Participate, Profit & Celebrate:
Q.: How has your investment strategy changed given that the consumer sector has been particularly impacted by the economic recession?
Ms. Mullin: The recession has certainly had an impact on consumer spending, but our investment strategy has remained largely unchanged in the face of the economic downturn. We are still as focused as ever on backing innovative brands that deliver best-in-class products to their consumers - these brands will continue to prevail, even as consumers pull back on spending and retailers reduce inventory. Furthermore, many of our focus areas (e.g., food, health & beauty, beverage, pet care) are less sensitive to economic cycle - consumers in these categories may be more discerning with their spend, sure, but at the end of the day, they are still going to spend - recession or not, they need to eat, bathe, feed the dog. Finally, many of our investments are in companies with under-developed distribution. These are companies that can continue to grow often at a rapid clip even in the face of a shrinking market simply by expanding their points of sale and extending into new markets and/or product lines.
Q.: In general, how would you compare branded consumer product companies with non-branded companies, especially since consumer spending habits have been changing recently?
Ms. Mullin: The recession-era consumer is more sensitive than ever to making sure they get value from the products they purchase. This doesn't necessarily mean buying the least expensive item on the shelf. Rather, it means making sure that each and every product they buy really delivers. If consumers spend top dollar, they want top performance. In this environment, brands can be a particularly powerful signal to consumers and engender long term loyalty. Brands that consistently deliver high consumer value will prevail at the shelf.
Q.: Looking ahead, where do you think valuations are headed for consumer branded companies?
Ms. Mullin: We think strategics will continue to pay up for brands that deliver differentiated consumer value and are well positioned for future growth. For instance, brands that sell in higher-growth, higher-margin channels will fetch higher valuations than those focused on more traditional slower growth or lower margin channels. Additionally, you will see strategics bid high for brands with opportunities for additional distribution gains (new markets, new channels or shelf space gains) or product line extensions. We also expect a continued correlation between gross margin and acquisition multiple. Categories that will fetch premium valuations include food & beverage, beauty and pet care.
Q.: How do you source deals, and how many deals do you look at on average?
Ms. Mullin: I hate to say it, but it's rare to originate more than one deal from any single source. Our deal flow comes from all sorts of places, and often where you least expect it. We therefore focus on casting a broad and tightly-woven deal net. In some cases, we call on a company directly, having come across its products in one of our routine store visits or category surveys. In other cases, the company hires a banker to solicit investors, and that banker calls on us given our deep category expertise. In other cases, we access business owners via unexpected sources - a recruiter, a lawyer, a retired executive or the proverbial friend-of-a-friend.
Q.: How does TSG organize itself to ensure its deal origination"net" covers this wide array of sources?
Ms. Mullin: We spread ourselves across a lot of direct and intermediary networks. This means near constant travel and a lot of meetings - with companies as well as bankers, brokers, industry experts and service providers. We look at well over 100 prospective investments for every one deal we close.
Q.: Do you find that deal competition is heating up between financial investors and strategics?
Ms. Mullin: Deal competition is indeed heating up. On the PE side, much has been publicized about the capital overhang - funds have ample capital to deploy, and businesses with strong fundamentals are likely to generate multiple bids. The favorable credit markets add fuel to this fire. We have seen recent auctions in which companies received dozens of indications of interest, with robust competition throughout the duration of the auction process. Strategic activity is further intensifying deal competition. Strategics have strong balance sheets and are hungry for growth. For this reason, we are seeing stepped up activity on the strategic side, and we expect this competitive intensity to continue for some time to come.
Q.: How do you go about doing due diligence and what are the most important concerns per your investment decisions?
Ms. Mullin: Beyond the standard quality of earnings review, legal assessment, commercial diligence, etc., we rely heavily on primary research. In the vast majority of cases, we commission consumer and trade buyer surveys to understand current and projected consumption trends, often in the very early stages of the deal and well before signing a letter of intent. The primary research helps us better understand category trends, comparative brand positioning, and how a given brand performs against key consumer purchase criteria. This research is not only a critical input to our diligence process, but also to our post-close strategy should we ultimately close the deal.
Q.: The process sounds exhaustive. Can you give us insight by example when you may have made or walked away from an investment?
