Frutarom, Naturex & others consolidate in raw materials, build scale to please demanding downstream customers
During the recession, many boutique food and dietary supplement ingredient suppliers found themselves without the capital to keep afloat. Loans were less than bountiful and investors were less than cordial. But, as global economic growth rebounds, a few like-minded ingredient companies have started to snatch up small specialists looking for a buyout, prepping themselves to satisfy the requirements of their increasingly fickle —and increasingly demanding—customers.
Frutarom, the Haifa, Israel-based flavors and functional ingredients supplier, has been on a buying spree since 2006, with takeovers surging in 2011 and continuing into 2012. From January 2011 until press time, the Israeli company has made eight acquisitions for a total of $151 million.
Frutarom makes no secret of the fact that it is using acquisitions to spur rapid growth, or that it plans to use that growth to sandbag its position as one of the world’s top 10 flavor producers. But Frutarom isn’t the only ingredients company fattening its roster. Naturex, a flavors, colors and botanicals supplier headquartered in France, purchased two companies in 2011, and plans five more acquisitions in 2012. Singapore-based ag giant Wilmar invested in Blue Pacific Flavors in February. BASF, DSM, Du-Pont and Kerry have all made sizeable purchases in the past 12 to 18 months as well. “It is clear that this trend is a result of increased consolidation in the industry,” says Lars Frederiksen, CEO at Chr. Hansen, whose savory unit in Italy was one of Frutarom’s targets last year.
Frutarom doesn’t always go for the biggest, baddest player that money can buy. Some of its recent acquisitions have been quite small, like East Anglian Food Ingredients, a British flavor concern purchased for the tidy sum of $4.8 million. Others, like U.S.-based Flavor Systems International, cost the company a more substantial $35.3 million. But they all show great potential for development.
“In many cases, the smaller and midsize companies are easier to integrate in a quicker way, and it’s easier to extract higher value from them,” says Frutarom CEO Ori Yehudai. “We like acquiring a combination of small and mid-size companies, but we will also participate in an opportunity that is much bigger. We are not limiting ourselves to large acquisitions because there are very few of them. We could wait too long without implementing our growth strategy successfully.”
Go Big or Go Home
Given today’s economic inertia, it might actually seem prudent to lay low for a while without leveraging hard-won capital. But customers won’t wait. Naturex president and CEO Jacques Dikansky says the industry today requires explosive growth. “Our customers are the large food companies in the world, the large pharmaceutical companies, the large nutraceutical companies. They expect more and more from us. They want us to be more sophisticated in terms of quality control, quality assurance, technology, research and development. You cannot finance all these investments—and the cost of all the staff you need—if you are not big enough.” According to public filings, Naturex’s 2010 revenues were nearly $300 million.
Dikansky says that even double-digit organic growth, like the 12% he cites for Naturex over the past 10 years, isn’t sufficient to meet customers’ growing demands. “It isn’t fast enough to answer the change of the business and the change of the market. What our customers expect from us—in terms of science, equipment, quality control, innovation—has nothing to do with what they were expecting from us 10 years ago. Nothing to do with it.”
It’s a message that Frutarom’s Yehudai seems to have taken to heart. “Our revenue was $80 million in 2000, and $450 million in 2009. I assume it will be more than $500 million in 2011, and more than $600 million in 2012.” He’s just winding up, though. Yehudai targets crossing the $1 billion threshold in the next three or four years, via a combination of acquisitions and organic growth.
Kantha Shelke, an analyst and principal at Corvus Blue LLC, a Chicago-based food science and research company, thinks Frutarom, Naturex and others of their ilk have the right idea. “The reason these companies are investing at this time is so they have a parallel path. They’re already leaders in their space, and are disciplined and long-ranged visionaries. They’re thinking, ‘This will keep us for this year and next year, but what do we have for 2014 and 2015?’ ”
Global Is the New Local
While acquisitions in Western Europe and North America permit a company to expand its product offerings and technology, establishing operations in other regions grants access to broader markets. “Probably two-thirds of the world’s gross domestic product in the next 10 years will be coming out of Asia,” notes Donald Wilkes, CEO of Blue Pacific. “Traditionally, CPG companies have focused on mature, English-speaking markets. Asia today has much more opportunity. They have the economic cycle in their favor right now. I call China the coal for the furnace.” It’s not just Asia, though. The demand for ingredients for processed foods is also expected to skyrocket in South America, Central and Eastern Europe and even Africa.
“Because of the multitudes that are migrating into cities, the people in emerging nations cannot consume the kinds of diets they used to and have turned to processed foods” which replicate local cuisine more closely than ever before, Shelke says. “As a result, the base for processed foods, and therefore the need for ingredients, has grown phenomenally.” Indeed, Dikansky says that while Naturex’s overall organic growth last year was around 12%, it was 20% in emerging nations.
It’s not enough, though, to have a worldwide sales force to meet the needs of these growing markets, says Dikansky. “Customers want us to be able to produce for them and deliver the products,” in every emerging market. “You cannot be in all these countries if you are not big enough. You need to establish yourself in these countries, build factories in these countries. They expect a global presence. Global is really the word.
“That’s why we acquired Pektowin,” a Polish producer of pectin and fruit and vegetable concentrates, says Dikansky. “It allowed us to have a foot in Central Europe, and that’s why we will make at least one acquisition in 2012 in Asia.” It also explains why Frutarom is building its first-ever plant in China, labs in Costa Rica, and acquiring businesses in Slovenia and Brazil.
