Money men seek deals

Evidence of the increasing number of deals in the sector can be seen from the statistics produced by OC&C Strategy Consultants that found 18 deals above £20M had been completed in 2005, compared with only nine in both 2003 and 2004.

This increased activity has been prompted by a number of factors, one of which is the availability of 'cheap' debt from the banks and the accumulation of large funds by private equity firms that are now keen to back MBOs in all areas.

According to Neil Sutton, head of corporate finance at PriceWaterhouseCoopers, the interest in food and drink follows a lengthy period in the 1990s when there was a nervous feeling about the industry - particularly from private equity firms.

"It was seen as a bit of a difficult sector as there were no contracts with retailers, lumpy capital expenditure [requirements], and there was a nervousness about own-label because retailers could quickly switch their business to other suppliers," says Sutton.

But this thinking has gradually changed and there is now recognition that there is "money to be made in the industry". Investors are finding it has a number of attractive attributes such as: it is largely unconsolidated; the emergence of some fast growing areas such as healthy, organic and cross-over foods that have a foot in the pharmaceutical camp; the increasing willingness of consumers to buy premium products; its stable cash generation; and the defensive nature of the food industry.

More MBOs on the cards

What is most interesting about these factors is that they affect all parts of the market, which has resulted in MBOs taking place within manufacturers of all sizes. Sean Moriarty, partner at HW Corporate Finance, advises companies at the smaller end of the market and predicts we will see a lot more MBOs in the sub-£10M turnover category.

"Recently we've seen many instances of very good businesses that are growing well in niche areas, but the owner finds the business has gotten bigger than they expected. But it's still not sufficiently big enough for a large corporate to buy it, so an MBO is seen as a route to take it on to the next stage," he says.

These MBOs are typically initiated by the existing management that wants to buy-out the company's owner, but they can also involve external executives wanting to buy into a business. In both cases they will seek bank or private equity funding - depending on the size of the deal.

Moriarty says there is currently an influx of skilled middle and operational executives hitting the job market as a result of many large companies scaling back their operations to concentrate on core businesses. Take Northern Foods, for example, which has just sold it speciality breads, chilled pastry, cakes and flour milling division to Vision Capital for £160M.

Rather than joining another large company, Moriarty suggests, that executives should instead consider buying into a small manufacturer. "There are management out there but they are not aware of the many possible businesses [to buy into] and that they might only need to scrape together £50,000, as the banks will find the rest."

Top-level management in all businesses are crucially important, but Moriarty says this is even more so in the case of smaller businesses. For companies that are doing £3M of business annually (and it is clear to investors where the next £3M of sales is coming from) it is the quality of the operational management that will satisfy the banks that they have a good MBO-lending proposition.

The quality of the management is also given this same high level of value among small-scale private equity firms that back slightly bigger deals than those that are funded purely from bank lending.

Bob Henry, partner at Matrix Private Equity Partners - which backed the MBOs of FN Ingredients, Pasta King and Maynard Scotts, says the difference between small and large deals - above say £60M - is that "management becomes a commodity" in the latter.

He adds: "With these larger deals the [heavyweight] private equity firm will likely approach the company itself [rather than acting upon an approach by executives with an MBO proposition] and they will put more of their own team in as these large businesses are more robust and will already have a good second-tier of operational management. In contrast, in a small £20M MBO, the production manager will personally have to deal with any problems [on the factory floor]."

Foodservice supply safety

Smaller deals have also tended to involve suppliers to foodservice companies since they are regarded by many to be a safer bet than those that supply retailers - especially large ones. "We tend to not invest in small companies that supply big customers such as the supermarkets as their influence can be too great," says Henry.

Sutton agrees that a reliance on a big customer would scare potential investors: "If they supply 90% into one customer then the banks will be reluctant to lend to them and they'll factor in this negative [on their rates of lending]."

However, many of these deals for suppliers to foodservice companies involve unbranded 'white label' manufacturers, which large private equity firms generally dislike, instead preferring branded manufacturers.

Phil Griesbach, director at Barclays Private Equity, says that branded is more favourable in terms of pricing because consumers' loyalty to specific brands means regular business. He notes that although the supermarkets are pushing some brands out, household names like Mars and McVities will always have a place on retail shelves. "In contrast, own-label can be difficult to defend and so is less attractive," he says.

Although unbranded has its downsides this is not a deterrent to investors. Henry says Matrix simply restricts its investments to those manufacturers that are positioned at the higher-quality, more innovative, end of the market because this creates a much stronger relationship with their customers than the producers of lower-quality commoditised white label goods are able to enjoy.

One of the many deals struck within this area was the October MBO of £25M-turnover TSC Foods from Gourmet Invest, which supplies foodservice (as well as some retail clients) with unbranded marinades, dressings, chutneys and glazes.

While many MBOs of small firms have centred on unbranded own-label manufacturers, larger buy-outs have been much more strongly focused on branded food producers.

Keith Ellis, global head of food and drink at major private equity firm 3i, agrees with Griesbach in preferring to back buy-outs of branded manufacturers: "We want to be in branded as your destiny is in your own hands. All the recent [large] deals have been in branded."

This is undoubtedly why the likes of private equity heavyweights Blackstone and PAI were willing to pay £1.6bn for United Biscuits (UB) - that includes McVities and Jacobs in its brands - and European Capital splashed out £85M for the Whitworths fruit snacks business.

Fierce competition

Paul Wilkinson is former chairman of RHM and current joint-chairman of Big Bear, which is looking to fund MBOs of niche branded confectionery businesses to add to its Fox's Glacier mints operation. He believes that Whitworths was bought for 25% more than it was worth and that this is a strong indicator that competition for buy-outs of well known brands is extremely fierce.

He says that branded manufacturers are typically sold for around ten times their earnings before interest, tax, depreciation and amortisation (ebitda), while unbranded producers will sell for only five times their ebitda.

Luke Jensen, head of the consumer practice at OC&C Strategy Consultants, is also wary of valuations for branded food companies being driven up by the competition between trade buyers and the groups of deal-hungry private equity firms.

He cites the recent Permira buy-out of Unilever Frozen Foods (that includes the Birds Eye and Iglo brands) as an example of a "full" price being paid. The new owners could well have a tough job creating growth from a frozen foods market that has historically delivered low-growth, he adds.

Such are the giddy heights to which valuations have been driven by private equity firms that trade buyer Premier was forced to pull out of the recent UB auction and leave it to major private equity players Blackstone and PAI. Since then, of course, Premier has put in a recommended offer to acquire RHM for £1.2bn to create the biggest food manufacturer in the UK and the owner of a number of iconic brands.

Wilkinson believes that valuations will soon reach a peak as potential backers of businesses begin to put a "cap" on the price levels at which they are willing to buy into companies. But even if valuations are pegged back in this way, it is highly unlikely that this will stymie the strong flow of buy-outs, of both branded and unbranded manufacturers, to which the sector has now become accustomed. FM

Printer friendly version

Email this article to a friend