Feeding frenzy

Feeding frenzy
Av Maharaj, counsel at Fasken Martineau DuMoulin LLP, easily recalls the acquisitions Kellogg Company undertook during his time at the cereal maker. In 2005, the business bought the Fruit Snacks line from Kraft Foods Group Inc. In 2012, it purchased Proctor & Gamble Co.’s snack unit. Kellogg made numerous other acquisitions and it wasn’t the only food and beverage business making such moves.

“You were seeing around the world a global consolidation of food companies,” says Maharaj, who was Kellogg’s vice president and chief counsel, international by the time he left the company a few months ago following a global restructuring of the company.

Straightforward business requirements drove Kellogg’s acquisitions. With each purchase, the company aimed to address some simple questions: Is the acquisition target complementary to the business? Can it help Kellogg increase revenue and profit?

“[Does the acquisition target offer] manufacturing capability or a brand the organization didn’t have, that could easily scale and grow?” Maharaj adds.

Many food companies are asking similar questions today with respect to their own businesses as they merge and acquire. Canada’s food, beverage, and agribusiness sector is abuzz with M&A activity. Industry observers say companies are feasting on each other to not only reach new markets with new products, but also address a market-wide revenue challenge.

According to PricewaterhouseCoopers LLP, the food and beverage sector in this country saw 64 mergers and acquisitions in the 12 months ending March 2014, up 45 per cent from the 44 transactions recorded over the same period in 2013. In its “Capital Markets Flash — Canadian M&A Deals Quarterly” for the first three months of 2014, PwC said companies primarily seek to extend their market reaches by purchasing established brands in new areas. That’s why Ebro Foods, a Spanish company, scooped up Olivieri Foods Ltd. from Canada Bread Company Ltd. for $120 million last October, for example.

“Building a brand is difficult and time consuming,” PwC said in its report. “It’s faster to acquire one. Multinational food and beverage giants are always on the lookout for targets that have established a strong brand. Right now, they’re looking closely at North American companies.”

A global trend
This feeding frenzy isn’t just happening in North America. In the U.K., for instance, the number of mergers and acquisitions in the food and beverage sector increased by a third between Q4 2013 and Q1 2014, according to analysts at Grant Thornton UK LLP.

Back in Canada, investors on stock markets are fanning the M&A flames. “Financial players are also active buyers,” PwC said. “They like the stability the sector provides. Consumers always need what food and beverage companies sell.”

Canadian food regulations play a role in the increased M&A activity, says Peter MacGowan, partner at Blake Cassels & Graydon LLP. He points out that Canada has a strict supply-management regime for meat and dairy. This system attempts to balance domestic production and consumption. The Canadian Dairy Commission, for instance, limits the amount of milk, farmers can produce.
One characteristic of this system, MacGowan explains, is prohibited production for export: companies that need dairy for manufacturing aren’t allowed to use the milk or cheese in products destined for sale outside of Canada.

So Canadian companies that want to use dairy for exported products are going abroad and establishing operations where dairy production isn’t restricted. “By buying businesses outside of the country, they are able to expand their businesses in a way they’re not able to do in Canada,” MacGowan says.

Canadian businesses that have dairy suppliers abroad may not need them forever, though. “There’s strong economic commentary from economists and policy markers saying this supply-management system in Canada is a lose-lose,” MacGowan says. “Canadian consumers pay far more than they would if we didn’t have the system in place, but it’s also a major loss for the industries because they can’t grow the way they should be able to.” He believes it’s only a matter of time before the federal government dismantles the supply-management system. He says at least some of the M&A activity is generated by global companies betting supply management won’t last much longer. “The time to make an acquisition is right now, given the huge potential for growth that may come in the future.”

Revenue repair projects
Even if the potential for growth is substantial, it has been hard for some companies to grow recently. They face a fundamental revenue challenge — and that’s why they pay substantial sums for good acquisitions.

“The top lines for many companies are not growing,” Maharaj says. “That’s especially true for packaged-food companies.” He points to a couple of reasons: price pressure from cost-conscious retailers and consumers, and increased competition from fast-serve restaurants. “Subway is offering breakfast. McDonalds and Tim Hortons are doing breakfast better than they ever have. Those are taking away from food companies’ revenues.”

In laste August it was announced Burger King, perhaps in an effort to compete more seriously in the breakfast/coffee market, was merging with iconic Canadian coffee chain Tim Hortons.

“If you can’t grow, you have to find [revenue] somewhere,” Maharaj says, completing the thought: many businesses merge and acquire to improve revenues.

Business managers may think this is the time to buy, but government regulators are wary. “The biggest challenge is antitrust legislation and competition act legislation,” Maharaj says. “Competition bureaus around the world are looking at these mergers closely. That could prevent further large-scale acquisitions.”

The market for food is changing according to global population trends as well. Countries where people used to struggle to afford high-quality products are becoming relatively affluent. “As income goes up, they want more protein and they want more calories,” says Lucas Thacker, associate at Norton Rose Fulbright LLP.

Brooke Valentine, partner in the corporate finance practice at PwC says companies in the meat sector are hot. He notes the activity surrounding Hillshire Brands, maker of Jimmy Dean sausages.
Two other companies, Tyson Foods Inc. and Pilgrim’s Pride Corp. fought each other to take it over. Tyson knocked Pilgrim’s Pride out of contention, offering US $63-per-share — well above Pilgrim’s US $8-per-share offer. Tyson’s price “pushed valuation beyond where most investors thought it would pan out,” Valentine says.

Healthy food, healthy profits
Protein isn’t the only popular food these days. Healthy food is another growing area. “I think the biggest are natural and organic,” Maharaj says. “People are looking for food that’s better for them.
. . . The key is to get ahead of the next curve. Ten years ago, it was low carb. Then it became low fat, then high fibre.”

But people also want “local” — products that come from farms and manufacturing facilities close to home. Meanwhile, many mergers and acquisitions see Canadian companies acquired by businesses from other countries. Grupo Bimbo, from Mexico, bought Canada Bread Co. from Maple Leaf Foods Inc. in May for $1.83 billion. Brazil’s JBS S.A. bought meat packing company XL Foods Inc. in Edmonton in January 2013 for US $50 million.

Do these global deals undermine the local credibility of the companies involved? “I don’t think those trends are necessarily mutually exclusive,” MacGowan says. “Ownership of a processor by, for instance, a Spanish entity doesn’t mean the product can’t be sourced, marketed, and consumed locally.”

Specific to this country, Canada’s depreciated dollar is a problem for some businesses. The loonie is worth less than the U.S. dollar, and that depressed value negatively affects companies that rely on imported goods. “Canadian food retailers derive approximately 10 to 15 per cent of their revenues from produce, which is largely imported from the U.S. or countries which export product priced in U.S. dollars,” PwC said in its Capital Markets Flash. This increased cost is then passed on to the consumer, who typically chooses less expensive products over imported produce to save money.

Regardless of the dollar problem, PwC expects the high M&A activity level to continue. One potential risk is that stock markets will dip, which would mean less investor money available to fund mergers and acquisitions. Given that the Dow Jones Industrial Average, the Toronto Stock Exchange and the Standard & Poor’s 500 have been trading at or near record highs lately, the risk of a slowdown is substantial, Valentine says.

“Other than that, I think it will be a strong market,” he says, “largely driven by the thesis that with rising middle class populations, the demand for and scarcity of food will continue to be a central concern that the world will grapple with. Companies in the food and beverage sector will be highly sought after.”

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