September 17, 2013
Interviewed by: David Snow
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How PE Keeps Food Portfolio Companies Fresh

Private equity firms have made big profits in the food sector. Meet three experts who know the ingredients for success in this surprisingly dynamic and disruptable industry. Learn what motivates founder and corporate sellers to sell, why talented food executives are eager to join private equity-backed companies, and how corporate orphans can grow into formidable brands. Part 1 of a series.

Private equity firms have made big profits in the food sector. Meet three experts who know the ingredients for success in this surprisingly dynamic and disruptable industry. Learn what motivates founder and corporate sellers to sell, why talented food executives are eager to join private equity-backed companies, and how corporate orphans can grow into formidable brands. Part 1 of a series.

How PE Keeps Food Portfolio Companies Fresh
Investing in Food & Beverage Brands

David Snow, Privcap:
We’re talking all about the private equity opportunity in the food sector. All of you are veterans of the space, so I’m very interested to hear what you have to say about deal flow and value add in this space.

Let’s talk about deal flow first. Starting with William Spizman from RSM. You’ve advised on many transactions in the food space involving private equity buyers and sellers. What have you seen as some important sources of opportunities? Include seller motivations, reasons behind why the private equity capital connected with the entity for sale.

William Spizman, RSM:
One of the largest motivators for calendar year 12 was the increase in capital gains rates effective, January 1, 2013, which brought a lot of companies to market in the 2012 period. That was one motivating factor, so sellers could reduce their income tax liabilities. Second being, entrepreneurs have been able to grow their businesses just to a point where they have a significant net worth in their business. They don’t want to necessarily risk additional capital to grow the business. Private equity is a great alternative to bring in additional equity, take some chips off the table, and continue to run and operate your business into the future.

Snow: Dan, as someone who has overseen many different deals, including the food space, but also in other sectors as well, what have been some recurring themes as far as seller motivations, or the reasons that certain opportunities have come to your firm?

Dan O’Connell, Vestar Capital Partners:
There are three or four categories. First is large, consumerpackaged goods companies looking to sell off brands that perhaps have lost their way a little bit, or don’t provide the growth that they’re looking for.

Second are private companies, family companies like William mentioned. They feel that whether it’s liquidity for the family or feeling like they’ve reached their point that they want to move on. Then there are young emerging companies that need capital to grow, maybe want to some expertise. In tough times, you might have distressed situations where companies have gotten themselves overleveraged and they’re out looking for a partner to help shore up their balance sheet and keep them above water. That’s where we’ve found our deals over the years. The flow of opportunities is different at times depending on what the economy is doing and what people think valuations are.

Snow: Joan, your firm is one that has a specialty in, I think you call them “orphans,” right? Can you talk a bit about how “orphans” become available for you?

Joan McCabe, Brynwood Partners:
“These orphans need to be adopted” is what we like to say. As Dan says, it sometimes takes years to be in a position to buy a corporate orphan. Generally, they are businesses that a large company owns. They are milked for cash and they are not global. Not one or two in their market place. The role that private equity is able to play and what we like to do is to resuscitate what may be a U.S.-­‐only brand. We’re a lower-­‐middle market private equity firm. Our fund is $300 million, so we don’t need to have a billion dollars and we don’t have the expertise to go international, so we focus on revitalizing the distribution in the U.S. and putting effort into those single brands. We like to say that we’re like Gerber, food is our business, our only business. Frequently, just a little attention can get you a long way.

Snow: William, you mentioned some dynamics that might cause a family group or an entrepreneur to maybe want to sell, maybe some of it is taxdriven. Is there anything interesting going on within larger corporations that you cover that you think is causing them to either decide to sell certain divisions or decide to partner with private equity sponsors in certain ways?

Spizman: Yes. They look at a brand and they have their capitalspend for property plant and equipment and for advertising. This is going to go to the larger brands, the brands with a lot of growth. The brands with a small amount of growth or ones that have some element of distress, maybe it’s not a natural product that is drawing a lot of attention. They’ll look at that and they’ll say ‘okay, how can we maximize our return on that?’ and the only real way for them to maximize their return is to sell it to someone like Joan or Dan. They’ll get a much better return than they will if they are holding because if there isn’t a lot of growth, there isn’t a lot of attention and private equity can nurture a product like that or a product line like that, that a large corporation cannot. Their best and brightest, their attention is not on that product; it’s on other products.

O’Connell:         I think one of the traps now too is given where the big CPG companies trade, in that eleven to thirteen times, fourteen times EBITDA multiple range and they’re looking at having to pay meaningful tax to sell a legacy asset. It becomes deluded for them to part with it, part with something given the price they will get and the after tax hit there. So you’re starting to see the development and I think you’ll see more and more of those types of things. Some companies are being set up just to do this and that’s become a driver of these separations to be on a tax advantage basis.

