November 2, 2018 Newly Acquired Risk, Post-Acquisition

M&A insight within the food & beverage industry sheds light for executives in other manufacturing categories.

October 31, 2018

By Sanchayita Ray

High Merger & Acquisition Activity Continues in Food & Beverage

As food and beverage companies continue to face disruptive pressures – in large part spurred by changing consumer preferences, with an increased demand for organic and natural products – the industry is being forced to adapt. Acquisitions are increasingly helping food companies expand their product lines, increase efficiencies, meet consumer demand and maintain market share. According to Mergers & Acquisitions, the U.S. food industry saw $42 billion in deals in 2017, and deal activity within the food and beverage industry has remained active in 2018.

“There are a lot of emerging trends in food, especially with the increase in demand for healthy and organic brands,” says Jeff Wahba, former co-chief executive officer and chief financial officer of Farmer Brothers Co (NASDAQ: FARM), a $600 million national manufacturer of coffee, tea and culinary products. “It’s generally a lot cheaper for a food company to buy a brand that already has some momentum in a desired channel, rather than having to start from scratch.”

This sentiment aligns with data from a recent survey conducted by Mortenson, in which 67 percent of CFOs surveyed say that mergers and acquisitions (M&A) was likely for their company in the next three years.

Likely M&A, Likely Risk

When food and beverage companies turn to acquisitions, there is one area that is often underemphasized. According to the Mortenson survey data, 78 percent of executives say that facilities carry a risk during M&A, and 38 percent say that in their experience they uncovered a risk within the real estate and facility portfolio after a deal transaction closed.

“In most cases, if you listed all of the reasons a CFO in a food and beverage company is making an acquisition, real estate would most probably be near the bottom of the list,” says Wahba. “For this reason, there may be warts related to real estate that a CFO simply acknowledges and decides can be addressed after the acquisition, even if there is some additional cost.”

While at Farmer Brothers, Wahba led the integration of a $30 million Coffee Bean International business and an over $200 million Sara Lee coffee business, after both were acquired within a short amount of time. What they did not anticipate was the magnitude of issues that would come with one of their acquired manufacturing facilities.

“We inherited a large six-floor manufacturing facility that was originally built in the 1900’s, and it came with a lot of surprises – air circulation issues, low ceiling heights, logistical nightmares… I could go on and on. Unfortunately, at the time, our only feasible option was to utilize this antiquated facility.”

Expensive Surprises

Whether conducting environmental audits during due diligence, or simply acknowledging that there may be issues that they will need to address later, CFOs across all manufacturing categories often think they have their real estate covered prior to the acquisition.

“In acquisitions, timing is of the essence. Solving for real estate issues is probably not going to happen in the due diligence period – facilities just don’t get fully addressed,” says Wahba. “Depending on the magnitude of the real estate issues, it is not uncommon for a CFO to take the position of believing their escrow will cover those types of things later. In hindsight, I would evaluate the real estate as thoroughly as possible as part of the acquisition.”

“There are surprises you don’t want to be dealing with in the final hour,” agrees Tom Poe, former financial executive of a subsidiary of Vectren, a $2.5 billion utility. While real estate may only amount to a small fraction of the costs of an acquisition, it may end up being more costly than executives anticipate. Poe has seen this first-hand, when working with a company as a consultant to analyze their facilities plan. “We ended up having to change our initial decision, because we later came to find that the facility we wanted to expand had costly environmental issues that had not been identified pre-acquisition. We then shut this particular facility down and expanded one in another state, but the late change in decision was ultimately a multi-million dollar negative.”

For a $4 billion food processing company, the expensive surprise came in the form of unplanned plant shutdowns leading to loss of production and high energy costs. In analyzing these facilities, Mortenson found the company could implement a renewable energy solution that proved 189 percent return on investment and a five-year payback period.

“What a CFO should do as part of their 90-day plan is a full facilities audit up front – ideally with a third party firm. We didn’t do that – and I think we definitely paid for it,” says Wahba.

A Holistic Approach

By way of a real estate portfolio assessment, executives can ascertain the true conditions, costs and opportunities for existing assets across their combined ecosystems.

“Increasingly, executives are relying on outside consultants to uncover not only hidden issues, but also hidden value,” says David Wood, project manager at Mortenson.

Untapped opportunities often exist that executives can turn into significant ROI wins for the combined company.

For a large utility, Mortenson discovered a $129 million property valuation for a severely underutilized site and subsequently devised a capital expenditure plan, a capital improvement plan and a new facility growth plan that allowed the company to capture real value that otherwise would have been missed.

“Across multiple industries, executives are increasingly seeing a need for this type of visibility and certainty in order to make crucial strategic decisions,” says Wood.

According to Mortenson survey data, over two-thirds of CFOs said that M&A conditions would increase the strategic importance of their facilities. With M&A activity remaining strong for all types of manufacturing in 2018, executives analyzing their newly acquired businesses and expected synergies should take a second look at their real estate portfolio.

Podcast: Likely M&A, Likely Risk

Sanchayita Ray, Mortenson

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