Carve-Outs Bring Optimism to Consumer M&A

Consumer corporations’ drive for efficiency creates a welcome pipeline of potential acquisitions for PE.

By Carolyn Vallejo

The consumer products and services sector may be particularly exposed to volatility during periods of market uncertainty, but an influx of corporate carve-out activity in the space has unlocked attractive M&A opportunities for eager middle-market private equity sponsors.

Investors are often drawn to non-cyclical sectors during a market downturn, and pressure from high inflation on consumer spending has forced larger consumer conglomerates—especially consumer discretionary businesses—to focus on efficiency and cost-cutting.

For some, that means shedding non-core assets. The result is a growing source of acquisition targets for PE business development professionals facing a persistently challenging M&A market. According to experts, this carve-out opportunity has reframed consumer investments in a positive light, even in a volatile climate.

Only the Essentials

Ken Firtel, co-founder and managing partner of middle-market private equity firm Transom Capital, says the consumer industry can indeed be a challenging one. “The macroeconomic environment is obviously volatile right now, and consumer specifically is probably more volatile than most industries,” he says.

In February, S&P Global Market Intelligence forecast a slight decline in retail sales amid heightened inflation this year, with sales likely to remain suppressed below pre-pandemic levels. Analysts also noted the strong correlation between consumer spending and the onset of a recession, which would continue to drag down retail performance.

Yet Firtel says it’s precisely these market conditions that are creating new investment opportunities for PE acquirers as large consumer conglomerates are encouraged to shed assets. “The need for corporates to divest non-core assets is even a little bit more pronounced” amid such conditions, he notes.

Transom Capital is well-versed in corporate carve-outs, including acquiring assets from consumer brands. Earlier this year the firm acquired the business-focused unit of audio solutions company Bose Corporation as Bose refocuses on its consumer operations. In another high-profile transaction, Yellow Wood Partners acquired beauty and personal care brand Suave from its parent company Unilever in February. Strategics are active in this area, too: Last month, Campbell Soup Company divested its Emerald Nuts brand, which was acquired by food manufacturer Flagstone Foods.

Recent private equity fundraising could signal more consumer carve-out deals ahead: Food- and consumer-focused Kainos Capital noted corporate carve-outs will be an investment focus for its Fund III, which closed in February with more than $1 billion in capital commitments. That same month, Rainier Partners, a lower middle-market private equity firm, closed its inaugural fund at $300 million. The firm targets a variety of industries, including consumer services, with corporate carve-outs a key component of its investment strategy.

A Win-Win-Win Transaction

Considering the state of the economy, one might assume that corporations are divesting underperforming assets weighing down the brand. But Ayla Queiroga, Managing Director at private equity-focused financial and technology consulting firm Accordion, says many of these carve-outs involve strong businesses with high growth potential—they simply haven’t benefited from the attention and resources of a parent company.

“It’s a really great opportunity for large organizations to get sell off a product line that they’ve probably underinvested in over the last few years, and for private equity to pick up a business that’s already established,” she says, adding that Accordion has seen an uptick in carve-out transactions beginning in 2022, a trend likely to persist into 2024.

There are several advantages to investing in assets that a consumer corporation has divested.

Many business units come with their own infrastructure, including manufacturing plants, as well as teams that are well-versed in how to manufacture and distribute the product. In a sense, says Queiroga, these units already operate as standalone companies. For the parent company, these operations can come with challenging business silos and require significant resources to adequately oversee and manage the operation. But for PE acquirers, these qualities set up the business unit for a “clean break” from its previous owner.

Firtel agrees, describing many of these assets as “orphaned” without the parent company’s resources required to succeed. That could mean human capital, money, or simply mindshare and attention. Often, he says, these divisions will express a desire to pursue strategic initiatives that the parent isn’t green-lighting. For PE acquirers, those initiatives can provide a preestablished roadmap to value generation already baked into the deal.

It’s a win-win-win for buyer, seller and target, says Queiroga: The seller can get rid of a business unit that has been dragging down its bottom line or which isn’t contributing to growth of its core business, while the buyer can use its resources and expertise to fuel growth for the divested asset, benefiting both investors and the acquired business.

Cutting the Cord

Carve-outs offer another buying opportunity for PE acquirers, but investors must be cognizant of the nuances of post-transaction integration.

While a divested business unit may come with a value creation plan, it won’t necessarily come with senior management teams, as its C-suite leadership is usually retained by the parent organization. “You’re not getting a CFO; you’re not even getting a CEO sometimes,” says Firtel.

Queiroga adds that many of these assets lack their own finance and accounting teams, noting, “99% of the time, that’s commingled with the back office of the seller. The parent is the one doing all the finance and accounting, so it’s particularly messy to divest from that back office group.” She recommends acquirers examine targets’ finance and accounting functions early in the diligence process to adequately prepare.

Transaction service agreements (TSAs) are particularly helpful in carve-out transactions, as they ensure a buyer is able to work with a seller and its existing resources, like finance and accounting teams, to support a smooth transition. Everything from ERP systems to insurance, preexisting customer contracts and supplier relationships can be intertwined with a parent company, so having the seller’s aid is vital to detangling those assets and identifying what a divested business will need once it’s fully separated.

Adding to the complexity, corporate sellers will often need buyers capable of transacting quickly, Firtel notes. That’s especially true for public companies, which may have already announced publicly and to shareholders that they plan to divest an asset by a certain date, and which face mounting pressure from shareholders to boost efficiency and cut costs. “In conditions like now, speed and certainty are really important,” Firtel says.

For PE acquirers up to the task, carve-outs remain an attractive source of investment opportunity, even in the consumer space. After several years of upheaval fueled by COVID-19, supply chain challenges and high inflation, Firtel points to strong jobs data and cost normalization as positive signs in the consumer sector.

Even as retailers remain cautious about building up inventory, his outlook remains positive. “I’m optimistic that consumers will continue to spend money if you have a good product and a good offering,” he says.