1Can M&A Reignite Growth in Consumer and Retail?

Can M&A Reignite Growth in Consumer and Retail?2018 Consumer and Retail M&A Report

Traditional consumer and retail companies will fight back and increasingly look to adjacencies in M&A to drive growth.

1Can M&A Reignite Growth in Consumer and Retail?View online: bit.ly/2018-RetailMA

For consumer product and retail companies, 2017 offered more of the steady M&A activity that has characterized the past several years. Not accounting for large deals, M&A deal value was a scant 2 percent below the previous year, with activity essentially matching the hot market of 2016.

Simply keeping pace may have felt like a small reprieve, but even so, the pause in rapid M&A market growth will likely be short-lived. Private equity firms are sitting on piles of dry powder, while brick-and-mortar retail and consumer products companies report record amounts of cash reserves.

The means for an uptick in M&A activity are there—but more importantly, so is the motivation. Legacy companies are fighting for their futures as they search for new markets, new consumers, and new ways to grow. Finding opportunities where industries and sectors converge is the way forward, and M&A is how industry stalwarts will get there.

Our consumer and retail M&A outlook includes four predictions for the year ahead:

• Legacy consumer and retail companies fight back

• Global M&A deals heat up

• Corporate venture funds evolve—or face becoming irrelevant

• Private equity firms continue their buying spree

As newer players disrupt the retail and consumer product space, the choice for the established companies has become clear: Use M&A to help pivot business toward the future—otherwise, face losing relevance or being acquired.

2017 Trends in Mergers and Acquisitions Merger and acquisition activity showed a decline in 2017 as global uncertainty gave some investors pause in consumer and retail.

The M&A rally takes a breatherConsumer and retail M&A activity has been on the rise since 2009. Last year, activity leveled off with 2017’s deal value down 16 percent overall from 2016 levels. However, when megadeals valued at $30 billion or more are excluded, value was down only 2 percent (see figure 1 on page 2).

In fact, these megadeals have accounted for most of the M&A activity growth since 2013. Without them, the market growth has been essentially flat. That’s due, in part, to softening valuations that affected nearly every region. The exception was the Asia Pacific region, which was bolstered by acquisition activity in China. In North America, the EV/EBITDA multiple dipped to 10.4—the lowest multiple since 2011.

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Large M&A deals persisted The number of large M&A deals—those valued at more than $1 billion—reached a new, post-recession record of 59. The biggest deals highlighted both ends of the strategic M&A spectrum: consolidation and convergence. British American Tobacco claimed the title of the largest completed deal as it further consolidated the sector with the Reynolds acquisition for $64 billion.

Meanwhile, Amazon’s $13.7 billion acquisition of Whole Foods provided a prime example of convergence and of a company using M&A to capitalize on adjacent opportunities. For example, the e-commerce heavyweight is already exploring how to use Whole Foods to improve its on-demand food delivery services.

Even as the number of large deals increased last year, the average megadeal size dropped to $4.9 billion, a 19 percent decrease from $6.1 billion in 2016. That’s due primarily to the varying size of large deals year to year. For example, the largest deal in 2016 was the AB Inbev acquisition of SABMiller. At $107 billion, it trumped 2017’s large deals and certainly skewed deal value averages.

The new M&A normal? There was no normal Between the first year of Donald Trump’s presidency, the fallout from Brexit, and the multiple elections around Europe, political upheaval was 2017’s calling card. Even as global markets continued to rally, the resulting uncertainty slowed new M&A deal announcements. The US regulator’s objections to the AT&T and Time Warner deal based on size (vs. market concen-tration) was surprising and certainly added to the M&A market ambiguity.

Additionally, last year yielded $363 billion in announced M&A deals, the lowest of the past three years: $561 billion in new deals were announced in 2016, and $470 billion in 2015. That repre-sents a 35 percent decrease and 23 percent decrease respectively.

–2%

–16%

Consumer and retail M&A activity ($ billion)

Sources: Dealogic; A.T. Kearney analysis

Figure 1 M&A activity reached $392 billion in 2017, down 16% from 2016

Year-over-yeargrowth

M&A deal volume

M&A deal value

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

$474$512

$154

$231 $237 $250$318 $294

$358

$468

$392

+7% –3% –22% +11% –1% –6% –9% –2% –12% +9% –6%

+57% –18% –55% +50% +2% –10% +50% –8% 0% +14% –2%

$418

$56

$37

$63$64

$133$171

$341

$213

$295$335 $328

Deals > $30 billion

Deals < $30 billion

3Can M&A Reignite Growth in Consumer and Retail?View online: bit.ly/2018-RetailMA

Private equity firms put dry powder to workPrivate equity dry powder reached new heights last year, thanks to record years of fundraising and successful deal exits in 2014, 2015, and 2016. Investable cash at the end of 2017 totaled a whopping $951 billion. Fortunately, it wasn’t sitting idle. Private equity firms began to put their dry powder to use last year, capturing 30 percent of the consumer and retail M&A market, up from a low of 16 percent in 2016.

