Food industry hungry for deals

April 2013 | FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

The food industry is no stranger to trends and fads, and we are all accustomed to ‘flavour of the week’ diets and the ‘super-foods’ occupying column inches in magazines and newspapers around the world. However, the most talked about food development of 2013 so far has revolved around the $28bn (including debt) acquisition of the HJ Heinz Company by Warren Buffet’s Berkshire Hathaway and private equity (PE) firm 3G Capital of Brazil.

Since the shock deal materialised in February, analysts have been discussing the possibility of a new M&A boom in the food sector. Mr Buffett himself has fuelled further speculation that the sector may see a fresh round of consolidation. The investor spoke with CNBC’s Squawk Box in mid February, noting that he is “ready for another elephant”. Analysts and investors, who were already excited about the prospect of a resurgent M&A market were buoyed even further by Mr Buffett’s admission. Accordingly, shares of other food companies immediately rose in anticipation of potential deals.

The purchase of Heinz, a giant in the food sector, provides the company’s new owners with an enormous platform in the revenue-driving emerging markets. That said, they have had to pay handsomely for the opportunity; the $28bn offered by Berkshire Hathaway and 3G makes the deal for Heinz the fourth-largest food and beverage acquisition of all time.

The acquisition of Heinz will see Berkshire and 3G offer shareholders $72.50 a share, which represents a 20 percent premium on the company’s previous all-time high share price. The deal also values Heinz at 13.8 times earnings before interest, taxes, depreciation and amortisation (EBITDA). Encouragingly for the company’s new owners, Heinz has recorded 30 consecutive quarters of organic revenue growth; this consistent performance is largely a result of Heinz’s growing presence in emerging markets. The emerging markets have driven between 80 and 100 percent of Heinz’s growth over the last five years. Furthermore, 21 percent of Heinz’s revenue for the financial year ended April 2012 was generated in these markets, and it is anticipated that sales from the emerging markets this financial year will account for around 30 percent of the company’s overall sales.

Snowball effect

Analysts are predicting an explosion of M&A activity in the food sector in line with the increased activity that has already occurred across numerous other industries in 2013. The acquisition of Heinz pushes year-to-date US M&A volume to $182bn. However, although the deal for Heinz is a blockbuster one, M&A activity in the food industry was already beginning to pick up in 2012. Last year saw a number of smaller deals completed in the food sector. The Kellogg’s Company’s $2.7bn acquisition of the Pringles brand from Procter & Gamble Company in February and the purchase of Morningstar Foods LLC by Saputo Inc., for $1.45bn in December, were two of the stand out acquisitions.

Yet despite the plentiful M&A activity in 2012, megadeals were few and far between, due largely to ongoing macroeconomic uncertainties. Towards the end of the year, however, bumper M&A activity did pick up. In December, Nestle, the world’s largest food group, announced the $11.85bn acquisition of children’s food manufacturer Pfizer Nutrition. The purchase of Pfizer Nutrition is another deal which seems to have been motivated by emerging markets. Nestle noted that 85 percent of Pfizer Nutrition’s expected sales were due to come from these markets. With the Heinz acquisition quickly following on from the Nestle deal, analysts suggest we may see an M&A boom kick-started across the food sector. 3G Capital’s involvement in the Heinz deal has also provided a boost to those expecting, or hoping, for a flurry of M&A activity going forward. 3G was behind the rise of Am Bev, the Brazilian brewer which formed the world’s largest beer maker in November 2008 when it created Anheuser-Busch InBev. 3G pursued a policy of expansion and cost cutting in order to build the brand, and although the firm has not explicitly stated that it will pursue similar tactics with the Heinz brand, many analysts expect that it will.

Following the Heinz acquisition, past rumours about the company’s alleged interest in the Campbell Soup Company, the world’s largest soup maker, surfaced once again. First mooted in 2008, Heinz’s interest in Campbell has persisted ever since. Speaking in 2008, Heinz chief executive William Johnson expressed his admiration for the soup manufacturer, stating that Campbell was a “great company” that would make a “nice fit” within the existing Heinz structure. There would be a number of benefits for Heinz if it decided to pursue an acquisition of Campbell. Chief among these would be the name, value and sustainable nature of the company’s iconic brand of soups, which have not lost their lustre despite stagnant sales over the last few years. Furthermore, Campbell currently fetches almost exactly the same price as it did in 2008 when Heinz first courted the company. Following the Heinz acquisition, shares in Campbell climbed 6 percent to $40.56, the biggest intraday gain for the company in more than four years.

