Mergers and acquisitions (M&As) are increasingly being seen as an antidote to low or no organic growth,in a commercial world where established retail and consumer goods companies find themselves struggling for survival in the face of radical consumer change and a series of continuous, devastating attacks on their markets and historic value propositions.
Retailers are looking at new or reinforced competition, much of it intensely price focused. Aldi announced this year it will commit an additional $1.6 billion to remodeling 1,300 stores, an investment that comes on top of its previously announced $3.4 billion capital investment earmarked for new store openings — an aggressive program that could see as many as 2,500 stores sporting the Aldi banner by next year. Lidl, a traditional Aldi competitor in Europe, has announced plans to open 100 U.S. stores by the end of next year and is seriously considering adding as many as 500 additional stores to its U.S. rolls before it is done.
Where 2016 was a banner year for mergers and acquisitions (M&A) in the consumer and retail sectors, with deal levels setting post-recession records despite a decline in deal pricing, 2017 promises to end at what may well be even higher levels. That bullish perspective is just one of the conclusions contained in Off to New Peaks In Uncertain Times, a report on consumer and retail mergers and acquisitions in 2016 recently published by A.T. Kearney, which identified the three key trends driving this growth:
Value will be created at the extremes: There will be an increase in both megadeals and smaller buyouts as higher-value M&A activity migrates to the far ends of the innovation-to-efficiency spectrum.
Increased activity is expected from private equity (PE) and other financial buyers: As we have noted, buyers will be moving off the sidelines armed with a large supply of capital.
Growth across markets: Reflecting a rise in consumer and investor confidence, the consumer M&A market will grow across geographies.
Let’s look at each of these drivers in more depth.
Micro To Mega: Value At The Extremes
The valuation of both micro and mega deals will rise thanks to higher-value M&A activity on both the polar ends of the innovation-to-efficiency spectrum, with large deals driven by consolidation and small deals focusing on new growth horizons and nimble innovators.
On the mega end of the scale, consolidation — such as the Essilor/Luxottica deal — will remain a popular strategy for improving bottom-line results in the face of subdued earnings growth. Consolidation allows consumer and retail companies to expand into premium market tiers where consumers have proven they are willing to pay more — as in the case of natural, organic and “free from” products shoppers identify as healthier or better for them. Companies with large capital reserves on hand can be expected to target thriving companies rather than relying on trying to squeeze growth out of distressed assets.
On the other end of the deal spectrum we see in-house venture capital funds such as Unilever Ventures and Coke Ventures focusing on new growth opportunities, many in the food and beverage sector. Over the last five years Coke Ventures has acquired stakes in Rani soda drinks, Barbican malt beverage, Suja Juice and the Nigerian-based Chi.
Local “nimble innovators” are one, perhaps surprising, beneficiary of these trends and the rise of nationalism. Large acquisition minded companies are in the market for local producers, especially in cases where governments provide incentives rewarding domestic M&A or where the innovators provide new aligned-to-trend brands, technologies and/or R&D capabilities that cannot be matched in-house.
Return Of Private Equity
A number of PE firms and other financial buyers sat on the M&A sidelines last year, but in 2017 they are rushing off the bench — their enthusiasm fueled by a decline in high-yield interest rates from peak levels last year. By March of this year those rates had dropped to historic lows and the gap between those rates and Treasury bond yields had narrowed to unprecedented levels.
Lower rates equal lower acquisition costs for PE firms sitting on record hordes of capital. And, we should remember that PE firms have to find ways to shore up their own underperforming shares, whose value dropped in the face of last year’s decline in acquisition activity.
Global Growth Returns To Balance — BIC Is Back
This year, like last year, consumer and retail companies are advised to diversify geographically. That said, there is no question that political uncertainty in the United States, specifically with regard to trade policies, and in the European Union, as the implications of Brexit continue to be worked out, are making global expansion strategies more complex.
With those caveats in place, we expect to see high deal values across all geographies, but a greater emphasis on domestic M&A activity. One note before we continue. Today, select regional brands are giving many national brands a run for their money and/or beating them in categories such as food and personal care. We expect this trend to reverse as younger population segments spur a homogenization of demand, giving international brands greater incentive to acquire regional players and to consider the adoption of a status quo approach to those acquired regional brands.
It may surprise some to see that the BIC (Brazil, India and China) nations are back.
Brazil, which has witnessed diminished consumer spending and turmoil in recent years, is poised for a rebound in the face of a more stable macroeconomic and political environment and declines in both inflation and interest rates.
It seems likely, at this point, that with real GDP growth between 6.75% and 7.5%, India, Asia’s third-largest economy, will continue to compete with China for the title of the world’s fastest growing major economy, although many think, in the end, it won’t be able to catch the Chinese. Consumer and retail M&A is expected to rise in India, where organic growth often suffers at the hands of intense local competition.
Inorganic expansion, however, can be achieved through deals such as Unilever’s purchase of Indulekha. Any number of hurdles are in India’s way, ranging from demonetization associated with the ban of two high-value currency notes, a growing inclination toward trade protectionism, and rising oil prices, to the gap that exists between the fundamental performance of Indian companies and their rising share valuations. Of course, China is the real wild card among global economies.
In 2016, with a 40% surge powered in part by a 40% decline in multiples, China drove record Asian consumer and retail M&A. This March, in an attempt to promote inward investment, Gao Hucheng, China’s commerce minister, announced formal curbs on outbound investment. The move came in the face of some alarming — from a Chinese perspective — economic reports that saw direct foreign investment to China drop by over 9% this January.
As for Russia, the economy has been in crisis as a result of a number of factors ranging from oil prices to U.S. sanctions to the machinations of the Russian Federation itself. Many investors are looking at this market but waiting until sanctions are lifted to invest.
Consumer And Retail M&A In 2017: The Same, But Different
So, recapping, as we look to the end of the year we see that much in the retail and consumer M&A world will change, and much will stay the same.
First, we expect many trends to continue. We foresee continued and accelerated growth in retail and consumer M&As. And with the continued absence of organic growth, we expect consolidation to remain a primary investment theme driving those new M&As. And, finally, we think we will see PE companies and other financial companies continuing to enjoy steady and even increasing capital access and balance sheet strength.
As to those things that will change, we expect three major trends.
The first is a potential return to sky-high multiples by year’s end, led by valuations in developed countries, but extending to more balanced growth across markets.
Second, we believe political uncertainty and rising nationalism will continue to build, requiring U.S. and E.U.-based M&A strategists to exercise caution when pursuing global deals and growth.
Third, we don’t believe the ongoing pressure on consumer companies is going to decrease any time soon. A lift in stock prices this year will just put additional pressure on companies to demonstrate increasing profitability. This pressure could translate to even higher levels of M&A activity in the consumer sector, especially in the U.S.
Finally, one last sobering note: M&As often don’t create permanent value. The odds favor buyers with a long-term vision and a healthy risk tolerance. 50% of the executives surveyed by A.T. Kearney admitted their transactions over the past year or two created less value than expected.
Bob Haas is lead partner in the Strategy, Top Line Transformation and Private Equity practices of A.T. Kearney, a global strategy and management consulting firm, and co-author of the M&A report, Off to New Peaks in Uncertain Times. Bahige El-Rayes is a principal in A.T. Kearney’s Retail and Consumer practice, and co-author of Off to New Peaks in Uncertain Times