Deal or no deal

If money was sloshing around in bucketloads to fund food sector deals in the heady days of 2007, it was rather harder to come by in 2008/9. Not surprisingly, mergers & acquisitions (M&A) activity has been correspondingly sluggish.

However, there are signs that the tide could turn over the next 12 months as confidence returns and vendors that have been sitting on assets hoping things will get better accept that valuations will not return to 2007 levels and resolve to quit/exit and cut their losses.

Likewise, while private equity funds do not have the firepower they once had, they still have money to spend, notes Grant Thornton (GT) corporate finance partner and head of GT's food sector team Phil Jackson. "They didn't all spend in 2007 as they felt prices were too high, and when things got really tough in 2008/9, they didn't spend either, so many are now in a position to buy."

There is also a more general sense that confidence is returning, even if tough times still lie ahead, he says. "You only have to look at the share prices of the quoted food companies at the end of '08 versus '09 which, if you exclude Uniq and the Real Good Food Company, were up 34% although they are not anything like the levels of 2007."

It's also clear from the Kraft/Cadbury saga that there was a perception in the market that the shares were undervalued, as only a bid representing a significant premium over the current share price was finally deemed to be acceptable, according to Jackson.

"Likewise, as things have improved a little on the cost inflation front for many companies in 2009, profits should be higher than in 2008, which gives vendors that have been sitting on assets more leverage, he says. "People don't want to sell on the back of lacklustre 2008 profits, so they have been hanging on."

Buy-outs and buy-ins​

There are also private equity firms out there that have held on to some food interests for longer than they planned and now need to exit, adds Mark Lister, head of corporate finance for the north of England at business advisory firm PKF. "I think a lot of this will happen through secondary buy-outs."

However, management buy-ins have been "very difficult" over the last 18 months as private equity investors tend to view them as more risky than management buy-outs (MBOs), says Julian Wild, food group director at commercial solicitor Rollits. "Bringing in an external management team can be risky. MBOs in which the management already knows the business inside out, are seen as safer."

Meanwhile, capital gains tax (currently at just 18%) is likely to rise whoever wins the election, predicts Lister, so many vendors are thinking they might as well sell up now, he says. "While you often get a grace period when new tax measures are introduced, it's possible they could be implemented fast via an emergency budget, so this could prompt activity."

As for bank lending, "many banks are still focusing on existing customers rather than financing deals", adds Lister, "although things have picked up a little and new players [in the banking sector] are also arriving in the market". As for trade deals, buyers could come from overseas, predicts Lister: "We've had a few bits of intelligence that food manufacturers [based overseas] are looking to acquire in the UK."

Bob Henry, partner at Matrix Private Equity Partners, says there are three things that will drive M&A activity in food this year: continued financial distress (prompting further consolidation); a renewed drive on research and development and new product development among larger companies that could prompt them to buy smaller, more innovative companies with exciting ideas and concepts; and the desire of privately owned companies that have been sitting on their businesses for a couple of years to exit.

So what businesses could change hands over the next 12 months? Hard to say, says Investec Securities food producer analyst Nicola Mallard, but two names worth watching are United Biscuits (owned by PAI Group and Blackstone) and Birds Eye Iglo (owned by Permira), which have been in private equity hands since December 2006 and August 2006 respectively, which means their owners could be looking for an exit.

As for chilled food, Northern Foods recently ruled out in-fill acquisitions, while Greencore is likely to pump any cash (generated by a possible sale of its malt business) into its fledgling US operation, says Mallard. Uniq, meanwhile, is "not in a position to buy anything", and would itself be a target were it not for its hefty pension deficit, she notes.

In the bakery sector, tough times have prompted some distress-driven deals, although some more appealing assets have also changed hands (Noble Foods has just snapped up a controlling stake in Gü). It will be interesting to see whether the former Northern Foods businesses [bread, chilled pastry and cakes businesses sold to Vision Capital in January 2007] come back into play this year, she adds. Tangerine Confectionery is also rumoured to be on the lookout for acquisitions.

However, while the Kraft/Cadbury deal has been the talk of the City, deals of this scale are pretty rare, she adds, and there is no indication that it will prompt a flurry of other mega-deals although deals of this size often prompt residual activity as chunks of businesses are sold off in advance to help raise funds (such as Kraft's sale of its US pizza business to Nestlé) or subsequently as restructuring programmes are implemented.

Henry, meanwhile, predicts more action in fresh produce which is still quite fragmented and frozen food which has become more sexy, both from an environmental perspective (no waste) and an economic one (better value for money in straitened times).

There are also some interesting ethnic food businesses for sale in the London area, while there could also be some activity in more innovative areas of the cakes and confectionery market, he predicts.

As to what kind of businesses appeal to private equity investors, unloved brands, good management teams, strong and maintainable cashflow and resilience are just as important as stellar growth prospects, he says.

On a broader level, the market is willing to pay for "category scale, a presence in emerging markets, strong brands and international diversity", adds Neil Sutton, head of corporate finance at PricewaterhouseCoopers. "But health, convenience and indulgence are still the buzzwords."

Some sectors have lost their sparkle, noticeably organics, he adds, while functional foods and ingredients have suffered owing to uncertainty surrounding the health claims regime in Europe. However, "there is still good growth in more established areas of the market with proven science such as sports nutrition and there will always be strong interest in truly innovative products or brands in this area", he predicts. "Food manufacturers also need to address the demographic issue the growing numbers of older consumers I'd like to see more innovation aimed at the over-50s."

Tale of two markets​

The food market, says Sutton, is like an hourglass, with revenue coming from a large group of small firms and a handful of global multinationals, but not a huge amount inbetween. Perhaps unsurprisingly, M&A activity matches this, he says. "Where you're looking at deals of up to £200M, the banking market has come back in the last few months in terms of willingness to finance transactions often in combination with other banks.

"And then you have the über-deals, with Nestlé buying Kraft's pizza business and the Cadbury deal and no doubt residual activity resulting from this. However, I don't see as much deal activity in the £200M£1bn arena; there is less finance for these kind of transactions."

There was a boom in M&A in 2006/7, but much of that was driven by the availability of cheap credit, he adds, and the value of M&A has reduced since then. "But in terms of the volume or number of deals, M&A activity has been much the same over the last 25 years."

Fast forward​

Looking forward, distress will continue to drive activity, says Lister. "Banks that have extended a lifeline to companies over recent months may decide things are not going to get better and pull the plug before they lose any more money." In January to June 2009, Grant Thornton dealt with a lot of distressed companies, adds Jackson, "and that will continue, albeit at a lower level"

2009 did, nevertheless, see some interesting deals, including NBGI's purchase of Pasta King and Key Capital's purchase of TSC Foods, C&C's purchase of Gaymer Cider, Cranswick's acquisition of Bowes of Norfolk and Molson Coors' acquisition of Cobra Beer, he notes. "There were 70 deals in the food sector in 2009 compared with 132 in 2007 but what was significant about 2009 was that half of the deals were 'distressed' transactions sales out of administrations or larger firms selling off loss-making assets and so on."

Tom Phipps, director at corporate finance firm Livingstone Partners, says 2009 was "an exceptionally quiet year M&A transactions in Europe were down 50% in the European food sector. Corporates have not really engaged in active M&A and, from an owner-managed perspective, it's also been very quiet as people have been sitting on businesses because if you didn't have to sell in 2009, you wouldn't. But they will want to exit at some point, and I do see things picking up in the second half.

"The banks are slowly starting to lend again but lending is not going to go back to how it was in 2006/7. They are very selective, but when an attractive asset comes up they will all chase it quite hard."