The long-awaited rebound in consumer products deal volume remained out of reach in the second half of last year, according to data compiled from PitchBook, as themes that have remained consistent over the previous year continue to affect transaction activity.
Uncertainty surrounding the direction of interest rates, continued weakness among select consumer demographics and stickier-than-expected inflation are weighing on market participants.
Further, the second half of the year brought about additional uncertainties as the presidential election and the pending impact on the regulatory environment for deals likely delayed transactions.
Now, as the balance of power in Washington, D.C., changes, the expectation of a more business-friendly regulatory environment should provide a tailwind for both transactions and a loosening of the IPO market, which could serve as catalysts for deal activity to pick up later this year.
This optimism is welcome news to private equity investors who have been waiting to exit long-held investments. We’ve seen hold periods across consumer products sectors remain elevated, most notably within the apparel and household goods sectors, which now extend over six years.
However, investor enthusiasm has been delayed by policy uncertainty that has contributed to a slower than anticipated start to the year. Perhaps the strongest headwind is the reset of interest rate expectations as the Federal Reserve evaluates how the economy absorbs the impact of anticipated policy decisions.
Given recent Fed commentary, and with the 10-year Treasury yield hovering around 4.5%, we don’t expect interest rate relief in the near term. In addition, anticipated U.S. tariff actions and reactions from trading partners have caused investors to proceed with caution as they await the impact of these decisions to unfold.
Themes that emerged throughout last year are expected to remain, most notably a continued focus on add-on acquisitions that are the most effective way for investors to close geographical, channel or product specific gaps through acquisitions or gain economies of scale.
Nowhere has this strategy been more pronounced than within home services (home improvements and renovation, personal wellness and services) and consumer services (primarily wellness, medical and automotive) as buyers continue to quickly build scale eagerly supplied by small business owners looking to exit businesses started decades ago.
Activity within this sector is not fully reflected in consumer products deal counts given inconsistency in reporting.
We expect corporate acquisitions to accelerate as they continue to look to expand market share, especially as pricing elasticity is challenged, particularly in the United States. While we anticipate an improved environment for larger transactions, many acquirers will focus on smaller strategic acquisitions as well as the continued reevaluation of brands that will further the carve-out trend that started in the second half of last year.
Investors with the ability to quickly integrate new acquisitions and confidently carve-out non-core brands will be well positioned to succeed in this environment.
Another trend we expect to continue in this environment of uncertainty is the reliance on the use of earn-out provisions to help bridge valuation gaps and product buyers, and align interests post-close.
Food and beverage
Activity within the food and beverage sector modestly declined last year as macroeconomic pressures on food companies continued to pose a challenge.
Margin pressures are expected to remain a theme into this year, as elevated input costs (in some cases historically so, such as eggs, coffee beans and cocoa) are expected to be a drag on earnings throughout the year.
In addition, as consumers appear unwilling to accept additional price increases, businesses are shifting their focus toward improving efficiency to drive margin expansion and earnings growth. A theme that began to emerge last year that we expect to continue is the acquisition of distributors by larger food and beverage companies as they look to control more of the value chain and cost structure.
Corporate acquirers are expected to be active, especially in the middle market, as they look to shore up product portfolio gaps, expand geographic and customer reach, and drive scale and efficiency.
With a conclusion to the long-considered Kroger-Albertson’s merger, we expect more regional consolidation as larger regional grocery chains expand footprint through acquisition of independent shops and new greenfield locations.
This will only further investor interest in private label goods, as sustained pricing pressures appear to have permanently shifted consumer buying habits towards lower cost products for food and beverage purchases. Contract manufacturers and those with strong private label businesses will continue to garner interest by investors.
In addition, we’ll likely see companies continue to evaluate overall brand portfolios and look to divest brands not aligned with long-term strategies to provide debt relief or fund investments for strong performing organic and inorganic growth. A winner in the beverage sector is expected to be non-alcoholic beverage brands, particularly those with better-for-you attributes, as well as ready-to-drink offerings like caffeine and alcohol.
Consumer goods
Consumer goods deal activity declined again last year as continued uncertainty surrounding consumer spending habits, and the impact of shifting policy positions, continue to affect investor appetite within the space.
Pricing pressures remain a key theme for lower-to-middle consumers, and long-term shifts in buying patterns toward private label or discount shopping remain a focus for mass market consumers.
With 2021 and 2022 sales comparisons behind sellers, a new challenge has emerged as retail bankruptcies increase and questions on the sustainability of wholesale channels impact asset attractiveness.
In addition, the uncertainty of tariff policy will continue to impact this space as many goods are sourced from Asian suppliers. This uncertainty will benefit companies that successfully transitioned supply chains post-pandemic and likely makes companies with locally made and sourced products more desirable.
That being said, we expect a rebound in certain categories that have remained stagnant over the past two years, most notably apparel, even with the uncertainty of the wholesale channel. Beauty and personal care companies are also reevaluating their product portfolios, given the disruption of traditional sales channels, which will drive activity of larger market participants as pressures from international sales weigh on overall performance and a recalibration of product portfolios takes shape.
We continue to see home services and consumer health acquisitions take market share. And we anticipate this trend to remain as generational change continues to provide ample supply to those looking to consolidate in this highly fragmented sector.
Combined with anticipated popularity of do-it-for-me services as well as millennials entering the housing market, we expect the service economy (lawn/outdoor maintenance and home services contractors providing roofing, plumbing, electrical, garage doors and HVAC) to thrive.
Retail and restaurant
More than any other sector, retail and restaurant mergers and acquisitions activity illustrates the clear line of winners and losers driven by changing demographics, customer preferences and convenience.
Restaurants strongly rebounded last year driven partially by the generational change in ownership meeting with investors’ appetite to consolidate franchisees, particularly within the quick-service restaurant space.
We also observed a significant uptick in activity with well-placed franchisors as new openings have accelerated following the pandemic and related strain on building resources. This was particularly noticeable within better-for-you brands with strong customer connectivity. This trend is also impacting the convenience channel as larger players look to add scale and upgrade their product offerings.
Retailers that provide consumer services (health and wellness facilities as well as the automobile industry) have been and will be active as companies look to build scale and expand into new geographies.
We anticipate several larger concepts within this space to come to market as many investors have scaled portfolios and while benefitting from continued organic growth.
The increase in activity within these sectors was more than offset by continued weakness in traditional and specialty retail concepts.
The pressure is most noticeable on mall-based operators of all sizes due to challenges passing on increased labor, rent and product costs to customers that sufficiently offset continued traffic declines.
This secular trend continues to create opportunities for well-placed buyers to add to their portfolios and implement recovery strategies; however, this is often limited to bankrupt or severely struggling sellers.
Sellers that have been able to maintain operations but struggled to grow are often not finding valuations to their liking. Those finding receptive buyers usually have a combination of an engaged customer base, a portfolio of proprietary products and have made investments in technology to better connect with customers.
RSM contributors include Kunal Bhatt, Mary Loera, Tom Martin, Doron Neuman and Ryan Schloer.