Indeed, private equity firms went on a buying spree in 2017, making $120 billion in total acquisi-tions. Deals to note include Sycamore Partners’ purchase of the office supply retailer Staples for $6.9 billion. It was the largest deal ever for Sycamore, a regular player in the retail space.

The median private equity-backed deal went for a 14.1 multiple versus 10.4 for their strategic counterparts (see figure 2). That was because more than 25 percent of the private equity activity was centered in the Asia Pacific region, and more specifically China, where multiples remain sky high. Comparatively, only about 10 percent of corporate deals were in the Asia Pacific region.

+19%Deal multiples (Median per year)

Notes: PE = private equity. VC = venture capital. Financial acquirers = 73. Strategic acquirers = 140.

Sources: Dealogic; A.T. Kearney analysis

Figure 2PE firms were often paying a premium compared to their strategic VC counterparts

EV/E

BITD

A%

of t

otal

dea

l val

ue

0

3

6

9

12

15

18

0%

20%

40%

60%

80%

100%

20062005 2007 2008 2009 2010 2011 2012 2013 2014

Financial

Strategic

2015 2016 2017

Strategic vs. financial deal share

20062005 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Financial

Strategic

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The 2018 Consumer and Retail M&A Landscape This year some key trends in the M&A market will become even more entrenched—and others will shift. Here’s a look at what will stay the same and what will change.

Same: The M&A market’s got grit Even with relatively flat deal value last year, executive confidence remains very high. Only 11 percent of executives surveyed for this report expect M&A activity to decrease in 2018. Divestitures may account for some movement as CPGs look to rationalize their portfolios. But only 5 percent of executives reported that divestitures will be a main M&A driver.

Instead, the goal remains top-line growth. Three-quarters of executives reported that they’re using M&A to help their companies acquire new capabilities, expand their product portfolio, access new customers, or increase their geographic reach. Only 18 percent of executives say that they’re counting on M&A activity to help them achieve economies of scale or cost consoli-dation. That’s down from 24 percent the previous year.

Optimism from those at the top is certainly contributing to the M&A market’s resilience. Our annual survey asks executives whether M&A has helped create, destroy, or maintain value at their company; an overwhelming 71 percent of respondents reported that M&A is creating value—up significantly from 48 percent last year.

Same: Cash hoards fuel M&A activityFor private equity firms and consumer product and retail companies, cash reserves remain at record highs. While much is written about massive levels of private equity dry powder, the under-reported news is that publicly traded CPG and retail companies are also sitting on nearly $1 trillion of cash on hand.

These cash hoards will most likely continue to grow in the US in 2018 due to the recent tax reforms, which included corporate tax cuts and incentives for repatriation of overseas funds. All of this will help drive continued M&A activity from both camps.

Still, even with copious amounts of cash-on-hand, global debt within the consumer and retail industries exceeds $2.2 trillion. US companies are carrying twice as much debt as cash reserves and the debt to EBITDA ratio keeps reaching new highs, largely thanks to an unprecedented period of low interest rates and cheap money (see figure 3 on page 5). For now, we don’t antic-ipate debt levels to impede M&A activity—though they may become an issue in the future.

Different: Outbound M&A picks up steamLast year, North American targets accounted for 67 percent of all M&A activity. This year, we anticipate an increased focus on US companies acquiring foreign businesses. There are a few reasons for this shift, including the new US tax laws, which may boost domestic valuations, making acquisitions more expensive for foreign companies.

At the same time, retail and consumer product executives in the US report that geographic expansion is one of their top three priorities this year. Combined with the aforementioned cash reserves, we anticipate 2018 will include an uptick in outbound deals for US companies.

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Debt to EBITDA ratio (Publicly traded firms)

Note: CPG is consumer packaged goods.

Sources: Capital IQ; A.T. Kearney analysis

Figure 3Debt of consumer and retail companies continued reaching new highs

2009 2010 2011 2012 2013 2014 2015 2016 2017

Retail

CPG

0.7

0.2

2.0 2.0 2.12.1

2.2 2.4

2.42.42.3 2.2

2.4 2.3 2.42.4

2.6

2.5

Different: Interest rates are headed upAfter an unprecedented period of extraordinarily low interest rates, we now see rates inching up around the world. In the US, inflation has picked up steam, fueling expectations that the Federal Reserve will continue to raise interest rates throughout this year. The Fed most recently raised its benchmark interest rate in March, the sixth increase since rates hit near zero in 2008. However, even with the rise, we are still nowhere near historic high points—if anything, we are still near record lows—and we expect minimal disturbance to the M&A market as a result.

