can strengthen their core businesses through consolidation and look to purchase growing firms with diversifi-cation potential,” he says. Larger companies may indeed seek to acquire distressed rivals in order to enhance their brand reputation, extend their product lines and expand their geographic presence. But for such consolidations to be successful, realistic valuations are essential, as illustrated by the Kraft/Cadbury deal. In November 2009, Cadbury rejected a renewed offer of $16.4bn from Kraft, saying the bid was undervalued. The US confectioner had to raise its bid by about $3bn before it was finally accepted two months later. Besides consolidation, other recent trends in the sector are expected to contribute to more M&A or further growth in the months to come.

 

During the downturn, many companies have sought to expand their businesses in developing economies to ensure continued growth. This has been the case for Nestlé, SAB Miller and Danone, all of which have established operations in Russia in recent years. Not only are companies seeking to expand geographically,

they are also looking to diversify their product range. “Private label offerings are currently among the fastest growing segments in the industry,” explains Mr Mulvey. “They provide a natural complement to branded products and can help strengthen relationships between retailers and consumers. While private label offerings

deliver lower margins, they don’t require advertising investments or promotional allowances typical of their branded counterparts. They also are supported by retailers,” he adds. But some experts believe this trend may reverse as the markets pick up again. “The weak economy has benefited retail brands and private label, as consumers have eaten at home more and traded down to cheaper choice at retail. Foodservice suppliers have suffered, as restaurant sales, especially higher end, have declined. A strengthening economy will likely reverse those trends,” predicts Mr Ellcessor. “That could make retail brand companies more in need of acquisitions for growth, and foodservice businesses with cash may have opportunities among competitors that are strapped for cash coming out of the recession,” he continues. As private label offerings may not remain attractive opportunities going forward, food & drink companies are also launching new nutritional items and healthy lifestyle products to target ageing populations and concerns over childhood obesity. In addition, green initiatives are being implemented by offering, to customers, environmentally-friendly packaging and biodegradable cups. Such products are expected to boost sales through 2010.

 

Getting over hurdlesBut for companies to achieve success and stronger performance this year, they first need to tackle current challenges in the industry. The most common include fluctuations in commodity prices making it difficult to predict pricing in the long term, declining sales and profits, rising interest rates, unrealistic valuations for M&A bids, declining interest from private equity firms for deals and the difficulty of obtaining financing. But declining consumer demand and con-

fidence is the main concern for many food & drink companies, which are forced to be creative with their packaging and product offerings while maintaining reasonable prices. But savvy companies can, by demonstrating the value they bring to their products, expect to strengthen their customer relationships and drive sales while improving margins. Problems may also arise for companies that established an international presence recently, or are considering doing so, due to different regulatory environments and the necessity to adapt to local market demands. “Also, cross-border M&A can represent a potential challenge because some governments or unions may oppose foreign takeovers of local companies for fear that jobs could be lost,” points out Mr Kruh. “For instance, the Cadbury takeover bid by Kraft was opposed by the British Government and trade union Unite, since the deal could result in layoffs. Cadbury currently employs more than 7000 people in the UK and Ireland.”

 

Another major regulatory challenge faced by food & drink companies concerns food safety, according to Mr Mulvey. “There has been a fair amount of media coverage regarding contamination and product recalls, with considerable attention focused on the challenges of tracing the sources of food-borne illnesses. In recent years manufacturers have seen the border closed to critical raw materials, as well as increased scrutiny over the sourcing of key ingredients. It is an issue the industry takes very seriously, since the financial and reputational costs of a recall are so high.” He adds that, with the rapid expansion of the food industry and the introduction of new products, companies need to be particularly careful. This cautious behaviour should also be applied in M&A situations to avoid surprises once the deal is completed. Thorough due diligence can help mitigate most of the potential risks. In the meantime, food & drink companies have been faced with an increasing number of lawsuits brought against them for marketing products as presenting certain health bene-fits. This has been the case for Cheerios cereals,which said that its products lowered cholesterol, as well as frosted Mini Wheats, which claimed that eating these cereals reinforced children’s concentration at schools. Although companies should exert caution when making health-related claims on their products and be aware of regulatory limits, experts believe that lawsuits have not really hampered the growth of so-called “functional foods”, and such claims will remain very useful marketing tools. Not all regulatory developments may pose challenges. Some, on the contrary, present opportunities as is the case in China, where the government relaxed its M&A regulation in 2009. Aimed at attracting foreign investment and capital, these new rules consist of greater powers delegated to local governments, and Chinese banks are now allowed to extend loans

to finance M&A. Foreign food & drink companies may therefore find it easier to conduct deals in China, according to Mr Kruh.

 

In general, many companies in the industry will likely start or continue expanding in developing countries in the months to come. “Due to the economic crisis, market factors and changing consumer trends, the market growth potential has slowed down in developed economies. Therefore, many companies are eyeing developing economies to expand their businesses, in order to counter the maturing domestic market sales,” explains Mr Kruh. In the meantime, strategic deals are expected to continue increasing, as the number of private equity deals remains subdued. Companies are looking to grow existing operations and divest their non-core assets, in order to meet investor demands. As a result, niche companies will remain attractive acquisition targets as they allow larger companies to expand their brand offerings or capitalise on recently developed products. “Many strategic buyers sat on the sidelines last year, perhaps due to financing issues. As a result, many private owners with strong businesses to sell had good reason to hold off and wait to see if the market improved,” recalls Mr Ellcessor. “Many of them are concerned about the possibility of an increase in capital gains rates.

 

So, if financing becomes more available, expect an uptick in deals done and in multiples.” Overall, the next couple of years should see an increase in all types of M&A transactions, due to improving economic conditions and improved access to financing. According to experts, large global transactions should also characterise M&A activity in the food & drink sector going forward, as evidenced by the deal between Kraft and Cadbury. Although challenges will continue to emerge, the outlook for the sector appears to be positive