The food sector and its investment potential

United Kingdom


The €1.3bn acquisition of Picard Surgeles, the French producer and retailer of frozen foods, by BC Partners at the end of 2004 capped a year of impressive private equity activity in the Food sector. Yet with talk of mounting regulation and interest from competition authorities, increasing retailer power and a perceived scarcity of available businesses, it appears that the private equity sector is going to have to get smarter to continue to reap rich profits from the Food sector.

What is clear is that the Food sector has held immense appeal for private equity houses of late. Michael O’Donnell, Managing Director at Legal & General Ventures Limited - whose portfolio of successful investments in the sector have included ownership of the Young’s Seafood and Golden Wonder brands – says that the opportunity to bring a number of brands together is part of the appeal: “Food brands which have strong revenue streams are attractive to the private equity sector as they enable a buy and build strategy. When put together, previously under performing brands can tap into synergies and economies of scale.”

Yet there is every reason to believe that minor investors and the brands themselves can benefit from private equity involvement. The ability to harness strong management teams with experience of businesses producing fast moving consumer goods, who can deliver improved efficiency, strong profits and better returns for investors is at the heart of the appeal private equity houses hold. As a consequence, investors and their management teams have been able to deliver the consumer increasingly cost effective and innovative products, with the minority investors sharing in the gains private equity houses attain.

Mike Parker, Managing Director at Young’s Bluecrest Seafood, which has been in the hands of private equity houses since 1998, adds that the support of a private equity house is a boon to a strong management team: “These guys know what they are doing. As well as supporting the management, they bring a clarity of thinking that has seen us go from strength to strength.”

Yet there is a growing feeling that the success of private equity houses, and in particular the ‘buy and build’ philosophy, has exhausted the major opportunities, leaving a scarcity of investment targets. Equally, acquisitive expansion for some of the larger groups would bring with it the risk of riling the competition authorities, while escalating concerns over health and safety issues (as highlighted by the recent furore over Sudan 1 contamination) and age-old issues of brand loyalty reiterate the point that the food industry is not a risk-free target for investors.

The challenge for the food industry now is to be sufficiently open-minded to explore different avenues and turn the threats into opportunities, allowing the vein of private equity M&A activity to continue long into 2005.

Trends for the future

Mature industry leaves fewer targets

Private equity firms have not merely invested in the food sector, they have also realised their investments – through secondary (and tertiary) buy-outs and trade sales – ensuring that M&A activity has been buoyant in the twenty first century. In fact, private equity activity has been growing steadily over the last four years and now accounts for 11% by value (2.5% in 2003) and 7% by volume (3% in 2003) of all worldwide activity. In the UK in 2004 private equity deals represented 22% of deal activity by volume.

As the industry consolidates, it is inevitable that opportunities in the UK market will become harder to find, involving higher-risk ventures and less well-known businesses. The alternative that many investors are following is to look towards Continental and Eastern Europe and the CIS as exploitable markets.

Europe has provided plenty of recent examples: the €32m acquisition of a 37% interest in Bambi-Pozarevac, a Serbian based manufacturer of confectionery and frozen fruit products, by Salford; Henderson Private Capital’s recent acquisition of Homann Feinkost GmbH & Co. KG, the German manufacturer and supplier of chilled and convenience food products, for approximately €140m; the €850m acquisition of the sugar confectionary unit of Dutch food group CSM by CVC Capital Partners; and the acquisition from EQI, the Swedish private equity firm, of Vaasen & Vaasen, the Finnish bakery company by CapVest for €300m.

The fragmented market in many territories provides the opportunity to replicate the market activity seen in the UK over the last few years. However, these markets will inevitably reach the UK market’s level of maturity. It is in this climate that we may begin to see the emergence of a handful of much larger pan-European groups building market share through the acquisition of producers and manufacturers whose operations complement their own. It is here perhaps that we see the logical extension of the economies of scale that have brought the UK market this far, and the makings of a longer-term strategy for investors with an eye on yet greater returns.

Retailer power

Should consolidation of producers and manufacturers occur, the size of the enlarged groups may enable them to represent a more effective bloc to the power of large retail groups. The consolidation of retailers has allowed the major players (principally supermarkets) to leverage their purchasing powers more and more effectively, driving down manufacturers’ margins and extending payment terms and demands. Recent criticism of Sainsbury’s intention to extend payment terms from three to six weeks has highlighted the extent of this increased buying power. The OFT’s criticism of Sainsbury’s decision, and the forthcoming publication of its revised Supermarket Code of Conduct appear to signal a new direction for the regulator.

