2018 looks set to be a year in which M&A activity in the food industry intensified. What could shape the sector’s deal-making in 2019? Dean Best reports.

The latest findings from just-food’s M&A index suggests there has been a step up in the level of transactions in 2018. As we move into 2019, what do market watchers believe could be factors behind deals struck next year?

Robust demand for health-centric assets

There is consensus that assets centred on health and wellness will continue to prove popular – and potentially command healthy multiples – amid the growing consumer interest in those parts of the store.

Shaun Browne, co-head of UK corporate finance at investment bank Houlihan Lokey and an experienced M&A adviser, calls out “the free-from arena – whether that’s meat-free, dairy-free, gluten-free”.

“I think that continues to be a very strong theme as we look into next year,” Browne tells just-food. “You’re still, in most categories that have a free-from component, getting a good level of growth, in an industry that is otherwise underlying flat.”

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2018 was a year in which a number of more mainstream packaged-food companies either continued their investments in – or entered – the plant-based market. Meat processors remained active investors, with European businesses such as Bell Food Group, Hilton Food Group and PHW Gruppe following counterparts in North America in striking deals involving plant-based businesses.

“You probably will see more of those deals and the likely acquirers will be from meat processors, from Big Food like Unilever, Nestle and also from the organic or natural companies. There are three areas of companies that could be interested in investing in the alternative meat market,” Cyrille Filott, global strategist on consumer foods at The Netherlands-based financial services group Rabobank, says.

Other categories still ripe for deal-making

The action won’t just be limited to companies doing business in categories benefiting from a health halo.

“I think a big thing is all of the free from – but my reading of it is there’s almost a health thing and an anti-health thing going on,” Jonathan Buxton, partner at UK-based M&A advisers Cavendish Corporate Finance, reflects.

“Plant-based has certainly been a very active area this year and I’m assuming that will continue next as well. At the same time, you’ve got Tangerine Confectionery, which Valeo bought early in the year and you’ve got people divesting their unhealthy snacks and you’ve got consolidators of those. Ferrero buying Nestle’s US snacks is another. There’s also Nomad Foods hoovering up all of these frozen businesses. I think that’s a little bit of a sub-pattern.”

Confectionery, at least in markets like North America and Europe where the category is low-growth (at best), is an example of a sector where there can be other factors at play when deals are done.

“From an M&A perspective, there is always an opportunity to go for unfashionable things and buy them, quote unquote, cheaply or relatively cheaply compared to other things. If you take a view that confectionery is not suddenly going to fall off a cliff and die and you’re buying a hugely cash-generative business that has been around for years and will be around for years, you can continue to generate cash out of it,” Browne says. “In the unglamorous end of the market, if assets go relatively cheaply and there’s an opportunity to buy plenty of them and create synergies by crashing them together, that’s always been an M&A strategy.”

Switching on to direct-to-consumer

2019, quips Rabobank’s Filott, could be “The Year of Graze”. The UK-based healthy-snacks purveyor – which in 2017 was rumoured to be up for sale – sells through mainstream supermarkets but started life as a subscription-only service selling boxes of nuts, seeds and similar healthy products.

Filott cites Graze (currently owned by private-equity firm Carlyle) not necessarily as an example of a deal that could be done next year but more to illustrate what he believes could be a growing area of interest when looking at M&A in the food industry – direct-to-consumer.

“It’s not about Graze itself. This is much more about what type of business model towards the consumer is going to be adopted, where are investors and strategics interested, and whether a business model like Graze, which was all the rage, and is perhaps still all the rage, still the way forward?” Filott says.

“I think 2019 is the year that people wake up to direct-to-consumer through all kinds of different categories”

Some major names already offer direct-to-consumer services, including Nestle with Nespresso, Unilever with the razor business Dollar Shave Club it acquired in 2016 and Kerry Group with meal-deliveries-for-the-elderly arm Oakhouse Foods. Manufacturers are eyeing the area closely and some are testing out new ventures, such as Arla Foods, which has started selling infant formula in the UK directly to consumers.

“D2C is one way to sell your product directly but it is also about the data gathering, the intelligence on the back of that that the companies can get, I think it’s still a big theme,” Filott says.

Cavenish’s Buxton agrees. “I think it is the year that people wake up to direct-to-consumer through all kinds of different categories,” he says. “It’s not in food but we sold a business called Orlebar Brown to Chanel and the price they paid was entirely because Orlebar Brown gave them the digital access they were looking for.”

