Evolving Due Diligence in Food and Drink: Industry Insights
The nature of due diligence is changing. Be it for mergers, acquisitions, capital investments, diversifications and new product or market entries. It is no longer primarily focused on a one-dimensional financial evaluation. Technical, operations, supply chain and category are increasingly becoming key components of the analysis.
“You cannot sit in some air-conditioned room in Central London and truly hope to understand what is really going on in a Food and Drink M&A deal. You might be able to populate some attractive looking charts, but you will miss the real story. Without direct experience of running food businesses and a real, living, breathing network of senior contacts in food and drink, the risk is one of an expensive and superficial analysis.”
Wherever a management team, corporate owner or private equity investor is wondering ‘is the battle worth the fight?’, HRA Global’s Commercial & Technical Due Diligence Practice exists to support them in any buy, build or diversify decisions.
We act as a critical friend to each business, bringing our specialist food and drink knowledge to the table as well as our technical expertise from statistics, economics, merchandising, psychology, technical and marketing. It has taken us 13 years of project work in Food and Drink consulting to create a rigorous, proprietary methodology which we tailor to examining every investment decision across many categories.
Now, many accounting-type firms offer the familiar but vanilla due diligence service – they work across many industrial sectors and jump from deal to deal. Of course, there are some advantages to this, but in my view such a cookie cutter approach does not suit Food and Drink companies. The nuances of Food and Drink where things like microbiology, quality, product format, provenance, legislation and absence of own label in a category can have a major impact on success.
Let us give a real-life example:
Company A had been trading for a couple of decades and was a branded business in a high growth part of a well-established category. The owners were looking for an exit. Some 12 months before the sale document was published, a large own label contract was taken on by the company in an adjacent category. This was strange in itself – why suddenly diversify into own label after 20 years successfully building and leveraging a clear branded position? And even more strange to do this outside of the core category they knew so well. And the final part of the puzzle was that this own label volume was not made in-house like the core products but bought in from a contract manufacturer.
This was most curious. But it is common for information to be ambiguous, hard to find and often contradictory, so we kept digging around.
We looked at the evidence from the market about comparative retails, net margins and manufacturing and logistics costs. We have our own in-house models which we are always updating, that enable us to understand what a good category margin looks like, what retailer expectations are likely to be, and how the drivers of costs are expected to change.
We looked at the site, walked the production line, met the team, poured over the microbiological and technical data, assessed the quality of the process plant, production assets and supply chain alongside the other company capabilities. We calculated the profitability of the contract as well as its longevity (‘stickiness’) given the competitive landscape, threat of substitution and available category capacity. We examined the small print from the contract manufacturing agreement. We looked qualitatively at the ‘distraction factor’ the own label business created for the company but also at the additional leverage this gave the company with its retail customers.
Finally, we unpicked the complex motivations of the company management team through interviews. We were able to place a value on this particular contract and give a view as to its importance to the business in the future and precisely what level of confidence should be put behind the financial projections for that contract. We will let you draw your own conclusions on how attractive this contract was, based on our pen portrait.
What this approach illustrates is the uniqueness of Food and Drink and the granular detail that you need to go into to really understand true value.
You cannot sit in some air-conditioned room in Central London and truly hope to understand what is really going on. You might be able to populate some attractive looking charts, but you will miss the real story. Without having run a food business or having a real, living, breathing network of senior contacts in food and drink, the clear risk is one of an expensive and superficial analysis.
You need to understand the dynamics of that category from both a shopper and market dynamics perspective. Understanding future shopper, competitor and retailer behaviour is key to underpinning any projections. Surveys from our in-house market research team are invaluable as are innovative, practical data sources and our own specific, actionable insights from desk research.
For instance, key assumptions are whether capacity is tight or over supplied, the quality of the assets, how deflationary the own label volumes are etc. And of course, the motivations and psychology of the management actors behind this decision are key.
In this case, the work took 4-6 weeks to complete – which is a timeline our methodology is designed to achieve, though we can also work within shorter transaction cycles i.e., up to 2-3 weeks. Typically, we report to an investment or credit committee, Managing Director, Board or Owner.
Now, not every piece of Commercial Due Diligence is a full study into M&A transaction
Sometimes, what is needed is a lightweight piece of tailored analysis looking at the category or the sector. This preliminary style of analysis can be extremely helpful in answering the ‘where to play?’ question – using our proprietary methodologies to screen acquisition targets, establish a shortlist and profile targets using our 360-degree analytical method.
We work seamlessly with the other parties in successful transactions – corporate lawyers, financial advisers and in corporate in-house specialists. We have been part of M&A transactions on the buy and sell side for over 12 years and fully understand the various investment considerations at play. For M&A, the valuation is key – where we help shape a maxima and minima value to plug into sensitivity analysis.
If any of this strikes a chord then please drop us a line and we can set up an outline chat.