Hungry for growth

Jon Levin is Managing Director of Consumer & Retail Mergers and Acquisitions at Credit Suisse.

Merger and acquisition activity in the consumer goods industry is poised to intensify in 2018 and beyond thanks to a combination of factors rarely seen. The global economy overall and the U.S. economy in particular are strong and set for continued growth. The favorable outlook combined with a strong labor market and signs of wage growth are feeding consumer confidence. CEOs and Board of Directors are generally optimistic as well, which enhances their confidence to make acquisitions.

These factors alone would normally drive a high level of M&A activity, but what’s unique about the current landscape is the competitive dynamic between large, medium and small brands; shifting consumer preferences; and the overall structure of an industry operating under a new playbook for how brands and retailers go to market. These additional elements are fueling what was an already attractive climate for Consumer Packaged Goods (CPG) M&A activity.

There are some well-documented trends leading to a dynamic and rapidly evolving consumer landscape. We have seen changes in consumer behavior as well as the advent of new technology that drive major shifts, impacting both CPG and food retailers. Generally speaking, today’s consumers are more brand agnostic than before and also seek healthier, better-for-you alternatives and immediate gratification. As a result, larger cap food brands have experienced volume weakness, with share losses coming at the hands of smaller, on-trend and “better-for-you” brands with strong appeal to Millennials. Large cap food companies have countered with a Millennial push of their own by offering more products with a clean ingredient focus to bolster their competitive position.


Meanwhile, branded manufacturers are also experiencing increased competition from private label. Retailers such as Aldi, Walmart, Kroger and Dollar General are faced with margin challenges of their own, and are emphasizing private label products. This creates growth challenges for major national brands already coping with shifting consumer preferences. Furthermore, technology advances have created a consumer who demands unprecedented levels of transparency, convenience and new expectations of how to shop.

Traditional food retailers in 2017 were impacted by weaker traffic, a deflationary environment, and intense price competition. Going forward, e-commerce in food retailing is expected to grow since it currently has the lowest penetration rate of any retail vertical. Retailers coping with online pressures are seeking better terms from CPG companies to improve their competitiveness even as CPGs are investing in their own direct-to-consumer distribution capabilities. Retailers have also made significant investment in e-commerce capabilities and partnerships including Walmart’s acquisition of, Albertsons’ acquisition of Plated, Target’s acquisition of Shipt, and H-E-B’s acquisition of delivery service provider Favor.

Against this backdrop, M&A activity in the CPG world has been robust driven by two primary motivations: capturing growth from on trend, emerging brands and unlocking synergies. For example, companies such as Mars, Hershey, Campbell’s, Kellogg, and Conagra all paid premium multiples for smaller, high-growth assets. On the other hand, companies such as McCormick, Reckitt-Benckiser, and Campbell Soup Company pursued larger takeovers in more synergistic transactions.

There are clearly some major drivers of M&A activity at work and the capacity to execute transactions is also high. Large CPG companies boast strong cash flow and balance sheets that have room to add additional leverage. There is also the prospect that favorable changes to the U.S. tax code, part of the Tax Cuts and Jobs Act signed into law in December 2017, could influence M&A activity since the reform promotes the repatriation of cash held overseas.

As for the type of deals, much of the activity is expected to be driven by large cap companies hungry for growth looking to identify and acquire smaller brands. This puts smaller brands in an attractive position since it is somewhat of a seller’s market. Small, high-growth brands are highly sought after and have negotiating leverage to drive valuations vis-à-vis a competitive sales process. When used appropriately, small brands are able to maximize their value by creating competitive tension among large cap firms. In addition, mid cap and large cap mergers are expected in order for CPG companies to gain scale and realize synergies to propel earnings growth while topline remains more muted.

Of course, determining the right valuation is as much art as it is science for companies with a limited sales history and promising outlook, that are looking to monetize. To maximize valuation, positioning is key, taking into consideration sales forecasts, earnings growth, potential synergies and capabilities of the acquiring firm. Smaller brands contemplating a sale, need to credibly explain their growth outlook and drivers behind the financial forecast model. For example, recent performance, especially in growth companies, is hugely important. Companies able to meet or beat expectations given to a buyer during the sale process and negotiation are typically able to command a high valuation and execute transactions more quickly. It is worth noting that there is asymmetric valuation risk if near-term growth targets are not achieved during the sale process. As for the science aspect of determining valuation, buyers are able to look at precedent deal activity and with M&A volume across emerging brands growing, this is providing an increasingly relevant reference set.

One variable that may impact the favorable M&A backdrop is rising interest rates as this can pressure the share prices of large cap CPG companies whose dividend yields are especially attractive to investors in a low rate environment. In U.S. public equity markets overall there has been some sector rotation out of higher dividend paying stocks as interest rates rise. Declining share prices make equity a less attractive acquisition currency. However, given large CPGs tend to generate very strong cash flows and have the ability to meaningfully increase leverage, equity is not expected to be a significant driver of the CPG’s ability to pay for a transaction.

The global economy is enjoying broad-based strength leading to confidence among consumers and CEOs. When coupled with a new set of industry dynamics, M&A activity will maintain, but more likely, accelerate from current levels.