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Investing in retail: why buyout firms must avoid brand dilution

Out-Law Analysis | 13 Aug 2015 | 11:58 am | 4 min. read

FOCUS: The retail and consumer market is one of the most important and largest targets for private equity investment. However, despite improving economic conditions generally, these areas present particular challenges for investors.

Consumers have become more careful with their money in response to the recession, while competition – particularly in the restaurant trade – has increased. The growth of discount and budget retailing has educated consumers that value reflects price as well as quality, and made consumers more likely to try alternatives to their favourite brands particularly in the 'middle-ground' space between budget offerings and luxury brands.

Retail and consumer brands and services have always been an attractive target for private equity investment and their importance is growing as the economy recovers. According to industry publication unquote" the consumer sector has accounted for 27-29% of total deal volume in the UK since 2012, and up to 39% of total deal value in 2014.

But with expansion comes the risk of brand dilution. As investors seek returns through expansion, both within the UK and overseas, retaining the 'soul' of the brand – and, with it, the loyalty of consumers – is crucial to their success; as emerged from the discussion at a recent event hosted by unquote" and Pinsent Masons, the law firm behind Out-Law.com.

Opportunities on the high street

Given retail's reliance on personal spend, the stability of the market remains tied to consumer income. However, just because the economic recovery has brought modest growth in real household incomes does not necessarily mean that the environment for private equity buy-outs has become more stable.

With increased numbers of retailers moving online, the landscape of the high street is in a constant state of change. The high streets that survive and thrive will be those that treat retail as more of a leisure pursuit, using events such as markets, pop-ups and festivals to engage consumers in a way that online simply cannot. David Torbet, investment director at Bowmark Capital, cited the Westfield shopping centre in Stratford, east London as an example of a retail destination that has done well because it has been able to "control everything on site" without being dependent on councils and planning committees.

CBPE Capital partner Anne Hoffman told us that the best performing high streets were those that had embraced differentiation. While many high streets have been taken over by discount retailers and gambling shops since the downturn, others had been able to attract more independent boutiques and cafes.

CBPE's purchase of the Côte chain of French bistros in 2013 was prompted by the transformability of the concept outside of London and the south east, she told us: the novelty of the brand and concept worked in its favour, and CBPE almost tripled its original investment when it sold the chain in June 2015.

Brand expansion

Our panel agreed that retaining the 'soul' of a brand when expanding could be very difficult. A theme that emerged from their responses was the need for continuity, for example by retaining existing management and keeping the business founders close in a consultancy role as the chain expands. There was also a difference between products and services, as with products it was easier to retain basic principles regardless of how big the company got, while consumer perception of services was based more around their feelings about the brand.

According to Torbet brands risked being tarnished when their actions on expansion went against the company's previously stated ethos. Smoothie maker Innocent was once the case study for not being a big corporate business, but then it sold out to Coca-Cola and compromised its identity, he said. At the other end of the scale were brands such as Nando's, based around the delivery of cheap, good fast food - which it could continue to do at any size, he said.

Tommy Seddon of the Riverside Company said that part of his firm's strategy was to "avoid pronounced fashion risk". If a brand that thrives on being "edgy" or trendy is bought out by private equity its identity could suffer, he said. When Riverside invested in Italian gelato ingredients producer MEC3, it ensured the founders maintained an active role in the business while using its own day-to-day business knowhow to influence pricing and sales, rather than "tinkering" with the core values established by the founders.

Internationalisation

This highlights the importance of finding the right backer to internationalise consumer companies. Although the digital revolution has made growing a business overseas much easier, without people on the ground it becomes harder to reflect cultural differences in your products and marketing and to 'localise' your brand's story.

Around 80% of Inflexion's current portfolio involves international sales. The firm's investment director, John Harper, told us that it had opened offices in Brazil, India and China "simply to accelerate growth", and that it had recruited in-country teams to source and assess add-on investments within their particular regions. Harper said that although the internet was a useful tool when exporting brands into new territories, "a lot of it is down to management and often a different skill set is needed".

Seddon talked about how Reima, the Finnish children's wear company in which Riverside had recently expanded its investment, had developed a localised strategy for China. Skincare company L'Occitane learned the hard way that it had to localise its offering for China, he said. The firm's core brand proposition in its western markets is all about the romanticism of Provence - a story that does not sell in China where people living in the cities only moved from living on farms in the previous generation.

Internationalisation also presents a good opportunity for businesses to review their UK store portfolios, although long leases in the UK can be tricky to exit. Most of the investors on our panel said that they were less keen to invest in businesses with heavy 'bricks and mortar' presences, preferring instead those with predominantly online sales that were easier to internationalise. Torbert said that Bowmark now spent more time "assessing a retail estate in detail" before preparing to bid, in order to avoid apparently successful businesses with longer 'tails' of underperforming stores.

Financing

During the economic downturn banks turned away from lending against consumer deals. The panel told us that although the market was recovering, traditional lenders were more cautious than they had been and would only lend on more modest multiples than before the crisis. Travel and leisure companies were having more success than retailers at raising large sums of debt: Harper gave the example of Center Parcs, which has been able to approach international lenders because of its constant cashflow.

Torbet said that financial leverage and debt finance was "not a major part" of Bowmark's investment strategy when investing in consumer deals. "In this sector, you do need to expect a level of volatility and need a financing structure that can cope," he said.

Tom Leman is a private equity, retail and consumer expert at Pinsent Masons, the law firm behind Out-Law.com