Big Food and its VC units

Over the last three years, an increasing number of food majors, predominantly in North America but also in Europe, have established an in-house development and venture capital arm to back innovative young companies with bags of potential, with a view to helping them to grow.

Companies from General Mills to Kellogg and from Danone to Barilla have taken minority positions in a string of fledgling businesses to try to tap into evolving consumer trends and learn more about how to innovate and do business in a more agile manner.

But what’s next? Will the giants of the industry with these in-house, VC-style arms look to buy some of these businesses outright?

“My personal view is [Big Food] tends to view them as an interesting way of knowing what’s going on,” Cavendish’s Buxton says. “I have a feeling they use them more as a way – which is why you have seen so few actually migrating up and becoming acquisitions – a way of them getting closer to the sector.

“I wouldn’t say it’s a con – because people go in with their eyes open – but there’s a non-alignment between what they’re actually doing, which is digging for info, and the expectation a lot of these small brands have, which is that they’ll end up being bought by them.”

What impact could Brexit have?

The UK’s departure from the EU is not just a local issue; it will affect the way business is done both within the world’s sixth-largest economy and between it and a market of what will still be 440 million consumers. Companies around the world that do business in either the UK or the EU (or both) are watching events closely – not least because, with the date Brexit is set to happen hurtling towards us, there is yet no clarity what shape it will take.

In the wake of the Brexit referendum of 2016, industry commentators believed there would be demand from Europe to buy production assets in the UK in case trade barriers emerged between the two markets. Some still see this as the case – but Cavendish’s Buxton sees another dynamic that could drive deals.

“All of the traffic I’ve seen has been the other way because if you set up in the UK who’s going to make your food? All of the food manufacturers I talk to are saying they’ve got to work hard to retain their European employees and stop them going back. Our office in Poland have had three or four really large food groups looking to invest in factories in Poland,” he says.

“If you’re a food manufacturer, you can only automate to a certain point. Beyond a certain point, you need the skilled labour force and, if your skilled labour force is back in Poland, or there’s a risk they’re going to be staying in Poland, then even if there’s a tariff [between the UK and the EU] in the future, they’d rather build a factory in Poland knowing they had access to that workforce and have the security of being able to carry out manufacturing.”

At Houlihan Lokey, Browne believes the uncertainty he saw among potential clients in 2016 about how they should react to Brexit has continued.

“I remember one particular business we were selling and I went to see somebody in southern Europe about it. They listened very patiently and they said: ‘Mr Browne, if you think we would buy anything in the UK at the moment with all the uncertainty over Brexit, you’re sorely mistaken. We would not touch the UK with a bargepole given all the uncertainty over Brexit.’

“I went to another meeting on the other side of the same city and the firm said: ‘Wow, this is impeccable timing. We’ve been worrying about Brexit and how we’re going to serve the UK market. We feel the only way to be certain we could do it is have an asset in the UK and therefore we’re desperate to buy something in the UK.’ And I’m sitting thinking: ‘Hang on. This is absurd. Within half an hour, I’m getting two completely diametrically-opposed perspectives on the impact of Brexit.’

“And I think that sort of chaos and uncertainty has continued. People who you talk to could give you a very different perspective and it’s all through their own personal lens.”

Looking further ahead

Industry strategists, of course, don’t limit their thinking to the next 12 months. At Rabobank, Filott put forward an interesting dynamic that could be a factor behind deals in years beyond 2019.

“Creating shareholder value can also be done by lowering your asset base. Improving your return on invested capital can be through improving your revenues and/or margin but also lowering your invested capital. So, I’m wondering whether many companies are interested in selling their production assets because, especially for the larger brands that are sort of stable or perhaps even in decline, why not have it produced by someone else?” he says.

“And what you see around contract manufacturing is that more and more of these contract manufacturers are creating in-house R&D teams, supporting their customers. Even R&D, to a degree, might be outsourced to some of these contract manufacturers.

“I think the dynamic might change there of what a Big Food company actually is. In the past, it would be marketing, distribution, R&D and production. And in the long run – so this may not be a 2019 thing but let’s say the next three years or next five years – there’s a chance that it will be distribution and marketing/sales but not necessarily production and who knows about research and development? That could be a joint operation with those contract manufacturers.”