Spizman: One of the interesting things that you see with a corporate carve out or a product line being sold is there’s so many costs that are being allocated from corporate to the product. It could potentially be showing a loss on their

books because of their allocations. So oftentimes that’s a great opportunity for private equity as well.

McCabe: However the corporations have gotten smart, they don’t show you any of those allocations. So we’ll buy businesses on brand contribution, it really is just sales, cost of goods sold, and direct marketing. It may look profitable to us and on their books it may not be. But further to your point on valuation, we tend to buy the little brands that don’t even matter. So I can think of one brand we bought. We bought it and we closed in September but we had to hold in escrow the money until they announced a large acquisition so that they could announce it at the same time. And nobody knew, no one knew. But there are such rounding errors.

Most of the brands that we buy are declining at double digits, so these are not brands that you’re talking about milking; these are a question of whether they will go away in five years. So there’s really not a terminal value for many of them.

Snow: I’m interested in talking about the resources, the ideas, and the connections that private equity firms can bring to these  portfolio  companies  once  they have acquired them. It’s one thing to take a view on the value of a certain brand or the trends that are perhaps creating new opportunities for the growth of a business. It’s another thing to actually execute on it. So maybe from all of you, some example of ideas and resources that your firms or your clients’ firms have deployed to improve the value and improve the operations of food businesses.

McCabe: We like to say we take businesses from kindergarten to high school. We have seven partners at Brynwood. Small firm, but five of my partners are operators, so either CEOs or CFOs. So we actually go in generally, we have to put in accounting systems, MIS systems, we put up plans. So there’s an extreme operational focus in our business to generate the returns. We look at it more from operating improvements rather than deleveraging necessarily or just multiple expansions.

Snow: And of course, in some cases you’re buying… not really a company, but just a brand—

McCabe: A trademark.

Snow: And you actually have to build a company underneath it. Dan, what are some examples of resources or ideas that you’ve brought to bear for some of your food portfolio companies?

O’Connell:          I think, you know, the neat thing about the consumer space, the food space, is that the talent pool is really deep and extensive. And it’s a lot of fun for a former corporate executive at one of these big companies to dig in and get involved in a smaller or even a mid-­‐sized company that’s been neglected where they can get to understand the brand equity, what it really stands for, what can be done with that brand, how it can be extended. And with a little

tender loving care and resources behind it, what you can do. You can really attract fantastic people. People that have risen up to be CEOs of major companies but they’ll all of a sudden want to work on a hundred million dollar or a few hundred million dollar brand and they just love it. And then they can attract other people that have worked with them, the best and brightest that they’ve had over the years, along with the promise of the ability to get equity in that situation.

The playbook from brand to brand or subsector to subsector can be replicated. Oftentimes, what’s worked in one area, you can make it work in another. And it’s fun, it’s really fun to take something that’s been neglected, has lost its way and to revitalize it and all of sudden have it start growing and building real equity value.

Spizman: These owner-­‐managed businesses are possibly regional in nature, so if you can just grow a footprint of a company, it will result in substantial growth. It could be a situation where the owner/manager has strength in marketing or strength in production and maybe he doesn’t have strength in marketing. By bringing in the operating partners from a private equity firm, they can easily make some changes to the business, which will result in substantial growth.

It might also be capital restrained from the perspective that an individual owner is putting his own money back into the business and at some point he doesn’t want to do that any longer so fresh money, fresh ideas, and fresh people can really grow a business substantially. And it’s been proven time and time again by private equity.

McCabe: We’re doing that now with a business we have called Pearson’s Candy. It’s a regional brand, a great brand out of Minneapolis. And we bought it from an entrepreneur and we just announced the acquisition of Bit-­‐O-­‐Honey. So the strategy there is to augment what is one regional brand with other, let’s call them encore brands to both grow the company and allow for further distribution gains in the core brands.

Spizman: That’s a nice private equity strategy, to buy a platform and then to have multiple add-­‐ons to grow that business. You’ve seen a lot of roll ups of regional types of businesses into, you know, national businesses by that strategy. But you first have to have the platform and oftentimes it becomes very competitive in the marketplace to buy that platform because there are several private equity firms competing against each other trying to buy food companies. So the multiples and the purchase prices are pretty high to first enter the market. But once you’ve entered the market, the add-­‐ons can be nice because you can fold them in easily into the business.

Snow: Do you agree, Dan? Is that the dynamic that you’re seeing where maybe the competition to become a food investor is there but once you’re established, the add-­‐ons make a lot more economic sense?

O’Connell:  Yeah, you may be able to do those; you’ll need synergies to average down your price. But it’s expensive, especially to buy businesses that are on trend, they can become very expensive.

McCabe: I would actually say that food is a pricy asset right now. If you look at Heinz for example, they went private at thirteen times and then same time Dell went private at five. The great recession and the trends that have occurred over the past five years have almost turned the food industry on its head from being sort of a low value added, low multiple to almost a high multiple.

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