This is a contributed column by A.T. Kearney's Bahige El-Rayes and Alexandre Terseleer. El-Rayes is a partner in the consumer and retail practice and Terseleer is a manager in the PE/M&A practice of global strategy and management firm A.T. Kearney. Views are the authors' own.
Last year saw a $100 billion drop (approximately 20%) in total Merger & Acquisition (M&A) volume in the consumer packaged goods (CPG) and retail sectors, leaving observers wondering what exactly was responsible for the decline, and if those forces will re-manifest themselves this year.
Both questions are answered in Fortifying Before the Storm, the fourth edition of the A.T. Kearney Consumer & Retail M&A Report. The report's conclusions are based on a proprietary analysis of M&A transactional data and more than 100 C-level CPG, retail, and private equity (PE) executives' answers to crucial strategic and financial questions, analysis of Dealogic transaction data from 2007 to 2018, and conversations and analysis between over 10 A.T. Kearney partners and principals.
Legacy players are under attack, frequently losing market share to smaller and more nimble players, able to capture much of the industry's growth. As a result, incumbent retail/CPG companies are starting to reexamine their portfolios.
Even after a decade of megadeals, the portfolios of several CPG companies are still not as fortified as they should be, especially with the possibility of a recession or other significant economic correction, looming in the horizon. The realization that they are missing critical capabilities in their portfolio — in digital, e-commerce, or supply chain — is forcing companies to shift their focus away from scale and on to building critical capabilities.
This shift in strategic mindset explains the rapid re-focus of M&A targeting toward more disruptive, but also often smaller and younger, companies and away from mega-deals in which one incumbent buys another. Large deals still remain relevant, but only for high-quality assets.
All of this has lead CPG and retail companies to understand that they need to look at M&A differently. Three key themes emerge from A.T. Kearney's analysis:
- Companies plan on using new capabilities to fortify their portfolios: CPG and retail executives indicate a willingness to invest in several missing capabilities including last mile delivery, digital/data science, and e-commerce, and last mile delivery.
- Divestiture of non-core assets: Four out of five executives believe divestitures will rise in the next 12 months, driven by this same need to rebalance portfolios while taking advantage of high multiples in the industry.
- Shift towards local decisions: Maintaining a global portfolio in an era of changing consumer preferences combined with lasting trade uncertainty requires a change in business model for international players, from a global way of thinking to a multi-local one. Executive respondents indicated a shift in M&A decision-making to local units as well as an increasing focus on "must win" countries, most notably China and India.
Students of the 2019 M&A market should look for corporations increasing their focus on the acquisition of smaller, disruptive companies. While the volume of midsize deals fell 4%, those deals increased 6% in value as investors looked to integrate bold challengers as change agents — in the form of new brands, new customers, new concepts, new capabilities, and new talent — at lower cost and risk.
Multiples look to remain high. The spread between CPG and retail multiples is shrinking, going from 33% in 2017 to 4% last year. These gains were underpinned by improvements in channel strategy and consumer experience and increased convergence from retail to CPG, the largest non-core M&A category in volume for retail, and to healthcare, the largest non-core M&A retail category in value.
Scope deals replace scale deals
2018 saw a pronounced shift away from scale deals with M&A activity focusing on building portfolio competencies, mostly in areas such as digital and e-commerce, analytics, or operational capabilities necessary to omnichannel experience such as last mile delivery and flexible supply chain.
Valuations are reflecting this trend, as companies below $25 million are now trending at EBITDA multiples of approximately 10% higher than those valued between $25 million and $1 billion. Large deals still remain relevant, but for high-quality assets only (EBITDA multiples for companies above $1 billion in valuation are at a 5-year high, but volume decreased in 2018).
Successful incumbents understand this trend and have doubled down on M&A.
Looking ahead to 2019
Unlike much public speculation, A.T. Kearney sees the 2019 CPG and Retail M&A market as sustainable. Ninety percent of the CPG/retail executives we surveyed also expect the overall deal size of 2018 M&As will be sustained this year.
Our analysis yields three conclusions:
- The 2019 M&A market for CPG/Retail companies will sustain due to high needs to both acquire new capabilities and divest from non-core assets, further sustained by the amount of 'dry powder' (uncalled capital) available for investment.
- The acquisition of new capabilities such as logistics, digital, data science and interaction channels like e-commerce, and the convergence between different CPG categories which facilitate "owning" the consumer will be the Number One driver of 2019 CPG and retail M&As.
- To adapt to changing consumer demand, International M&As will sustain, but evolve from a global, or sheer scale, model to a multi-local model, (ownership of various locally-focused assets).
Successful companies that are rewarded with higher valuation have clear long-term strategies and don't flip-flop to satisfy short-term objectives. It is therefore imperative to develop an M&A strategy that intertwines with the overall business objectives.
The strategic focus of CPG and retail companies has shifted gradually — but rapidly — from building market share and economies of scale to offering a differentiating customer experience. Legacy companies understand that millennial and Gen Z shoppers comprise a new, more sophisticated consumer base, and one that needs to be approached through a new set of skills.
For many companies, M&A is the right vehicle to acquire such skills, therefore 2019 should be seen as the year to strengthen the portfolio, acquire missing and new capabilities, and reallocate capital to fortify before a looming market downturn.