Will high-value M&A deals stay locked out in the cold?

When the economy nosedives, most companies are more concerned with clinging on to cash than looking for the next acquisition target. So at first it seems odd there were more food and drink deals in 2009 than 2008.

But analysis by food and drink M&A specialists Oghma Partners for The Grocer shows that the troubled times fuelled many of last year’s deals: more than one in five deals last year were insolvency buyouts a fourfold increase versus 2008. Large deals were also few and far between last year, with almost 80% of food deals worth less than £10m, as would be expected in a market driven by insolvency and distress sales. Even where financial collapse was not the cause for sale, the difficulty of acquiring finance was a factor in many other deals: Innocent chose to finance its expansion and recent marketing push by selling a stake of its business to Coca-Cola, rather than seeking bank finance, while Burton’s Foods restructured under pressure, resulting in a £331.9m buyout from co-owner CIBC.

The result, according to Oghma Partners MD Mark Lynch, has been to drive valuations sharply downwards. The firm estimates the total value of UK food and drink M&A in 2009 was just £1.25bn, compared with about £2bn in 2008, excluding the huge S&N purchase by Heineken. Provisional estimates produced by the firm suggest the average sales multiple on deals fell by over 40% to 1.1x, while EBITDA multiple fell to about 7x from 13x. “A good proportion of these deals were the result of pre-pack administrations, which have a low value,” he says. “Otherwise, the price paid for food companies has fallen in line with other assets as finance becomes more difficult to access. There have been very few deals driven by a desire to expand into new categories or markets. Instead, where purchases have been strategic, it’s been more a case of companies looking to continue their long-term strategies by buying up key targets in their core categories.”

Once-in-a-decade event
Lynch notes that activity was much higher in the second half of the year than the first, due partly to improving access to finance, and also acceptance by sellers that valuations are likely to remain lower than previous levels in the medium term. This suggests, he says that 2010 will be marginally better for corporate deals thanks to restored confidence, and an increasing willingness by banks to invest in resilient sectors such as fmcg.

The headline-grabbing attempt by Kraft to purchase Cadbury for about £10.7bn illustrates growing confidence, he concludes. “The Kraft bid for Cadbury is a once-in-a-decade event, so in a sense it’s not going to mark a string of multi-billion pound deals,” he says. “But it does reflect a more buoyant equity market and outlook.”

This is a view reflected by Martin Deboo of Investec, who says the long-term trends driving food and drink acquisitions are unlikely to change in the next 12 months. “I’m not too excited about M&A in food, and I don’t sign up to the notion we’re on the verge of a new wave of deals,” he says. “There has been a lot of consolidation among the big corporate, as well as divestment of non-core businesses. The real M&A flavour is focus, with companies exiting categories to focus on dominating their core areas, and a lot of this has already happened. The next trend would be diversification but there’s no real management appetite for that at this stage.”

On the other hand, Will Hayllar, a partner at strategic consultancy OC&C, suggests says any successful purchase of Cadbury by Kraft or another bidder would likely spark a chain of secondary deals, though these may take until 2011 to materialise. One secondary deal has already emerged in the US as Kraft this week sold off its high-growth US pizza business to Nestlé. “Big deals do tend to kickstart the deal market,” he says. “In any big acquisition there will always be parts that don’t fit as well as others, plus the buyer may wish to pay down some debt.”

Hayllar also suggests there may be some scope for diversification. The largest food and drink businesses have been willing to purchase assets in peripheral areas in order to boost growth, he notes.

Unilever’s acquisitions last year, which included haircare brand TIGI and Sara Lee’s personal care business, were indicative of this trend. The company is also rumoured to be considering further sell-offs, including its frozen food arm in Italy, as it concludes its rebalancing. Generally, however, Hayllar agrees consolidation will remain the main rationale for deals and one that can pay off.

“The underlying motive for many food and drink deals is to strengthen current positions by buying a high-value asset. Our analysis demonstrates that higher market share in any given category generally delivers higher profitability. Purchases to reinforce positions, especially with prices as they are, may therefore deliver.”

The recovery of the UK stock markets in 2009 also suggests a new wave of initial public offerings could be likely. IPO plans were all-but shelved by several aspiring food businesses in 2009, suggesting the later months of 2010 may see a flurry of deals.

The most widely anticipated food sector IPO is Ocado, in the wake of Jason Gissing stepping down as financial director in to focus on marketing and external relations. Gissing famously said he would rather shoot himself than be FD of a listed company. New chief financial officer Andrew Bracey doesn’t appear to share the sentiment.