Ms. Mullin: Sure. For instance, over the course of due diligence we spend a lot of time understanding how consumers and the trade perceive the brand and its key competitors. In one case, beauty consumers told us that their most important purchase criterion when buying in a given category was that the products promote healthy skin. They rated the brand that we were considering investing in as underperforming on this critical purchase criterion. We ultimately did make the investment since the brand scored very high marks across other dimensions.
As I'm sure you can imagine, one of the priority"post-close" action items was to reformulate core products to include more active ingredients and to tout skin care benefits more clearly in packaging and in merchandising material. When we re-commissioned the consumer research a couple of years later, consumers rated our brand as performing very highly against this key purchase criterion. As one would expect, company sales and market share accelerated rapidly.
Q.: How significant is marketing for building brands, and what are some of the key metrics you look at?
Ms. Mullin: Successful brands must of course deliver great product, but great product only gets you so far. We help our partner companies build brands that connect with consumers at a deeper level and elevate the products above the broader market fray. We encourage many of our brands to embrace less traditional marketing techniques - print and other traditional media are of course valuable, but social media plays an increasingly important role in connecting our brands with target consumers. We also encourage our brands to build credibility with key influencers and invest in sampling to literally get the product in people's hands and mouths.
Q.: Recently, TSG sold one of its portfolio companies - Smashbox Cosmetics. Can you elaborate on how the transaction process developed?
Ms. Mullin: Our 2006 investment in Smashbox is a good illustration of how industry focus helps create proprietary deal opportunities. Prior to our investment in Smashbox, we had spent considerable time evaluating the prestige beauty category and, in particular, the increasingly important role of alternative distribution channels, namely broadcast and open-sell format retailers. We noted that Smashbox Cosmetics, though relatively small at the time, had achieved promising momentum in these higher-growth channels. While catching up with an industry contact over coffee, we learned that the Smashbox owners were considering raising mezzanine financing. We quickly reached out to the company and successfully convinced the owners that an equity raise with a value-added partner like TSG consumer was a better alternative than a debt raise, as it would enable them to invest more aggressively in expanding distribution and building brand awareness.
Q.: Do you think foreign buyers are becoming more active in the consumer M&A space as was the case with VitaminWater?
Ms. Mullin: Yes, foreign buyers are increasingly active in the US branded consumer space. This is not surprising given globalization trends and the fact that many foreign strategics already have significant brand sales in US markets. Foreign buyers want to continue to access the US consumer market as well as expand distribution of US brands into international markets. Thus, we often see both domestic and foreign buyers participate in sale processes.
Q.: In your experience, what is the sale preference of the business owners in consumer branded?
Ms. Mullin: There are many reasons why a business owner may prefer a private equity partnership over an all-out sale to a strategic. First, a partnership with a PE firm enables the business owner to access outside capital while still maintaining a significant ownership stake in his or her company (with the associated upside opportunity). In fact, in about half of TSG's investments, the existing owner(s) go so far as to maintain a controlling stake in their businesses. Maintaining meaningful equity ownership is compelling for owners who see the benefits of taking on outside capital, but also see continued growth opportunities in their business.
In many ways, an investment from TSG offers a business owner the best of both worlds - they get access to a value-added partner and outside equity capital (for shareholder liquidity, growth capital, debt pay down - or some combination) while preserving option value for a meaningful"second bite of the apple" down the road. In contrast, a sale to a strategic typically means handing over the reins today and forgoing any additional upside. In addition, a sale to a strategic often means the dismantling of the existing team, which some owners find less attractive than partnering with a PE firm and keeping the existing management team intact.
Q.: TSG is known for investing in small companies with cool products. What is your secret in taking these companies to their next level of growth?
Ms. Mullin: We have a long track record of backing brands that deliver best-in-class products and speak to consumers in new and different ways. Often, we invest in these companies relatively early in their lifecycle when their products are only available in a handful of markets and/or they offer a fairly narrow product line. We help accelerate these brands' growth by providing the capital and resources to help them increase their points of distribution, extend their brand across more SKUs and into more categories, build awareness with key"influencers" and, in many cases, simply get product into consumers' mouths.
Q.: On a personal note, what book are you currently reading?
Ms. Mullin: Cutting for Stone by Abraham Verghese, February 2009. Cutting For Stone is a completely engrossing novel. It's beautifully written and tells a story of rebirth and renewal that cuts across generations and continents.

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