Consumer Products and Services: McGladrey Quarterly Private Equity Deal

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1 Products and Services: McGladrey Quarterly Private Equity Deal 2Q 214 Insight Analysis Experience the power of being understood. Powered by

2 McGladrey announces the 2Q 214 Private Equity Deal Flow Profile Private equity (PE) deal activity was soft in Q4 213, mirroring a lackluster holiday shopping season in the U.S. The first quarter of 214 recorded a small rebound for PE investments, however, in terms of both deal flow and overall capital invested. Likewise, consumer confidence has bounced back recently, according to The Conference Board, and there s been some improvement on the employment front, which is helping drive income. Some of the headwinds we saw in the fourth quarter should be subsiding, says Jeff Edelman, director of retail and consumer advisory services at McGladrey. Higher purchase price multiples continue to affect deal flow. In all, PE firms made 121 investments in the B2C sector in Q1, a tick higher than Q4 213 (11), but below most quarterly figures between late 21 and 212. Competition is driving up valuations for many companies, says William Spizman, partner of transaction advisory services at McGladrey. It s hard for a buyer to re-trade a purchase price, because the investment banker has someone else waiting in the wings. Despite the high price tags for companies, PE firms still need to put capital to work. Thanks to stockpiles of dry powder in the PE industry, McGladrey anticipates a healthy number of transactions crossing their desks in the coming quarters. Platform buyouts have declined in popularity, partially due to those high valuations. The 191 leveraged buyouts (LBOs) recorded last year represented a 17 percent decline from 212 levels. Instead, investors have been taking a second look at minority investments and add-ons, both of which carry lower valuations and less competition. Mega-firms like The Carlyle Group and TPG are recalibrating their strategies and focusing more on non-control investments. Carlyle announced two notable minority investments in the B2C industry of late, including a $5 million stake in headphone manufacturer Beats in September 213, and a strategic stake, said to be valued around $8 million, in shampoo-maker Organix this January. On the exit front, PE investors have enjoyed a strong run since 212, and Spizman believes it s still a sellers market. There s a lot of capital to be deployed, both by strategic buyers and by financial buyers. The public market has also been a reliable exit route for investors recently; 33 PE-backed B2C companies were taken public between 212 and 213, including eight in Q4 213 alone, the most in a single quarter since Q4 26 (9). Focusing on the middle market, McGladrey provides PE firm and their portfolio companies with integrated transaction advisory, tax, assurance and consulting services. Our work with thousands of consumer products, food and beverage companies and 1,1 PE firms gives us a deep understanding of the key trends impacting deal flow in the B2C industry. In the past six years, we have performed due diligence on more than 1,5 deals, nearly 3 of which were B2C transactions. Check out our top 1 lists of accounting due diligence observations for the B2C industry on page 6. Donald A. Lipari National Executive Director, Private Equity Services don.lipari@mcgladrey.com Michael Grossman Principal, Transaction Advisory Services michael.j.grossman@mcgladrey.com Jeff Edelman Director, and Advisory Services jeff.edelman@mcgladrey.com Carol Lapidus Products Practice Leader carol.lapidus@mcgladrey.com Cristin Singer Food and Beverage Practice Leader cristin.singer@mcgladrey.com William Spizman Partner, Transaction Advisory Services william.spizman@mcgladrey.com [1]

3 B2C private equity deal flow B2C private equity deal flow by quarter $6 $5 $4 $3 $2 $1 $ $5 $14 $42 $11 $6 $6 $8 $11 $16 $27 $1 $31 $22 $14 $19 $15 $17 $13 $14 $38 $19 $36 $26 $22 $26 25 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q Capital invested ($B) # of deals closed B2C deal flow waned in 213, recording 8 percent fewer transactions than 212. Capital invested in the industry surged last year, largely due to two megabuyouts ($23.2 billion for Heinz, $6 billion for Neiman Marcus) that closed in Q4. Unsurprisingly, the median deal size for B2C buyouts spiked to $125 million last year, a 67 percent increase over 212. High valuations are prompting investors to make fewer deals in the industry, but the deals they do complete are bigger in size. Companies with more established brands and differentiated product lines can justify some of the higher prices investors are paying. Based on current multiples, though, Spizman thinks valuations might be impacting the B2C industry in a broader sense. It would seem, based on the multiples that are out there today, it may be cheaper to build a company to capacity using a greenfield approach, versus acquisitions that bring in bigger customer bases and more facilities, but for a high price. The public markets have sourced some of the largest PE transactions in the B2C industry recently, including three take-private buyouts that closed in Q1 (Chuck E. Cheese for $1.3 billion, Mac-Gray for $584 million and Arden Group for $394 million). B2C private equity deal flow by year $25 $2 $15 $1 $5 $ $14 $16 $198 $117 $31 $84 $7 $83 $14 $26 Another large take-private, Cerberus $17.4 billion deal for Safeway, is expected to close later this year. Two other publicly traded B2C companies brought in PE money in the first quarter through private investment in public equity (PIPE) financings. Footwearmaker Crocs sold $2 million of preferred stock to Blackstone in January, and Golden Gate Capital disclosed a 9.5 percent stake in Ann Taylor s parent company in March Capital invested ($B) # of deals According to Carol Lapidus, consumer products practice leader at McGladrey, the apparel segment is active at the moment, as are the accessories and hair & facial beauty sectors. As an industry, the apparel and accessories sector has taken in a consistent number of PE deals since the recession, and hasn t experienced the yearto-year volatility that other B2C segments have. [2]

