Explainer: Why retail has lost its sparkle for private equity firms

Radiance Holdings (Group)

06/03/2024 15:56

By Abigail Summerville
       NEW YORK, March 6 (Reuters) - Private equity firms made
billions of dollars betting on major U.S. retailers, clothing
and accessories and restaurant chains, reshaping the consumer
sector from the 1990s to the early 2010s. But over the past 10
years the big firms, including Carlyle and Warburg Pincus,
collectively pulled back on investing in the sector, reflecting
changing consumer tastes and competition from corporate buyers
and family offices. 
    Investments in retail and consumer companies accounted for
just 7% of the total U.S. private equity deal volume of $2.6
trillion in the last decade compared to nearly 15% of the total
volume of $1.7 trillion in the prior decade, according to
Dealogic data.
    Street wear business Supreme, McDonald's China, discount
retailer Dollar General, and crafts retailer Michaels were big
winners for private equity firms like Carlyle, Bain, Blackstone,
and others, which "exited," or sold, their stakes at handsome
profits during the last decade. 
    The upshot for the sector is a scramble among new-age
investment firms to fill the void left by the larger firms.
Large consumer names like Unilever and L'Oreal are also
increasingly winning deals for smaller peers, as they face less
competition from private equity on price. 
    Here is why private equity firms are no longer making big
bets on the sector. 

WHICH LARGE FIRMS HAVE STOPPED MAKING CONSUMER INVESTMENTS?
    Apart from Carlyle, Warburg Pincus, THL Partners, and
Centerbridge Partners are not actively scouting for potential
consumer and retail (C&R) targets. 
    Last year, Carlyle told its staff in an internal memo that
it would pull back from investing in U.S.-based consumer and
retail companies, as the sector was no longer core to its buyout
strategy. Carlyle blamed "increasingly challenging investment
trends in this space" for its decision.
    Warburg Pincus stopped investing in US C&R companies five
years ago to focus on opportunities in other sectors, according
to a person familiar with the matter. THL’s C&R team is now
increasingly covering technology and business services, and the
firm has not made a single consumer investment in the last six
years. Centerbridge shifted its focus to branded industrial
companies about five years ago, according to a second source
familiar with the firm's strategy.
    
WHY ARE FIRMS CUTTING BACK ON THEIR INVESTMENTS IN CONSUMER
COMPANIES?
    The pullback can be partly blamed on the COVID-19 pandemic,
coupled with a tough macroeconomic environment that hurt
consumer products businesses over the past few years. 
    The pandemic disrupted supply chains all the over the world
in 2020 and the consumer goods industry has struggled to regain
its footing. 
    Market volatility and high interest rates over the past two
years further compounded the woes of consumer goods businesses.

WHY IS INVESTING IN THE SECTOR CHALLENGING AT A LARGE SCALE?
    The success of the private equity business model is built
around bets in industries that are stable, generate predictable
cash flows, and are essentially recession-proof. 
    Consumer goods companies, which have traditionally been able
to withstand bouts of market volatility, are now increasingly
vulnerable. 
    The explosive growth of e-commerce over the past decade has
also driven a generational shift in consumer behavior, as
shoppers increasingly prefer online channels like Amazon,
resulting in lower footfall at brick-and-mortar retailers like
Macy's and Kohl's. 
    The barriers for entry in the sector have also come down
significantly. Popular consumer brands are increasingly being
launched online by entrepreneurs or social media celebrities -
such brands are often able to scale cheaply, without having to
spend heavily on advertising. 
    However, customer acquisition costs remain high since it can
be challenging to turn an average consumer into a loyal shopper.
 
    Those industry dynamics have forced investment committees to
rethink their strategy on large consumer bets. Moreover, as
private equity funds have witnessed explosive growth, large
firms have needed to deploy bigger chunks of capital for each
investment. The scarcity in volume of large, high-quality
consumer goods makers and retailers has forced investors to turn
to other industries. 
    