Campbell’s chief executive Denise Morrison refused to comment on speculation linking Heinz with a takeover of her company but did note that the Heinz buyout had caused her to take stock of the current state of Campbell. Ms Morrison said that “For me, it’s a heightened signal that I’ve got to be even more aggressive about costs. Campbell is always looking for ways to create better productivity and I think this is a good call to action.”

Emerging markets

Industry consolidation has always been a major factor within the food sector. Most of the bigger, more attractive companies trade off the name of successful brands, many of which have proved to be resilient in times of great economic uncertainty. The constant reinvention and marketing of existing, trusted brands often leads to strong profitability and operating margins.

Heinz itself is no stranger to consolidation acquisitions, particularly in the emerging markets.

In 2010 the company agreed a deal to acquire Foodstar of China for $165m and followed this up with the $325m purchase of an 80 percent share in Coniexpress S.A. Industrias Alimenticias in Brazil. Furthermore, Heinz recently announced that it would be investing $120m throughout 2013 in various areas, including an initiative to improve operational efficiency, marketing and, crucially, performance in emerging markets. Thanks to an increase in consumer income in such regions, by 2018 Heinz expects its emerging market businesses to produce annual sales of $5bn.

The Heinz acquisition certainly represents a significant deal for 2013. As the M&A market continues to recover across many sectors and as confidence returns to businesses, we may well see more headline-grabbing deals occur. However, the food sector has always been partial to bolt-on acquisitions and smaller, more strategic purchases, and that is unlikely to change anytime soon. To that end, when speaking at the Consumer Analyst Group of New York conference on 21 February, PepsiCo chief financial officer Hugh Johnston noted that his company may consider M&A as a means of ensuring that the PepsiCo brands in emerging markets continue to contribute to the overall profitability of the group. “We may occasionally choose to do a tuck in acquisition, and we have talked about those in the past. They are typically a few hundred million dollars in size; they are accounted for in our cash flow expectations. And the decision we’ll make on whether we choose to do a small acquisition or whether we will build purely organically will really be driven by what is the right value creation move,” he said.

While many Western firms have been concentrating on strengthening their position in the emerging markets, the last 12 months have seen a number of companies within these regions show an interest in Western businesses. In May 2012 Chinese state-backed Bright Food acquired a 60 percent majority stake in UK cereal manufacturer Weetabix for £1.2bn. India Hospitality Corp. also purchased Adelie Food Holdings for $350m in April 2012.

Inbound investment from emerging markets, particularly from China, into Western businesses is a relatively new phenomenon within the food industry, and we may see more of it in the future.

Magnus Scaddan, head of the EMEA consumer and retail practice at Houlihan Lokey, feels that the influx of Chinese investment into Western businesses is only just beginning and that we will see “substantial” investment in the coming years. Mr Scaddan notes that Chinese businesses’ “strategic objectives are different to Western players – for example, (they) are interested in incumbent management teams, brand marketing know-how, brand transfer to China and a strategic position per se – so it increases the number of targets which are potentially actionable at more attractive valuations.”

In the aftermath of the buyout, Heinz has already begun to make divestitures. When reporting third quarter earnings the company announced that it would divest Shanghai LongFong, a frozen food business in China. Heinz expects to find a buyer for the company within 12 months. Other divestures, as well as strategic acquisitions, are anticipated. These divestures may also help to kick-start M&A activity in the food industry. Heinz enjoys a diverse portfolio of companies and brands, many of which may not fit in with the company’s new vision.

Despite sluggish recoveries in Europe and the US, economic confidence is slowly returning. M&A activity is also seemingly on the increase thanks to extremely favourable financing terms. Private equity firms have access to bank debt, equity prices are low, and many companies are sitting on balance sheets containing record-breaking levels of readily available capital. All of these factors have opened the door for more M&A deals to be pushed through. Accordingly, many companies are eyeing up potential targets for consolidation.

Many companies within the food sector generate steady revenue streams and enjoy high visibility via their well known brands. In that vein M&A also generates great opportunities for synergies in times of macroeconomic strife, especially when cost cutting measures have reached their natural zenith. Although it may not have been the intention of the respective firms at the time, the acquisition of Heinz by Berkshire Hathaway and 3G Capital has clearly sparked the interest of analysts, executives and investors within the food industry. Whether the acquisition will cause the anticipated spate of major M&A deals within the food industry remains to be seen, however, as macroeconomic uncertainties will continue to be a major consideration.

Richard Summerfield