“At the end of the day,” Yehudai says, “the business is much more local, with local tastes, operations, requirements. Being connected to strategic markets is the right way to grow, and more so in the flavor segment, which is tailored to customers’ needs.”
Not everyone can achieve the kind of global penetration that Frutarom is pursuing, however. “These regions are fertile for first-mover advantage,” says Shelke, “but only companies with deep pockets and long-term focus can have the discipline and wherewithal to weather the long lead time for profitability and market leadership.” Gaining a foothold in these regions will be costly, even for Frutarom, which currently generates almost three-fourths of its sales from Europe, she says. The price of entry will be even higher if the company should go after the “sleeping giants” of the industry who have alliances with the likes of Yum! Brands and Coca-Cola, rather than remaining in the “nooks and crannies” of the sector.
Nevertheless, the economics of the Western world today make acquisitions more, not less, likely. Many of the companies that were poised to capitalize on the global appetite for processed foods were shuttered in the past few years. “After 2008, many banks just stopped loaning money,” says Wilkes. “Small businesses and Main Street never had access to the resources to stay in business. I think that would have made a huge difference—a lot of guys wouldn’t be selling out today if they’d had access to capital.”
Those left standing now see consolidation of the industry as a strategic imperative. It helps them control costs and gain efficiencies as the regulatory ropes tighten, consumers’ environmental expectations heighten and the costs of raw materials, transportation and energy mount.
“We have more ability to unify and harmonize raw materials that we buy in several locations,” says Yehudai. “We now have more resources in key strategic markets for raw materials, such as China and India. Purchasing power and ability to buy more raw materials helps us overcome a key challenge.”
The acquisitions haven’t compromised Frutarom’s standing, either. Yehudai says that in mid-2011, the company’s net debt was only $30 million. “We are producing cash from our operations. We see no problem leveraging the company in a modest way. The debts we are taking on in order to do these acquisitions, and add on the synergies that exist, create more value. The combination is very positive.”
Savory Is the New Sweet
The consolidation trend is unlikely to subside anytime soon. “This still remains a rather fragmented sector,” says Chr. Hansen’s Frederiksen. “Some of the activities are certainly driven by a wish to focus and to strengthen key positions.”
Take, for example, Frutarom’s recent spending spree: Four of the eight acquired companies are manufacturers of savory flavors. In a news release early last year, Yehudai states: “Frutarom has identified the savory sector as an important growth engine.” And when it acquired Chr. Hansen’s savory unit in Italy four months later, Yehudai crowed that the purchase further cements Frutarom “as a leading global producer of savory solutions.”
By just as strong a degree, Chr. Hansen was not a leading producer of savory ingredients, or really of flavors at all—a recognition that has impelled the Danish company to divest not just that savory unit, but all its flavor segments in recent years. “We only want to be in areas where we are market leaders, and we did not have suffi cient strength in the flavor activities. Some five to 10 years ago, the overriding theme in the ingredients business was ‘one-stop supplier.’ Today it is more a matter of being a focused specialist,” Frederiksen says.
For that reason, Shelke says Frutarom is smart to enhance its now-strong savory holdings. But she also notes that Frutarom has correctly assessed the market’s prevailing direction and is, essentially, swinging at the right pitches. “Sugar and sweetened products have been played out rather tiredly. When consumers are looking for new products, companies go to a savory application, and more are coming up in the name of ethnic varieties. They’re trying to find something as magical as sugar. The one thing that’s done really well is bacon. You can rub bacon on anything and men will line up.”
If companies like Frutarom find success every time they strengthen their expertise in such focused areas as savory solutions, natural colors, sweeteners and the like, the rewards double when they do so in a region poised for growth, Shelke says. “When Frutarom buys a little savory company in Brazil, it does so very systematically. It’s watching very closely.”
Savvy companies are also looking to acquire holdings that complement their current lineup—again, so they’ll be positioned well when, inevitably, consumers’ concerns or tastes change again. If companies currently supply ingredients for nutraceuticals that support, say, weight and diabetes management, they are likely to invest in oncology-related applications, because of the strong connection between cancer and weight, and weight and diabetes, Shelke adds. And they’ll be able to expand their offerings without diluting their core strengths.
Does Consolidation Drive Innovation?
Regardless of how many reasons ingredients companies have for picking off the smaller players, there’s always a concern that innovation will suffer, and that near-monopolies will drive prices even higher.
“Innovations—the kind that can disrupt businesses and trends—generally originate from smaller players,” Shelke observes. “Acquisition of smaller players offers the giants a risk-managed and cost-effective way to enter into tried and proven areas.”
Naturex’s Dikansky disagrees. “You might think that having a bigger universe will create innovation but that is not correct. You cannot innovate in this industry anymore if you are not big enough. You cannot spend the money you need to spend in order to innovate. Innovation is better when the industry is consolidated.
“In terms of price,” he continues, “you could think that because we eliminate a competitor we would increase price, but that is not what we are doing. You also have some scale improvement, and you can save money on the production side. At the end of the day, I think consolidation is quite good for prices in the market.”
Frederiksen shares Dikansky’s sunny outlook. “We believe that the emergence of bigger and stronger players will be very positive for customers,” he says. “If you are big, you can provide more creative solutions, and you have the financial strength to live up to the increased demands for quality and regulatory approval.”