Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Private equity can say a big thank you to Kraft Heinz Co. The U.S. food group's failed tilt at Unilever NV creates an opportunity the buyout industry has salivated over for years.

U.K. bankers might call it a sausage roll-up. Their Continental counterparts might prefer a Swiss roll-up. However you slice it, the time may have come to combine European food assets into a sizeable leveraged buyout.

The portfolios of Europe's biggest consumer goods companies are stuffed with underperforming food businesses that could benefit from more aggressive management. CEOs have been reluctant to let new owners have a go. After the brief $143 billion Unilever siege, that's now changing.

Hungry for Deals
Private equity has long eyed unloved assets held by European consumer groups
Source: Jefferies, Bernstein
Note: All values are estimated proceeds

The drama has prompted the Anglo-Dutch group to review its entire portfolio, implying pieces might come onto the market. Its spreads business, with an estimated enterprise value of 6 billion euros ($6.3 billion) according to Jefferies research, is the stand-out disposal candidate.

Before Kraft's assault, Nestle SA was sounding pretty relaxed about its U.S. frozen food and confectionery businesses despite them being among the group's slowest growing divisions. Recent events should focus the mind of Chief Executive Officer Ulf Mark Schneider. The assets could be worth up to 14 and 19 billion euros respectively, say Jefferies analysts.

Then there's Reckitt Benckiser Group Plc. Last month's $17 billion deal for baby formula group Mead Johnson Nutrition Co. increases complexity and indebtedness, so disposals would make sense. Analysts at Bernstein reckon Reckitt could raise 9.3 billion euros from selling food and homecare brands. 

Altogether it's nearly 50 billion euros of potential targets, with 25 billion euros of sales and 4 billion euros of operating profit. The combined operating margin of all these businesses is 16 percent, based on Bloomberg data and analyst estimates. That compares with 23 percent at Kraft Heinz.

Fattening Up
There's room for improvement in the margins of some food divisions of big consumer groups
Source: Bernstein, Jefferies

The targets may lack growth, but they offer stable cash flows and scope for improvement. Margin gains could come from cost cutting and economies of scale. Marketing savings might be tricky given brands tend to be local, but manufacturing efficiencies ought to be achievable. It's not that different to how Kraft has lifted its own margins.

Suppose it's possible to buy about 10 billion euros of assets, funded half with equity and half with debt. If margins could be driven from the mid teens to the low twenties, while keeping sales steady, that could warrant an approximate 40 percent uplift in the valuation. The potential exit value would then be 14 billion euros. Deduct the debt, and the equity would be worth 9 billion euros.

Over five years, the typical holding period for a private equity investment, this would imply an annualised return of around 12 percent. Those returns could be amplified with additional leverage -- or organic growth.

The model has been tried by private equity before. In home and personal care, BC Partners put together a collection of brands, including Dylon dyes and Catch foods, selling the business in 2014 for 940 million euros to Henkel AG, which liked the (literally) cleaned-up operation. U.S. private equity group Advent International Corp. recently established Sovos Brands, a roll-up vehicle for food and beverage labels.

So what's keeping private equity from moving? The main obstacle is management. Financiers who like the idea of a roll-up say it's hard to assemble teams with the expertise to lead a series of deals and extract the synergies. If the right people could get their act together, they could really bring home the bacon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Andrea Felsted in London at afelsted@bloomberg.net
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net