Alibaba Offers Lessons in Convergence

Amazon’s acquisition of Whole Foods dominated M&A headlines last year. But when it comes to convergence plays, Alibaba has truly paved the way.

In 2015, the e-commerce company launched the high-end supermarket chain Hema in China as a way to reinvent grocery shopping. The stores are a far cry from traditional Chinese grocery stores, providing shoppers with a seamless blend of online and offline experiences—and giving global competitors a taste of what the future of retail could look like.

The brick-and-mortar stores provide 30-minute grocery delivery

to nearby customers who order online. Come into a Hema store and you can dine at the in-store restau-rant, scan QR codes for product ingredient information, and pay for items on the spot using Alipay.

All the while, Alibaba is collecting customer data and using it to serve shoppers with personalized food and product recommendations, related recipes, and even infor-mation about exotic foods via the brand’s app. It’s the stuff of digital-retail convergence dreams. But is it working?

Alibaba reports that the average customer makes 4.5 purchases a month and 50 purchases a year.

Conversion rates for people who open the Hema app are up to 35 percent. And online orders account for more than half of total orders.

However, operating physical stores is an expensive endeavor. Analysts have said that it takes tens of millions of yuan to outfit a Hema store, and Alibaba hasn’t said whether the chain is profitable. Time will tell. In the meantime, the e-commerce heavyweight is demonstrating the massive opportunities offered when tech and retail converge.

6Can M&A Reignite Growth in Consumer and Retail?View online: bit.ly/2018-RetailMA

The A.T. Kearney 2018 M&A Strategy OutlookIf last year offered the M&A market a moment to pause—and perhaps plan ahead—then 2018 is about capitalizing on opportunities or being left behind. Here are our four strategic insights to help consumer and retail companies and private equity firms navigate the next year.

Legacy consumer and retail companies fight backAfter years of disruption and ceding market share to innovative upstarts, the consumer and retail industry stalwarts are ready to test the age-old notion that the best defense is a good offense. Eighty percent of the executives we surveyed noted that traditional retail and consumer product businesses will be active in the M&A market this year. For many, that means driving growth by aggressively pursuing targets that have mastered different consumer segments, innovative go-to-market models, and new technologies or brands. This will include convergence across traditional sectors and will fundamentally become part of the new growth model (see sidebar: Alibaba Offers Lessons in Convergence on page 5).

Large CPG firms have a lot to learn from start-ups regarding product development, speed to market, agile marketing techniques, and their use of digital to capture consumers.

General Mills’ recent acquisition of Blue Buffalo Pet Products offers a prime example. Blue Buffalo is General Mills’ largest acquisition in 18 years, and the company’s first foray into natural pet food. With the purchase, General Mills didn’t just add natural pet food to its product lines, it bought additional top-line growth and new customers in an expanding market. Kellogg’s made a similar move when it purchased RXBAR for $600 million last year. The acquisition provided the legacy food maker with easy access to the growing body of consumers who prefer more natural food.

With growth on their minds, more legacy companies are expected to follow suit this year. As newer players disrupt the retail and consumer product space, the choice for the old guard has become clear: use M&A to help pivot business toward the future—otherwise, face losing relevance or being acquired.

Global M&A deals heat up With many of investors’ high-level questions answered regarding foreign elections, global interest rates, US tax reform, and other events, the global M&A market is primed for continued activity. Eighty-six percent of our survey respondents expect outbound M&A to increase or stabilize this year. Seventy-nine percent expect inbound M&A to do the same (see figure 4 on page 7).

Survey respondents anticipate that domestic M&A will also rise as legacy companies look for growth potential in established markets. Executives we surveyed cited expanding their product

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portfolios and acquiring new customers as their top two drivers of M&A in 2018. Hefty cash reserves combined with increased stateside valuations, which may boost borrowing power, ensure they’ll have the resources to do so.

Corporate venture funds evolve—or face becoming irrelevantThis year is ripe for a shakeup in the world of corporate venture funds. Most corporate venture funds were established as a way for consumer companies to benefit from the ongoing disruption they faced from encroaching tech companies and start-ups in their space. These funds invest in or acquire early-stage players, hoping to benefit from their buzz. Unilever Ventures, for example, targets personal care and digital start-ups. The fund’s 2017 investments included blow LTD, an on-demand beauty services company, and Peel-Works, a Mumbai-based big data company.

But it’s not enough to hope that the innovative strategies of start-ups will simply rub off on the rest of a CPG firm’s holdings. In fact, our research shows that, with the exception of Campbell’s and Tyson Foods, most of the consumer companies that have launched a VC have not witnessed increased growth.

