Private equity’s leveraged buyout food-shopping formula crumbling

A screenshot of Bain Capital's website.

Inflation and higher interest rates are straining private-equity funds that used leveraged buyouts to buy into the food and beverage market in recent years.

Private-equity funds purchased 786 companies in the food and beverage space in 2021 for a combined USD 32 billion (EUR 29.5 billion). The total sunk to USD 9.7 billion (EUR 8.9 billion) through the first 11 months of 2022, according to S&P Global Market Intelligence, in part due to rising inflation and interest rates and geopolitical instability.

The largest deals in 2022 included a USD 950 million (EUR 874 million) takeover of TreeHouse Foods by InvestIndustrial, a USD 700 million (EUR 644 million) purchase of Bundle Technologies by Sumeru Ventures and Prosus Ventures, and the USD 588 million (EUR 540 million) acquisition of Smithfield Foods by Solina Group and Astorg Asset Management. The USD 212 million (EUR 195 million) purchase of insect feed meal producer Innovafeed by a group of investors that included ADM, Cargill, Temasek Holdings, the Qatar Investment Authority, and Creadev ranked sixth.

Most of these private-equity takeovers employed the use of leveraged buyouts, which use money borrowed by the companies being purchased, which is then covered by the issuance of loans sold to mutual funds and collateralized loan obligation bundlers. However, with the loans tied to interest rates set by the U.S. Federal Reserve, private-equity firms are facing a cash crunch as a result of a 4-percentage-point jump in benchmark interest rates.

Leveraged buyouts can generate returns above 20 percent for private-equity firms, but in 2022, they had generated a net negative cashflow of 9 percent, according to a report by McKinsey & Co.

Higher labor costs, supply-chain disruptions, and the war in Ukraine all contributed to the downturn, as they forced private-equity firms to push through price increases on their products to cover rising costs. But with food prices rising 14 percent in 2022 – way above the 6.5 percent increase in the consumer-price index last year – shoppers changed their buying habits, downsizing some purchases and substituting cheaper brands for others. That can spoil the recipe for private-equity firms, which want to maximize profits but don’t want to raise prices so much that they lose market share to companies with smaller price increases.

Some leveraged companies can buy insurance to protect them from such economic shocks, but it’s an expensive option not always taken, according to the Wall Street Journal. When their loans are downgraded, it can compound their problems, as many investors, such as mutual funds, have limits on how much low-rated debt they can own …

Photo courtesy of T. Schneider/Shutterstock

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