Everyone will have read recent stories surrounding the interest of institutional private equity bidders in the UK’s supermarket chains with a growing lack of interest. The sums involved and the rumours and counter-rumours tend to cloud the issue, as we all await an outcome.
But at supplier level, private equity investment has remained a rare commodity. The fresh produce industry has not traditionally enticed private equity firms, with its largely conservative outlook and less-than-glamorous return potential. There has, however, been some activity in the last 12 months that suggests that, just maybe, the fruit and vegetable sector is now in the sights of investors.
THE MARKET ANALYST
Involvement with private equity, says Plimsoll’s David Pattison, is like riding a “risk versus reward seesaw”.
Plimsoll published a report 18 months ago entitled Dancing with the Devil, which looked at the private equity phenomenon. “It certainly increases the pressure when you get into bed with these guys,” says Pattison. “It can of course be very exciting.”
There are many things to be weighed up before the first steps towards private equity are taken by any company, he adds. “Does it offer an opportunity to the business that the current owners could not have afforded or were maybe not prepared to take a risk on? Or is it the sign that the owners want to reap some profit out of the business?
“These are of course two agendas, they are not necessarily mutually exclusive and often they are equally applicable.
“From the other side of the fence, it can be very humbling for a private equity business to put a comparatively small amount of money into a business, as their absolute agenda is to drive profits and sometimes the margins are not that great to start with.
“Some deals can be large, but more often in the fresh produce industry, private equity input has been relatively small volume. The nature of the industry means that in various cases the decision to sink equity into a business can in fact be tied to the individual rather than the company. And it is not unusual for equity to follow a favoured individual from job to job.
“This is an approach based on realism,” says Pattison. “Given the importance of large contracts in the fresh produce business, the individual that manages those contracts is more often than not vital to its success or failure.
“Many fresh produce firms are what you could call virtual businesses, with no real assets to speak of and no obvious base. That is not necessarily a bad thing, but under those circumstances, any investor has to take equity in the business and decide what they want from their investment.
“There have been a few deals recently where it is evident that the equity has been used to reduce debt problems rather than finance future growth,” says Pattison. “That is usually a tactic by the owners, but it is questionable.”
For the shareholders, private equity can mitigate risk. “If they only have to put in 50 per cent of the money to a joint venture, for instance, they reduce their exposure by 50 per cent. And if they are also getting 50 per cent of the returns, on balance that has to appear better than taking 100 per cent of the risk at the outset.
Private equity may add pressure, but does it add impetus? “It has been said in the past that an injection of private equity - and all that comes with it - offers an adrenalin hit to companies. The business has to take on a different set of characteristics than a traditional fresh produce business, as it has entirely new objectives,” says Pattison. “You can not go to private equity people and say ‘sorry, we’ve got nothing left’, that just is not in the game. They are ruthless and sharp and they will not let that happen.”
It can be hard to measure whether a venture has failed, as failure comes in many guises, says Pattison. “It is rare for companies to just go bang these days - in the way that Polly Peck did for instance. They are far more likely to fade back into the ground, have bits sold off or just return to their original position.
“Where there is a chance of reward, risk is always present. It can take a long time for the rewards to come through and private equity ventures sometimes have lengthy honeymoon periods.” They are not the panacea though, he adds: “If your business is built on unsustainable foundations, private equity is unlikely to make the difference you would like. The internet boom is the classic example of that - private equity firms fell over themselves to get involved and many of the businesses just weren’t set up to succeed in the long term.
“I’ve been surprised that more private equity firms haven’t looked at the potential of fresh produce. The next generation of consumers will definitely be closely linked with its products and there isn’t another set of products out there that you have to throw away within seven days, whether you have used it or not. Plimsoll has pointed out that the margins in fresh produce are low, but that is often because they are being eroded by debt. There’s no doubt that some businesses are poorly managed and private equity can be just what’s needed to sharpen the focus on that.”
THE PRIVATE EQUITY HOUSE
Spalding-based fruit specialist Empire World Trade gained a new private equity partner in September last year, when ISIS Equity Partners bought into the company and effectively financed the departure of previous partner 3i.
“When we first looked at Empire World Trade, it wasn’t because we had a burning desire to be involved with the fresh produce sector,” says Richard Bucknell, investment director at ISIS. “I think many private equity houses have been scared off in the past by two things. Firstly, that in layman’s terms this is a largely commoditised sector. And secondly, any business of any scale in the fresh produce industry is selling into the multiple retailers and therefore subject to customer concentration issues.
“Once we had our initial talks with Empire though, it became very clear that this is a company that stands out from its peers. It had an excellent track record over a 20-year period, which shows signs of continued resilience. Its key customers are very longstanding and the relationships are embedded, so the traditional view of supermarkets abusing their suppliers just doesn’t stack up. There is no doubt where the balance of power lies, but the situation is more one of mutual reliance than might be the perception.
“Empire, we felt, provided a value-added service, bringing knowledge of products, growers and sources that the retailer just doesn’t have. As a category manager, Empire is more of an outsource provider than simply a produce trading house and has relationships that stretch across all aspects of the business. There is not just one key account manager, around whom all hell would break loose if he decided to leave; there are people adding value in every department, from technical through to marketing and sales.
“As there is more consolidation to come in the sector, it is also highly relevant that Empire is consistently best in class. Whilst its relationships with customers are not guaranteed for ever, it does stand out as a company in a sector that has had some bad press when compared with the branded sector, and whilst its three major product areas are not the fastest growing produce categories, they are sufficiently robust to take advantage of the healthy-eating trend and the move towards premiumisation of products.
“Consolidation offers new opportunities for Empire. It is well placed both to supply existing products to new customers and new products to existing customers. Its relatively new stonefruit and horticulture businesses are both showing signs of great promise.