Large CPG firms have a lot to learn from start-ups regarding product development, speed to market, agile marketing techniques, and their use of digital to capture consumers. To truly take advantage of these relationships, CPG firms need to dig into these business models, and then use that knowledge to disrupt themselves. Similarly, the large companies can help start-ups scale faster by providing access to their customer base, supply chain, and consumer insights.

Particularly exciting in the corporate venture fund space is the use of incubators, which are designed to help start-ups scale and attract investment. In 2017, Kellogg’s and Ingredion supported the launch of The Hatchery, a food-focused incubator in Chicago. We expect more CPG firms to get involved with incubators as a way to help them more quickly identify the next wave of trends.

Impact of tax legislation on M&As in 2018

Note: More than 80 survey responses; only one response allowed

Source: A.T. Kearney analysis

Figure 4New tax laws are expected to boost domestic M&A, with less growth predictedfor cross-border deals

2%

39%

14%

45%

21%

43%

36% 41%59%

Inbound M&A(foreign companies

acquiring UScompanies)

Outbound M&A(US companies

acquiring foreigncompanies)

Domestic M&A(US companiesacquiring otherUS companies)

Increase

Stable

Decline

8Can M&A Reignite Growth in Consumer and Retail?View online: bit.ly/2018-RetailMA

The private equity buying spree continuesLast year marked the start of private equity’s return to the consumer and retail sectors, with firm acquisitions totaling $120 billion. That’s the highest level since 2008.

Private equity firms are primed to capitalize on many, if not all, of the aforementioned trends. For instance, they’re looking for acquisitions that provide synergies with their existing holdings. In fact, “platform companies” and “add-ons” are becoming a key growth strategy for private equity firms that want to compete with strategic buyers. They, too, are also interested in top-line growth and, much like the legacy players, they’ll likely consider adjacent industries to drive it.

Financially, the time is right for such moves within the private equity space, especially in terms of overseas acquisitions. Multiples of consumer and retail companies are at a four-year low. Low interest rates mean money is still relatively cheap. Meanwhile tax reform should increase valuations stateside, making foreign targets even more attractive.

Convergence Is the Name of the GameThe convergence theme is quickly becoming a key driver for continued M&A activity as many companies seek innovative pathways for growth-focused deals. But such deals are inherently more risky than their consolidation counterparts.

Most consumer and retail companies are familiar with consolidation deals. Many of these firms have developed strong playbooks for acquisition integrations that rely on stripping out costs and realizing headcount, procurement, and operational synergies. But convergence deals are a different beast altogether, and companies that want to succeed must rethink how they approach the integration. Cost savings will always play a role, but the primary focus must be on nurturing the people and the culture in pursuit of new customers and growth.

A clear approach to M&A is vital to strategic growth The bottom line: M&A will continue to play a key role in reshaping the consumer landscape. Leading companies will be on the offensive but need to remain clear-eyed on the type of deals they’re conducting—adjusting their approach to deal-making based on very specific goals that may run the spectrum from consolidation to convergence. Identifying the right targets is only half the battle.

Authors

Bob Haas, partner, New York bob.haas@atkearney.com

Bahige El-Rayes, principal, New York bahige.elrayes@atkearney.com

Marc El-Khoury, consultant, New York marc.elkhoury@atkearney.com

The authors wish to thank Greg Portell (partner, Chicago), Mohammed Dhedhi (consultant, Dubai), Wendy Wong (consultant, Boston), and Roberta Roeller (consultant, Munich) for their contributions to this study.

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About the StudyA.T. Kearney analyzed more than 100,000 consumer and retail transactions from 2006 through Q1 2018, spanning sectors such as food and beverage, grocery, pharmacy, and personal care. The study also included insights from C-level executives of global consumer and retail companies based on a survey that sought their perspectives on trends in consumer and retail sectors and future M&A activity.

A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea.

A.T. Kearney operates in India as A.T. Kearney Limited (Branch Office), a branch office of A.T. Kearney Limited, a company organized under the laws of England and Wales.

© 2018, A.T. Kearney, Inc. All rights reserved.

For more information, permission to reprint or translate this work, and all other correspondence, please email: insight@atkearney.com.

The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring “essential rightness” in all that we do.

A.T. Kearney is a leading global management consulting firm with offices in more than 40 countries. Since 1926, we have been trusted advisors to the world’s foremost organizations. A.T. Kearney is a partner-owned firm, committed to helping clients achieve immediate impact and growing advantage on their most mission-critical issues. For more information, visit www.atkearney.com.

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San FranciscoSão PauloTorontoWashington, D.C.

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