ARE LARGE FIRMS FACING INCREASED COMPETITION FOR THE BEST
COMPANIES? 
    Over the past 12 months, financial sponsors competed against
well-capitalized consumer giants amid a tough environment for
debt financing, which forced private equity firms to be more
conservative. 
    For instance, Unilever beat out large investment firms to
acquire haircare brand K18 and frozen yogurt brand Yasso;
L’Oreal won the auction for luxury cosmetics brand Aesop; and
Mars prevailed over private equity firms in its pursuit of
healthy-meals maker Kevin’s Natural Foods.
    Competition from family offices has hurt private equity
prospects too. For example, Redwood Holdings, the family office
set up by billionaire staffing industry veteran Jim Davis,
acquired Newly Weds Foods last year for about $4 billion - one
of the largest buyouts of a consumer business in 2023.  

WHO IS FILLING THE VOID LEFT BY PRIVATE EQUITY FIRMS?
    A new wave of middle-market and growth-equity investment
firms are targeting small-scale consumer and retail companies to
fill the gap left by large sponsors. 
    Carlyle’s former C&R head Jay Sammons left the firm in 2022
to start SKKY Partners with Kim Kardashian. SKKY, which focuses
on consumer and media investments, announced its first deal last
year with a minority investment in condiments brand Truff. 
    “There are obviously a lot of great incumbent brands out
there that have been around for a long time and have very strong
market positions and there’s a place for investments in those
areas, but our perspective is that the growth prospects of the
disruptors are more attractive to us as investors and that’s
where we’re spending our time," Sammons said in an interview. 
    Last year, ex-L Catterton partner Matt Leeds launched
Forward Consumer Partners, while ex-BDT Capital partner Tiffany
Hagge co-founded Citation Capital, which focuses on consumer,
retail, services and industrial companies. In 2019, some
Castanea Partners veterans launched Stride Consumer Partners and
former Reckitt Benckiser executives along with private equity
veterans launched the consumer-focused private equity firm Bansk
Group. 
    In 2017, a former L Catterton partner Neda Daneshzadeh
co-founded Prelude Growth Partners. In 2016, a former KKR
investor and former Vista investor launched Butterfly Equity to
invest in food companies. 

DO BUYOUT FIRMS STILL SEE INVESTMENT OPPORTUNITIES? 
    Some large firms are still prolific consumer investors.
Sycamore Partners, which manages $10 billion of assets, and
Ares, which manages $419 billion, were among the top 5 retail
investors last year, according to Dealogic. 
    Two other well-known names remain solely focused on consumer
investing: L Catterton, which launched in 1989 and is backed by
Louis Vuitton Moet Hennessy (LVMH), and TSG Consumer Partners,
whose investments include Corepower Yoga and Super Star Car
Wash. 
    Investors said the leveraged buyout (LBO) math can work
better for consumer services companies, which have more
predictable revenue streams from subscription or
membership-based models. Fragmented industries such as car wash,
medical spa, and residential services remain attractive
opportunities for sponsors.   
        TSG invested in residential solar company Trinity Solar
last year, medical spa firm Radiance Holdings, and residential
services firm The Wrench Group in 2022. L Catterton acquired LTP
Home Services Group, a residential services platform, in 2022.

WHAT IS THE FUTURE OF CONSUMER INVESTING IN THE UNITED STATES? 
    Consumer spending still accounts for a majority of U.S.
gross domestic product (GDP), thus presenting opportunities for
investors.  
    Some large overseas investment firms still view the U.S. -
the world's biggest consumer market - as an attractive
investment destination. For instance, Europe-based private
equity firm PAI Partners has in recent years ramped up bets on
U.S. consumer goods companies, and started building out a team
focused on investing in North America. Last year, it bought
US-based pet food manufacturer Alphia.
    “Even before we opened our US office, PAI saw that a sizable
portion of our portfolio companies’ revenues were being
generated in the US, given the scale and transatlantic nature of
our investments. And food & consumer has always been a big part
of our portfolio. We’ve raised a larger fund and the US is a
large market,” said Winston Song, who leads PAI's consumer
investments in North America, in an interview.

 (Reporting by Abigail Summerville in New York; Editing by
Anirban Sen, Vanessa O'Connell and Chizu Nomiyama)
 ((abigail.summerville@thomsonreuters.com;))