4 Deal flow details PE transactions (count) by deal type PE transactions (count) by sector 1% 1% Other Transportation 8% 8% Services (nonfinancial) 6% 6% Restaurants, hotels and leisure Media 2% 2% nondurables % % durables Apparel and Buyout Add-on PE Growth/Expansion Other accessories *as of 3/31/214 *as of 3/31/ High purchase price multiples may be behind a decline in buyout activity and an increase in minority investments. Compared to other PE deal types, LBOs don t command as much attention these days; only 37 percent of overall deal activity in Q1 went toward buyouts, down from 41 percent in 213 and 45 percent in 212. Minority deal flow, on the other hand, increased by 8 percent in 213, and got off to a strong start in Q1. Non-control investments can reduce the risk of getting in at high multiples. Most B2C sectors recorded less deal flow in 213, with the exceptions of transportation and consumer nondurables. Some of the declines were small, but the retail and media segments were hit hard last year, declining 33 percent and 16 percent by count, respectively. Belying their name, consumer nondurables were resilient in 213, and are on pace for another strong year in 214. Investors made 16 reservations in the restaurants, hotels and leisure industry in the first quarter, getting 214 off to a strong start. Capital invested details Median deal size ($M) $25 $2 $15 $1 $5 $ Buyout Growth *as of 3/31/214 PE transactions ($ amount) by sector 1% 8% 6% 2% % Other Transportation Services (nonfinancial) Restaurants, hotels and leisure Media nondurables durables Apparel and accessories *as of 3/31/214 The first quarter registered $26 billion of aggregate PE capital invested in B2C companies. That was a bump up from the $22 billion invested in Q4, and also halted a three-quarter slide that began in 2Q 213. Comparing quarterly numbers, Q1 looks lukewarm compared to the past five quarters, but several large, $3 billion or more transactions in Q4 212 and Q2 213 skew the distributions. Looking further back, Q1 214 outpaced nine of the past 13 quarters. durables, which saw a 1 percent decline in capital invested last year, should rebound in 214, if the $5.1 billion invested in Q1 is any indicator. Restaurants, hotels and leisure facilities attracted a large chunk of capital in the first quarter; in addition to the $1.3 billion buy of Chuck E. Cheese, a pair of health club chains (Snap Fitness, Mountainside Fitness) accounted for a combined $22 million of PE dollars invested in Q1. [3]

5 Add-on deals in the B2C industry Add-on deals as a percentage of buyouts Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q % 45% 35% 3% 25% 2% 15% 1% 5% % Add-on Non add-on Add-on % of buyout Historically, PE firms haven t focused as much on add-ons in the B2C sectors as they have in other industries. Organic growth is often a more viable option than acquisitive growth, since consumer-driven companies rely so heavily on differentiated brands and product lines. Even so, add-ons have been more popular for B2C investors recently; the 36 add-ons completed in Q1 accounted for 44 percent of all buyout activity in the quarter, one of the highest percentages for a quarter since 28. Much of that is due to high valuations for platform companies. Add-ons, Spizman says, give investors an opportunity to leverage down the multiples they paid for their platforms. Add-ons can be helpful in some cases, given the difficulty some investors have spurring growth in their portfolio companies. They don t always come with lower valuations, however, particularly in the B2C industry, where many of those differentiated brands and product lines attract a high level of competition. Select B2C Q1 214 transactions Company name Investor Sector Amount ($M) Chuck E. Cheese Apollo Global Management Restaurants, hotels and leisure $1,3 Mac-Gray CSC Service Works (platform) Pamplona Capital Mgmt, Macquarie (sponsors) Services (nonfinancial) $584 Arden Group TPG $394 Bob s Discount Furniture Bain Capital $35 E.L.F. Cosmetics TPG products $3 Crocs The Blackstone Group Apparel and accessories $2 [4]

