Food and beverage M&A on the rise, but determining valuations is difficult: Stikeman Elliott lawyer

Pandemic 'lift,' rising costs and supply chain all factors

Food and beverage M&A on the rise, but determining valuations is difficult: Stikeman Elliott lawyer
Stikeman’s Mario Nigro says food and beverage M&A is robust but closing gap on target valuations is tough

COVID-19 has led to a “transformational change” in the value of mergers and acquisitions in the food and beverage industry, says Stikeman Elliott LLP lawyer Mario Nigro.

The pandemic has hit different areas of the food and beverage sector differently, says Nigro, “some in a very good way and others in a very difficult way.”

Anything related to groceries and food distribution, for example, has been affected very positively in terms of their valuations, and the interest from prospective buyers. The pandemic, and supply chain issues related to getting food onto grocery store shelves, has highlighted the importance of this part of the industry. However, those businesses connected more to the restaurant business has seen the opposite happen.

It’s not just the restaurants themselves that are suffering, says Nigro. People “forget that the restaurant business isn't just the restaurant, it's the food equipment and all that's behind the restaurant business.”

A report on M&A deal activity in the North American food and beverage space by Duff and Phelps, using data from S&P Global Market Intelligence, says that in the third quarter ended Sept. 30, a record pace was set.

381 deals closing over the trailing 12-month period at the end of September marks the highest deal count over that period. Transaction volumes in Q3 were slightly above the previous year, 97 compared to 85.

“The past four quarters have had unseen levels of M&A activity, with all periods surpassing 90,” the report said, predominately driven by strategic buyers (including companies primarily owned by private equity investors), with strategic transactions representing 78 per cent of total deal value.

Of the 382 deals closed over the trailing 12-month period ended Q3 2021, 279 were completed by privately owned buyers.

“Abundance of capital, low interest on debt, and demand for high-quality assets continue to be leading factors in driving deal flow in the space. High valuations and potential change to capital gains taxes in the U.S. and Canada have spurred many business owners and investors to accelerate their selling timeline earlier.”

The Duff and Phelps report notes these Canadian transactions:

  • Lambert Creek Organic Meats Ltd, non-Core Assets of The Blue Goose Cattle Company Ltd., purchase by a private buyer
  • The Blue Goose Cattle Company Ltd., producer of organic beef products for the food industry, purchased by a private buyer
  • Black Sheep Vegan Cheeze Company Corp., manufactures and retails vegan cheese, purchased Feel Foods Ltd.
  • Equity Wine Group Inc., manufacturer and distributor of wine, craft beer, cider, and spirits, purchased by Diamond Estates Wines and Spirits Inc.

Nigro says that, even for food and beverage businesses that are thriving, it has become difficult to determine valuations for transactions in the sector. On-and-off lockdowns and supply chain issues are “showing their face in deal activity because these issues are having their dynamic on valuations.”

As for those businesses that have thrived, determining valuations also means trying to make educated guesses on future consumer habits. For almost two years, grocery stores and related businesses have benefited because people were staying home and making their own meals.

“Of course, owners of these businesses are saying, ‘hey this is a great environment to sell, by business has doubled.” But the problem, Nigro says, is that a seller doesn’t know if that revenue growth and profitability is sustainable.

“How do you price a business like this,” he asks. “Remember you're modelling . . . the purchase price is based on a more long-term perspective and so that's been the challenge for M&A in this space.”

The result of this uncertainty, Nigro says, is that lawyers and investment bankers have had to come up with deal structures that can account for this and help get the deal done. One example is to use earnouts, formally called a contingent consideration. It’s a mechanism under which, in addition to an upfront payment, future payments are promised to the seller upon the achievement of specific milestones.

“There are many ways to bridge the valuation gap,” Nigro says, and the job of a legal team on the deal is to use instrument that help mitigate risk and maximize value for the client.

Nigro says he recently was involved in two grocery business deals — one was completed, the other didn’t end in a transaction. With the deal that didn’t go through, “the buyer couldn’t get their head around valuation.” In the deal that was completed, “the seller literally said, ‘I’m going to ignore my entire COVID-bounce’ and sold the business at a multiple [that more related to the business] prior to COVID.”

Ultimately, this seller “bridged the gap himself,” preferring to take more cash on closing and leaving the buyer with any upside.

Another complication in determining the terms of a deal in this sector is figuring out a cost structure — given that rising staff wages and labour shortages, supply chain issues and inflation are factors that can increase costs. A snapshot of the business today doesn’t necessarily reflect reality in the future, he adds. Margins could change based on supply issues, and suppliers passing along their increased costs.

Given the importance of distribution in the food supply chain, and their increased “power” in setting terms with retailers have also made their targets for M&A. “We're seeing distributors who are basically saying to the grocers, ‘I don't care that you're the Big Brother in town’ and have newfound power in negotiating terms.”

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