When I evaluate companies in the consumer and retail space, one of the most important questions I try to answer is “Who will acquire this business in 5-7 years?”
Of the two most common exits for private companies—IPOs and acquisitions—the latter outcome is far more common among consumer and retail businesses. This is an important distinction between tech and the consumer space that every investor should understand, whether you’re investing through an online investing platform or investing offline.
Consider the mergers and acquisition (M&A) market last year. The total value of consumer-retail deals actually exceeded the value of internet and software M&A, combined, in 2013. In 2013, the consumer and retail market was about $91 billion according to PriceWaterhouseCooper. The internet and software industries had a total of $55 billion in M&A for 2013.
The point here is not that the total exit market is larger—it is only to highlight that the M&A market in 2013 was larger for consumer and retail than it was for internet and software. So why are deals so appealing in consumer and retail? Strategic acquisitions tend to be a source of innovation for consumer and retail.
Consumer goods and services companies frequently use acquisitions to keep pace with emerging preferences in the marketplace, says Accenture Accenture. As Accenture wrote in a report on M&A trends, “Many large beverage companies have acquired smaller sports and energy drinks makers to respond to consumers’ increasing appetite for these drinks, and because these large companies did not have such products in their R&D pipelines.” Pick a major strategic in the consumer and retail space (any major public consumer or retail company). Now think of the number of brands they have added to their portfolio over the past decade. How many did they buy versus build?
In the consumer packaged goods industry, the most valuable asset is the brand. For a larger consumer goods and services company, it is not particularly difficult to replicate a product’s formula, find a manufacturing facility, and begin producing a knock-off of a sports drink or energy bar. And yet, at the end of that assembly line what you get will not be Red Bull Red Bull or Clif Bar. That’s because the missing ingredient is the brand. When Danone Danone buys Happy Family Happy Family baby food, or Del Monte buys Natural Balance Pet Foods, for example, they are investing in an innovative and developed brand that they simply cannot create from scratch.
Contrast this with technology deals. For tech companies, the valuable asset early on is the team designing and building the product. Young, small tech companies can be attractive M&A targets. But as those businesses grow, their value lies in their scale, and the more likely path is an IPO.
A compelling tech company’s more typical route to becoming billion-dollar company is through an IPO. And private investors put their money into young tech companies with hopes of being in early on the next Facebook or Google. A consumer packaged goods company, however, can grow from a $5 million business to $200 million, and at that point be an attractive takeout target. Obviously, it doesn’t happen every time, and early stage investing is high risk in any asset class, but I’ve seen this scenario time and again in my years in this sector.
Acquirers get more than innovative products, too. The returns that strategics achieve in the consumer space tend to be higher than returns on tech deals, according to Towers Watson. Some research, for example, shows tech acquirers had overall negative returns on deals in 2011 and 2012, while acquirers in the consumer space had positive returns in both years on those transactions, including returns of around 10% in consumer products and services.
Last year was a good year for M&A across industries, and PriceWaterhouseCoopers expects that to continue in 2014. As PwC points out, corporate cash balances remain at all-time high levels and the funds available for investment and low debt financing costs in private equity should support continued M&A in the sector. This bodes well for growth companies in the consumer and retail space. It also bodes well for investors, whether they use an online investing platform or invest offline.