6 Exit activity in the B2C industry B2C private equity exits (count) by exit type Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q Corporate acquisition IPO Secondary buyout High valuations across the B2C sector have created a lucrative exit environment for PE investors recently. Momentum slowed a bit in the first quarter of 214, recording 34 total exits versus 53 in Q Spizman suspects that may be a matter of timing, and that the exit pipeline is likely to build through the rest of the year. After taking eight B2C companies public in the fourth quarter, PE firms pared back their initial public offering (IPO) activity in Q1, completing only two offerings to start the year. Given the increasingly jittery stock market, 214 may not see as many PE-backed companies go public as the prior year, which recorded 21 in total, the most since 26. Strategic buyers didn t make as many purchases in the first quarter; in all, 15 PE-backed companies were picked up by B2C private equity exits (count) by exit type strategics in Q1, a 38 percent fall from the previous quarter. Even so, Spizman believes strategic sales will have a strong year in 214, considering the large amount of cash on hand in corporate balance sheets. Moreover, strategic sales may bring in higher realizations to PE sellers. It s probably easier for a strategic to pay more for a company than a financial buyer, because there s less of a magnifying glass on what they re doing, Spizman notes. Given the mountain of dry powder stockpiled in PE coffers, secondary buyouts should account for a large number of exits going forward. Moreover, SBOs are attractive to buy-side firms having difficulty sourcing deals in the current market. In all, Q1 registered 17 sponsor-to-sponsor deals, which wasn t far off Q4 s total (21), and is relatively high compared to prior quarters. B2C private equity exits (count) by sector Corporate acquisition IPO Secondary buyout 1% 8% 6% 2% % *as of 3/31/214 *as of 3/31/ Other Transportation Services (nonfinancial) Restaurants, hotels and leisure Media nondurables durables Apparel and accessories [5]

7 Top 1 accounting due diligence observations products industry 1. Revenue recognition: Sell-in vs. sell-through (susceptibility of channel stuffing). Understanding of shipping terms, risk of loss and title. Consignment sales, buy-and-hold agreements. 2. Focus on gross margin: Understanding of revenue mix (by channel, by customer, by product, by geography). Timing of new product launches. Trends in average selling prices (ASPs) and pricing changes. 3. Selling and marketing initiatives: Understanding of marketing allowances and incentives negotiated with customers. Review of marketing accruals and credits. 4. Customer concentration and quality of accounts receivable: Accounts receivable factoring. Management of bad debt reserve. 5. Cost of goods sold and inventory accounting: Review of inventory by type. Quantification and review of inventory turns. Review of inventory costing methods. 6. Suppliers: Vendor concentration. Review of the existence and accounting of purchase commitments, rebates, kickbacks, discounts, etc. Review of supply chain management and logistics. Volatility in commodity and raw material prices. 7. Operating expenses: Review of research and development (R&D) expenses by project, by product, etc. Understanding of regulatory approvals required for product launches and associated costs. 8. locations: Implications of lease accounting, accounting for deferred rent, leasehold improvements and tenant allowances. Identification of related party leases or other transactions, and understanding of fair market value of rent. 9. Capital spending requirements and cash flow management. 1. Working capital studies to understand seasonal patterns and normalized levels to support the business. Food and beverage industry 1. High customer concentration (very few customers make up large proportions of a company s net revenue): Evaluation of the strength of customer relationships. 2. Rebate accounting: Usually recorded as a liability or recorded on the cash basis. 3. Product recalls (nonrecurring expense): Understanding who is responsible for the issue (the supplier or processor) to determine extent of any EBITDA adjustment. 4. Seasonality: Consideration of seasonal trends when setting working capital targets, making projections and developing future budgets. 5. Vendor commitments: Review of pre-existing contracts to understand vendor commitments. 6. Spoilage: Adjustments are often made to normalize spoilage. 7. Commodity pricing: Review of commodity pricing contracts to understand impact on EBITDA. 8. Price increases: Customer pushback can be extremely difficult with customer concentration. 9. Competitive bidding: Bidding can be an issue, particularly when it involves large companies using auctions to determine who will be the supplier. 1. Sales commissions: Sales commissions increasing without corresponding true growth. The following list shows a detailed breakdown of the PitchBook industry codes for the B2C industry. 2. Products and Services (B2C) 2.1 Apparel and accessories 2.2 durables 2.3 nondurables 2.4 Media 2.5 Restaurants, hotels and leisure Services (nonfinancial) 2.8 Transportation 2.9 Other consumer products and services [6]

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