“Empire also has an excellent management team and that is what all private equity houses back first and foremost. [ISIS] is not at the institutional takeover end of the spectrum, and we would only conclude any agreement if the management team wasn’t right.
“I think there may be increased activity in the fresh produce sector - as it professionalises there are better businesses being created and as consolidation continues, private equity houses will undoubtedly see that as an opportunity. But I do not see the floodgates opening.”
THE FRESH PRODUCE FIRM
Denis Punter’s business was involved with venture capitalist 3i from 1995, when 3i put money into the venture that saw Frumar and Francis Nicholls merge to form Redbridge Holdings, until a secondary management buyout in 2003.
Punter says that there are “good and bad” sides to working with outside investors. “From our company’s point of view, if we had not had venture capitalist involvement we would not have been able to move forward in the way we have since 1995,” he says. “We had just come away from Geest and had limited opportunity to expand on our existing resources, so to that extent it was invaluable.
“Private equity creates opportunities, that might not have been there before, for people to be able to pass a business on, often to the existing management.”
Anyone entering a deal with a venture capitalist must have their eyes well and truly open, he adds. “When entering the process, it is crucial that there is a clear understanding of the exit plan of the venture capitalist. It is not just a question of achieving return on investment targets on a year-to-year basis, but also of working towards a clear exit target - if you don’t manage that properly, you will be in a position where the likelihood is you will fall out.
“You have to be a business that is capable of delivering high-quality financial control. Monthly and quarterly financial reviews are a matter of course and to put those together accurately you need to have people in the business with the right financial acumen.”
The biggest issue in the relationship between Redbridge and 3i was the decision of the latter to float in the late 1990s, which altered its focus into areas of business it felt added more value. Fresh produce took a backseat, as technology, pharmaceuticals and other high-margin industries became priorities. “Once this had happened, it was inevitable we would have to find a means of exit for 3i from our business,” Punter says. “The original timeframe of 10 years was set down in 1995, but it became pretty clear that the long-term commitment to growth was not there.
“We were able to achieve that through the secondary mbo and, as we were in a solid position, the deal was struck on pure bank debt.”
In retrospect, Punter believes the deal with 3i was the right one for his business. “To begin with, the relationship with 3i was extremely successful and I believe that, had we fulfilled the original timeframes, it would have continued to be very successful. We didn’t have a falling out, but there were frustrations on both sides as the objectives changed. From our point of view, there was recognition that we could no longer look at 3i as a long-term partner.”
He recognises that the new breed of private equity investor is looking for a faster return on its investments, saying: “You have simply got to have a build-and-sell strategy that is far more rapid now,” he says. “There has to be clarity between the financial objectives of the venture capitalist and those of the firm it is investing in, otherwise they are bound to become uneasy bedfellows.”
THE BUSINESS BANK
The main reason that the fresh produce industry has, until recently, largely flown under the radar of the private equity houses is a fundamental lack of scale, says John Laud, national head of Barclays food, drink and packaging division and relationship director of Eastern Business Banking.
“Fresh produce is a notoriously small-scale sector and the private equity houses have increasingly been looking for larger investment opportunities,” he says. “But, when Grant Thornton compiled its consolidation index around 18 months ago, fresh produce came out on top. As that consolidation occurs, the business scale and growth opportunities are bound to draw attention from investors.
“Already there is a little bit more growth in the sector than previously. I’m not saying that these are easy times, but here has probably never been a better time to be in fresh produce, with the increasingly green agenda and focus on healthy eating. Investors will be looking to ride on the back of this and because of the types of risks involved, the opportunities look more ripe for private equity than banks.
“A lot of fresh produce businesses are still family-owned and therefore tend to be on the conservative side, which creates initial resistance to being managed by private equity houses,” says Laud. “An influx of private equity can drive a business forward by bringing about a change of culture, increased dynamism and a refreshed entrepreneurial aspect. The average third-generation family-run business is not as entrepreneurial as the average first-generation family business. I must stress the word ‘average’ in that though, as there are many examples to the contrary. But generally speaking, the concept of private equity has not generally been welcomed in this type of company.”
This is understandable, as the prospect of letting a private equity house dictate terms can be offputting. A business that had been plugging away towards reaching its 25-year investment horizon will have no such long-term outlook under the strict medium-term exit plans put in place by investors, which typically fall in the three to five year range. “The focus shifts inevitably from creating assets and wealth to driving short-term profits,” says Laud. “A private equity house is of course going to be more interested in the turnaround of its exit plan than the long-term aspirations of the business.”
Despite that, Laud reports an upturn in the willingness of his clients to countenance the private equity route. “More and more are asking me for my personal opinion, and the opinion of Barclays, on the pros and cons,” he says. “These things tend to snowball once there is some activity within the sector - the involvement of ISIS with EWT in Spalding, for instance, has caused a few ripples to start.
“In the cold light of day, it is still difficult to say that private equity will be the right solution for companies in this industry. There are a lot of companies in the £30m-£50m bracket and it could be argued that even the bigger companies, with turnover of £200m plus, should be twice that size. Consolidation is moving the market that way.”
Consolidation can also provide synergies and cost-saving opportunities that broaden the scope of affected companies, and Laud argues that this does not sit ideally with the objectives of a private equity house. “Synergies are not on the agenda when a private equity house gets involved with a business, whereas they are bound to figure highly in any corporate takeover’s list of objectives. The question is why does a corporate firm not outbid private equity houses in such deals in the fresh produce arena? Is it because private equity investors overvalue companies or do potential corporate bidders undervalue businesses? I would suggest it’s a little bit of both. Some private equity houses are paying high for food businesses, but many corporate firms when faced with the choice are not prepared to go the extra mile to buy new business.”
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