Consumer and retail M&A market finding its way back to rationality

26 May 2016

The global M&A market has been awash with activity over the past years, as private equity firms sought to exit stock built up from before the crisis and corporates, flush with cash, sought to pick up growth opportunities. Activity in the global consumer and retail industry has been no different – a new report shows that the value of deals in the sector has more than doubled over the past five years, yet, going forward, the market is likely to see a change in deal conditions. The focus is set to shift more towards high-quality targets, and lower valuations, taking the landscape to a more balanced and rational state.

In a new report from A.T. Kearney, titled ‘Has the Consumer-Retail M&A Market Lost Its “Froth”’, the consulting firm explores the state of the deal market in the consumer and retail industry. The report examines more than 1,000 consumer and retail transactions from 2005 to 2015, spanning the food and beverage, grocery, pharmacy and personal care sectors, and other subsectors. In addition the consultants interviewed C-level executives of consumer and retail companies, asking them to highlight key trends for future M&A activity and changing market conditions.

M&A in the consumer and retail market

Back to boom
The past ten years have seen considerable ups and downs in M&A activity within the global consumer and retail industry. The pre-crisis boom years, which saw deal values hit $500 billion in 2008, are becoming a distant memory. 2009, the year following the onset of the financial crisis, saw value drop by almost 70% and deal volume by 21%. In the intervening years to 2015, deal value has enjoyed a CAGR of 10%, with deal value reaching $365 billion last year – even while deal volume continued to fall.

The market in 2015 was buoyed by a variety of trends, which drove the total deal value up. Mega deals represented a high share of M&A activity; for example, the HeinzKraft deal (combined revenues of about $28 billion) was worth more than the four largest deals of 2014 combined. Other factors influencing the continued deal activity include high liquidity in the market, access to low-interest debt, and sharp focus on inorganic revenue growth.

 Average multiple by market size

In addition, buyers were willing to pay large premiums for acquisitions of all sizes. The research found that it was particularly the mid-market that was able to command the highest Enterprise multiples (EM), the enterprise value divided by its EBITDA. EM almost hit 17 for companies ranging from $100 million to $500 million, closely followed by companies in the $500 million to $1 billion range. Only $1 billion plus deals saw their EM down on the 2014 level. Across the board the median EM value for consumer and retail market enterprises exceeded those of 2007, particularly in Asia Pacific, where the median multiple in China exceeded 40.

Regional M&A outlook

Bullish markets
2016, according to A.T. Kearney, is likely to shape up to be another good year for M&A in the consumer and retail industry – although changes are afoot. The regions to enjoy the strongest performance are North America and Western Europe. North America, according to respondent sentiment, will see a rise in activity, with 6% saying there will be a strong increase (>20%), 42% an increase (>10%) and 35% between stability (0-10%), while only 13% expect a strong decline (>-20%) or decline (-10%). In Western Europe the story is slightly more reserved, with around 6% saying there will be a strong increase, 26% an increase and 42% stability, while only 12% expect a strong decline or decline.

China and Latin America are the regions of the biggest contrast between increase and decline. In China for instance, while 27% expect a strong increase or increase, at the same time 22% say that there will be a strong decline or decline. In Latin America 26% say there will be a strong increase or increase and 19% say that there will be decline.

High yield debt

Market split
A number of tailwinds and headwinds are expected to hit the consumer and retail M&A space this year however, which may well come together to split the market. One of the tailwinds is that the maturity of the market is leading to declining EBITDA margins, dropping from 10% to 9% between 2014 and 2015. As a result, companies will continue to look at M&A as an effective way of creating larger, more efficient, more profitable businesses. Another is low growth in developed economies, a development which, according to the research, may result in more large companies seeking acquisition of innovative, higher growth brands to fuel top-line growth.

The headwinds are partly due to macroeconomic factors resulting in declines in the high yield debt market, this has a follow on effect on private equity players as tighter credit pushes up the cost of capital used to fund the majority of their deals. This in turn will hit particularly smaller, higher risk, deals. Consequently, there may be a split within the market as high-quality targets continue to be sold – likely at a high valuation – while smaller and riskier deals face decreased financing and more shrewd investor scrutiny, resulting in lower valuations than in 2015. The combined effect will, according to the authors, contribute to a greater sense of balance between buyers and sellers in the M&A markets.

Bob Haas, Partner at A.T. Kearney and leader of the firm’s global M&A practice, and co-author of the report, notes: “Despite the expectation that 2016 will yield a similar level of deal-making, the M&A picture isn’t so simple. In our view, 2016 will be characterised by tighter credit markets and lower valuations, especially for smaller companies with riskier, more volatile cash flow. Thus we see an active M&A market in consumer retail overall, but also a return to a more rational market with a better balance between buyers and sellers and more reasonable deal values for higher risk acquisitions.”

Factors impacting M&A in retail

Quality targets
Some consumer and retail business will remain strong candidates for acquisition however. Respondents are in 2016 particularly keen to pick up targets that offer strong propositions in e-commerce and digital capabilities, seen as highly relevant by 55% and relevant by 29%; those that offer the adoption of new, disruptive technologies, seen as highly relevant by 42% and relevant by 29%; and companies that offer new business models, seen as highly relevant by 32% and relevant by 42%.

The demand for global money in the industry will spark a movement of capital investments towards the West, say the authors. “The ongoing struggles of major Asian economies, particularly China and Japan, have renewed investment interest in the United States and other Western markets,” comments Haas.

Bahige El-Rayes, a Lebanese origin Principal at A.T. Kearney, based in New York, says that in light of the changing macroeconomic conditions, deal hunters or those with dry powder will require a “more strategic approach to transactions”. He adds: “Buyers and sellers that recognise this changing dynamic will be well positioned to find opportunities and conduct transactions at a fair price.”

An analysis by A.T. Kearney earlier this year revealed that megadeals may drive M&A in the chemicals industry to new heights this year, with another study, by EY, found that, across the board, CxO sentiment towards inorganic growth is still riding high.