M&A as Innovation Pipeline for Consumer Companies
By Steve Tardio,
The largest consumer companies have struggled for many years to grow through internal development programs, despite a sector-wide renaissance in innovation driven by cutting edge manufacturing technologies, big data marketing strategies, and, at a fundamental level, a shift in consumer behavior itself. As a substitute, they have turned outward to external growth strategies such as M&A, which has presented a significant opportunity for smaller companies with the right attributes to achieve exit goals for their shareholders and other stakeholders.
According to a McKinsey & Company analysis of Nielsen data (“From lab to leader”, September 2018) of the food and beverage consumer category from 2013-17, the top 25 manufacturers are responsible for 59 percent of sales but only 2 percent of growth. Conversely, 44 percent of category growth has come from the next 400 manufacturers. Various reasons for this are offered by many consultants and industry experts, from inertia of scale, to entrenched systems to public market earnings requirements. Regardless of which reasons and in what measure they are responsible for this phenomenon, the widely held opinion is smaller, more nimble companies just innovate better.
Give the large companies credit though. They recognize their shortcomings and are trying to innovate through means of mergers & acquisitions, venture/growth arm investments and business incubators, which can all be viable external growth strategies for them depending on their growth and return goals. The number of consumer M&A transactions tracked by EdgePoint over the last nine years is consistently up over 56% on average annually from 2009 recession lows. Most of the largest consumer companies now have formal or are beta testing venture capital investment affiliates or start-up company incubators staffed with both seasoned parent company functional professionals as well as outside investment professionals. Participants include General Mills (301 Inc.), Tyson Foods (Tyson Ventures), Kraft Heinz (Evolv Ventures and Springboard incubator), Unilever (Unilever Ventures), Nestle (Inventages Venture Capital), Kellogg (Eighteen94 Venture Capital), Chobani Incubator and many others. Some are also investing in outside consumer-focused venture and growth capital funds.
Venture/growth investments and incubators give the larger companies unique and often proprietary perspective into the smaller company’s category niche and target consumer behavior. It also gives them a “spot at the front of the line” of potential acquirers if the business prospers and is offered for sale. Despite the widely believed notion that this relationship requires the larger company receive a right of first refusal to buy the smaller company within a specified period of time, often this is not the case. The terms of the relationship are typically much more balanced. From the smaller company’s point of view, the relationship is in effect a valuable opportunity to “model at scale” its business strategy in the market using resources provided by the larger company. The primary purpose behind venture/growth investments and incubators is as a “dry run” on the fit and combination of the two businesses.
By contrast to scaling up, controlling stake acquisitions of later stage innovative businesses by large consumer companies presents an opportunity to exit on favorable terms in a seller’s market for owners of small and middle market consumer businesses. The sector finds itself in a period where the attributes by which consumers make their purchasing decisions are changing rapidly, where new attributes like “purpose-driven” products and services, and “flexitarianism” (a diet rooted in vegetarian principles but with the flexibility to enjoy animal products in moderation – one-third of U.S. consumers now say they are flexitarians) in the food & beverage category, are gaining prominence. Companies that embody these new attributes and can demonstrate penetration of a new consumer niche market will draw extensive interest from strategic buyers with the infrastructure and systems to act as the engine and pathway to growth. Sellers of controlling stakes in these situations can garner strategic multiples near the upper end of the historical pricing range. For example, consumer M&A transactions tracked by EdgePoint show that on average EV/EBITDA multiples over the last twelve months have been in the 12x range (irrespective of size – this figure is skewed by large transactions in excess of $500 million – multiples for smaller transactions are inevitably smaller). Private equity firms play a part in the story as well. Given their overhang of investable funds, in some situations PE buyers will outbid strategic buyers if it can be shown a PE sponsored growth path is nearly as compelling as a strategic one.
Large consumer companies will continue to work at improving their innovation function and, given a wealth of resources to devote, undoubtedly get better at developing new products and services through internal means. But to achieve their growth objectives they will always have a need to look outward at buying, rather than building, cutting edge innovation businesses whose owners have a unique perspective and desire to solve problems and deliver new solutions for consumers. “Big food’s inability to quickly innovate creates continued opportunity for smaller, more nimble brands to disrupt and innovate within the market,” said Jon Sebastiani, founder and CEO of Sonoma Brands and also the founder of Krave Pure Foods which was acquired by The Hershey Company in 2015. “While the landscape has certainly become crowded with these smaller brands, they truly innovative and differentiated brands will continue to excel and garner attention from strategics, propelling M&A activity”. This attention represents a significant opportunity for such smaller companies to monetize in the current M&A market and to achieve owners’ and stakeholders’ exit goals.