However, some commentators argue that the pressures imposed by the major retailers may instead have a positive impact, as the supermarkets’ demands encourage and reward those providers who are innovative and efficiently run. It will come as no surprise if those providers who benefit from the experienced management supplied by private equity houses are those best placed to innovate most effectively.

Scarce Management

With strong, innovative management key, competition among employers for the best staff is rife. It is apparent that any successful private equity investment is characterised by a talented and driven management team. As the private equity model begins to dominate the food sector, the number of management teams who are available to turn investors’ funds into strong profits and high returns becomes a rarer commodity.

As one supplier admitted: “We have really struggled to identify suitable managers to run these assets - it is becoming an increasing issue in the industry. Talent will need to come from other dynamic sectors: but will they have what it takes to succeed in the food industry?”

The rise in secondary management buyouts (from £3bn in 2003 to £7bn in 2004 – 36% of deal value) is a further issue for private equity houses as incumbent management become less likely to avail themselves of opportunities to demonstrate their skills in alternative businesses. For the time being, the industry remains optimistic about the ability of long-term managers who have experienced more than one private equity transaction to deliver consistency, innovation and healthy growth. As Guy Weldon at Bridgepoint points out: “Whilst we might have had some concerns that managers would become less motivated following a realisation of a successful investment, in fact we have continued to benefit from their proven experience. Second or even third time round, they are even more in tune with mindset and requirements of private equity owners.”

Safety Issues

Sudan 1 has forced product liability and food safety issues to the forefront of minds again. Premier Foods’ involvement in the debacle has been well documented elsewhere, but the lessons to be learned are clear:

Due Diligence – A commercial decision will need to be taken to assess whether or not a supplier’s assurance of compliance will be sufficient. Case law in the area is inconsistent. It is recommended that some level of additional quality checks and testing should be carried out and reviews undertaken where ingredients can have a long shelf-life.

Trace-ability - documents should be kept up to date and document retention policies reviewed. This is particularly the case where there are long-life products involved.

Recall & Customer Help - A recall system and customer complaints must be in order to rapidly remove products and deal with any complaints/queries. All food business operators must collaborate with the competent authorities on action taken to avoid or reduce risks posed by a food that they supply or have supplied.

Brand Reputation - The Rapid Alert System for Food & Feed and the Hazard Alerts provided by the Food Standards’ Agency can impact on the reputation of a manufacturer or retailer and/or their market share. A rapid response from industry to any agency enquiries and the provision of robust risk-based evidence may serve to better inform these announcements.

Media Relations - Spokespersons should be primed with relevant information in any withdrawal or recall scenario. Inaccurate and misleading reporting should also be corrected swiftly. The various codes, voluntary and statutory, provide mechanisms and opportunities to secure corrections and apologies without the need for recourse to, often unattractive, legal challenges for defamation.

Insurance & Contract Terms - Assumptions are often made that losses will ultimately be insured. However, the extent of any insurance is likely to be limited as compared to the overall nature of the loss. This is because recall policies generally provide only quite restricted cover and are not a standard feature of product liability insurance policies.

Availability of funds provides opportunities to sell

As Mergermarket’s food perception survey indicates, there remains some ignorance in the food industry regarding the availability of private equity funds and relatively cheap debt finance. More than one-third of senior personnel who responded to the perception survey indicated that they have ‘limited awareness’ of financing methods available to acquirers.

It represents a significant opportunity for investors, when there appears to be wide scope for mutually beneficial deals. As one told us: “We have the funds, and we just need to find suitable assets.”

For those investors and advisers who are willing to cast their net further and wider, there remains the possibility of successful investment in the sector.

Under performing businesses still available

An inevitable aspect of any industry is that some businesses will fail - and the food sector is no different in this regard; providing private equity investors with the opportunity to identify and develop assets that may have lacked profile or received insufficient backing within a wider group. With the search for the ‘diamonds in the rough’ intensifying, it is here that some of the biggest gains may be made.

It is a view endorsed by Mike Parker of Young’s: “We managed to acquire from the liquidators of Albert Fisher an asset which we have successfully integrated into our existing platform with enormous success.”

While developing neglected parts of a failed business may constitute a larger risk, the plus side is that it also offers more significant gains.

Food sells

Fundamentally, the food sector will always attract investment activity and investors - it is an inherently attractive model providing relatively stable strategies and business models with the ability to generate significant cash.

“There will always be a demand for well run businesses in this sector - the business model has been tested and it works; the retailers will always need suppliers and vice-versa and the consumer will always need food”, says Michael O’Donnell.

The outlook for private equity involvement in the food sector is positive. Further opportunities are available, but responding to the key issues of growth, product safety and innovation will be central to future success.