When our India-focused private equity fund started out in 2007, branded consumer goods were our No.1 investment theme. In our first year of operation, we saw all of three investment opportunities in branded consumer goods companies that were worth considering (we’re a growth capital fund, so I exclude venture opportunities). We got serious about one of them but were outbid by an overseas strategic buyer who offered twice our valuation. Over the next year and a half, the same trend continued. We were able to invest in exciting companies in our other investment themes but we never managed to get our capital invested with a quality branded consumer goods company.
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Consumer brands: A popular investment theme
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Many PE funds operating in India list consumer branded plays among their favourite investment themes. The reasons for this are not hard to discern. Investors love branded consumer goods companies because such companies have low volatility in revenues (a strength proven through last year’s trial by fire), deliver a great return on capital and have persisting value in the form of brands that customers recognize and trust. With India’s young demographic and the currently limited penetration of branded goods and services, sustained growth over the long term is a given for almost all consumer goods categories. Hence, investing in such companies is an ideal way to benefit from the rising purchasing power of the Indian middle class. The weakness in overseas markets has only heightened the relative attractiveness of the Indian domestic sector.
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Loosely defined but vast
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Branded consumer goods companies are characterized by:
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a. Brand strength: A true brand is much more than a label on the box. It creates demand pull and conveys a clearly differentiated value proposition to the consumer, which allows the brand to command a price premium and deliver a good return on capital. By comparison, commodity players (e.g. rice companies) lack pricing power and their margins erode over time.
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b. Selling to individual consumers: Consumers have proven to be a less volatile customer set than business purchasers due to which B2C businesses have been less volatile through the recent economic slowdown than B2B businesses.
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c. Supplying goods as opposed to services: Brands can be built around consumer services (gyms, beauty clinics, video rental chains etc) too, but branded consumer services businesses have historically delivered a lower return on capital in India than branded consumer goods businesses.
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Such companies span a range of categories – personal care (including OTC pharma), packaged foods, apparel & footwear, toys, sportswear, home interiors and so on. These categories cover a wide swathe of the economy and branded consumer goods companies are present in each of these categories.
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PE activity in India
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Given all the interest from PE investors and the breadth of branded consumer goods, one would imagine that many PE deals would have occurred in this sector. However, branded consumer goods is among the most under-invested sectors for the PE industry in India. In the past 5 years, it has attracted just under $800 mm (of which the top 4 deals account for 50%) or a measly $160mm per annum on average. This represents just 2.2% of total PE investment into India in the same period.
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The paucity of deal activity is the result of three traits of the Indian branded consumer goods sector.
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a. Few independent brands and scaled up private companies
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In most categories in India, the leading brands are owned by large, listed companies that do not need PE funding. From the toothpaste we brush with in the morning, to the jam on our breakfast toast to the watch we strap on while rushing out, most of the leading national brands belong to listed Indian companies or MNCs. Exceptions do exist, but they are few and far between. This is unusual for an economy of India’s size and cultural diversity. I have no doubt that a great number of new brands are going to emerge over the next couple of decades as a younger and richer population seeks more variety and asserts its own identity. This creates an opportunity for early stage investments in new ventures in this space. At present, most VC firms in India tend to focus on technology investing and are not investing in this opportunity.
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b. Leading brands generate cash
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Once consumer brands become established, they typically generate significant cash flows for their owners. Hence, the companies often don’t need to raise money to fund further growth. In a sense, the businesses that growth capital investors like most are too good to need outside capital. Such companies need equity infusions only early in their life cycle when they are trying to establish the brand. At that stage, growth capital funds shy away citing inadequate proof of success. By contrast, a construction firm or a retail chain will likely continue to raise funds for expansion even after it is well established.
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A notable exception to this rule is the apparel segment. In apparel, the brand owner often sells partly or wholly through its own exclusive retail outlets. The retail element of the business requires substantial funding, so even successful brands (Koutons, Satya Paul, Biba, to name a few) have raised funds.
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c. M&A beats PE
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Over the past five years, overseas branded consumer goods companies have paid some eye-popping valuations to acquire a foothold in the Indian market. In such deals, valuations in excess of 20x EV/EBITDA have been the norm rather than the exception. Financial investors simply cannot and should not match such valuations; strategic buyers can pay such a price because they have a pipeline of products ready to pump through the same distribution channel once they gain access.
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Given the paucity of genuine branded consumer goods companies raising capital, investment bankers often project retail and branded services businesses as equivalent plays on domestic spending. While retail and branded services businesses also benefit from rising consumer spending, they do not typically generate the same RoCE as branded consumer goods companies do. Hence, investors treat them differently and would typically pay a substantially lower valuation multiple for these sectors.
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Crystal ball gazing
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Two and a half years into my search for branded consumer goods nirvana, I shall take the risk of making a few predictions for the next two and a half years:
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1. The wave of inbound M&A will weaken. For one, foreign companies shall prefer to hold on to their cash. Two, their boards shall be more circumspect about the valuations they can offer.
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2. VCs and early growth funds focused on the consumer sector will emerge and early stage deals in branded consumer goods ventures shall start happening. For instance, take the case of Times Private Treaties which has already built a very interesting portfolio of such ventures (though it invests advertising credit rather than cash and therefore cannot be categorized with VCs).
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3. The large buyout firms that have entered India over the past three years shall conclude a deal or two in branded consumer goods. Paras would probably be the prize catch in the sector, should its existing investors – Actis and Sequoia Capital, desire an exit. I would think Paras, with its attractive brand bouquet, should fine many takers.
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4. I shall continue searching for my dream deal - a consumer goods SME with a brand(s) that has strength in a limited category or geographical market, that needs our capital to expand and that is owned by an entrepreneur with a strong enough desire to remain independent to resist lucrative acquisition offers…
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…I probably won’t find a company like that. Entrepreneurs, please prove me wrong.
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[With thanks to VCCircle’s research team for their inputs.]
