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Consumer Products M&A Cooled in the First Half

September 22, 2023

Article | September 7, 2023

Merger and acquisition activity among consumer products companies took a breather in the first half of the year as valuations were reset amid rising interest rates.

Closed deal activity declined by more than 25% from the same period a year earlier, driven not only by the reset in valuations but also by comparisons to the booming market of a year earlier.

But we believe the bottom of the deal market is likely in the rearview mirror, as economic headwinds like rising interest rates and elevated inflation have stalled or subsided.

In this uncertain lending and growth environment, we’ve observed a notable increase in earnout arrangements and the use of existing credit agreements to drive add-on activity.

While deal activity has had a recent uptick, the uncertainty over financing will continue to limit deals that are heavily reliant on debt.

Impact of interest rate campaign

From March 2022 through July, average monthly closed deal activity fell below the four-year average in all but four months, a direct result of the Federal Reserve’s interest rate increases and related economic uncertainty.

The higher cost of capital has had a cascading effect as increasingly higher debt servicing costs further separated the valuation gap between buyers and sellers.

Add-on strategy growing

Add-on acquisitions have constituted a larger share of deals recently, averaging more than 68% of deal activity per quarter since early last year against a 62% average in the three years prior.

These acquisitions are cost-effective for buyers, especially during periods of elevated borrowing costs.

With consumer discretionary spending entering a period of uncertainty, add-on strategies are becoming particularly popular among food and beverage businesses. These strategies are also being embraced in consumer service businesses like roofing and HVAC repair and installation, and in areas where investors can quickly scale the number of locations while centralizing back-office operational and marketing support.

We anticipate this trend will accelerate, particularly within consumer services and franchised businesses more broadly as sellers evaluate exit and transition options for long-held businesses.

Food and beverage

Food and beverage activity rebounded in the second quarter as closed deals reached the highest volume since early last year. Food inflation has recently eased as year-over-year food-at-home prices have fallen to the lowest level in nearly two years. Much of the investment activity within the space has been focused on carve-out transactions.

With investors paying renewed attention to margins, companies have heightened their focus on integration, planning and synergies as the grow-at-all-costs model fades. Demand for private label goods continues to grow despite the easing of food inflation. That demand will in turn spur investor interest in contract manufacturers and companies with strong private label businesses.

Beverage companies are benefiting from heightened demand. Two areas that continue to drive activity are alcohol brands driven by innovation and a rising demand for ready-to-drink beverages that provide higher contribution margins.

We expect the same themes to continue into next year as the emphasis on margin growth underscores companies’ focus on portfolio optimization.

Further divestitures of brands not aligned with long-term strategies should be expected. Additionally, the anticipated consolidation within the grocery and convenient store space will shape the performance of many packaged goods brands.

How is the consumer products landscape changing for the middle market?

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Consumer goods

Consumer goods activity continues to show signs of stress, with closed deal activity declining in the first half of the year. The sector is navigating a challenging macroeconomic environment, including reductions in consumer discretionary spending, softer retail sales and a higher cost of raw materials.

But bright spots have emerged, with strong demand for consumer home services and consumer health.

Consumer home services platforms have continued their roll-up strategies, targeting add-on acquisitions to expand either service offerings or geographic market.

We expect to see further investment in the subsector through the second half of the year, as a number of generational transitions will drive consolidation.

Consumer health has been bolstered by transitions from prescription to over-the-counter (Rx to OTC), as well as a focus on wellness with vitamins, minerals and supplements. We expect this trend to continue in the second half of the year.

Retail and restaurant

Retail and restaurant M&A activity was hit hardest in the first half of the year, with the deal count reaching the lowest level since the onset of the pandemic in 2020. A combination of rising interest rates, inflationary pressures and a potential recession led recurring investors in the sector to adopt a wait-and-see approach.

But there were bright spots, including continued consolidation across franchise systems driven by first-generation franchisees retiring, consolidation among grocery and convenience stores (the Kroger-Albertsons merger notwithstanding), and a sustained investment in consumer services businesses, most notably in the automobile industry and in health and fitness.

The slowdown in restaurants was particularly noticeable, with exceptions for high-growth brands and aggregators of fast casual concepts. The successful initial public offerings of both Cava and the Gen Restaurant Group and the recently announced sale of Ruth’s Chris Steak House and Fogo de Chao may provide a boost to restaurant valuations overall and pave the way for more activity in the second half of the year.

Conversely, more M&A opportunities may arise from restructuring or distressed situations, in line with the sale of Corner Bakery Cafe.

This article was written by Mike Graziano and originally appeared on 2023-09-07.
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