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Selling Without Selling Out:
Private Equity Firms Step Up Investments In Consumer Product Companies

BY SONYA TARNOW BROWN

Since 2003, private equity firms have invested about $58 billion in buyouts of consumer product companies, providing capital to an increasing number of spin-offs or divestitures from big companies. According to Thomson Financial, there were 2,322 spin-offs and divestitures in the United States during 2003, with a total value of approximately $170 billion. Private equity firms participated in 23 percent of these transactions, up from 19 percent in 2002 and an average of 15 percent in earlier years.

The trend is clear: there are more private equity firms active in the consumer products sector and these firms have more cash to spend. Private equity firms are actively seeking sound investments in a sector that will benefit from a strengthening economy.

Consumer product companies are welcoming the entry of private equity into their sector for a number of reasons. These firms have a commitment to growing spun-off brands to their full potential. They are often interested in keeping existing management in charge. They can work with the divested company to take advantage of growth opportunities, offering capital, management expertise and strategic guidance to support the firm's management team. Finally, private equity investors can often complete transactions more quickly than corporate buyers.

Working with a private equity firm often eliminates many of the risks associated with selling consumer product brands to corporate buyers, including:

  • Exposing one's business to competitive scrutiny. Since the most logical corporate buyers of consumer product spin-offs are direct competitors, many managers worry about providing information to buyers who may use their due diligence against them. A private equity buyer is not a competitor, so this concern can be eliminated.
  • Clash of cultures: Combining two competitors through acquisition is a difficult process and one that often dramatically changes the work environment at the acquired company. In many cases, this can lead to lower productivity. A private equity buyer typically tries to keep the existing culture intact so that the company can continue to thrive.
  • Employee uncertainty: The divestiture process itself can be stressful for workers because many corporate acquisitions result in downsizing to take advantage of synergies between two companies. By contrast, private equity investors need all of the employees and therefore do not typically initiate lay-offs when they invest in a company.

Right now, many equity firms are seeking investments in consumer products companies because of stable growth, high margins and strong brand equity in this sector.

Physicians Formula, a high-growth manufacturing company that was recently divested from a French owner. Founded in 1937, Physicians Formula is the manufacturer of some of the United States' top-selling facial make-up products and the fastest-growing color-cosmetics brand in the drugstore and mass volume retail distribution channels.

Although the company had done well under the ownership of Pierre Fabre Dermo-Cosmetique SA, the parent company had a shift in strategy, and the management team of Physicians Formula sought a partner to help continue its growth path. Eventually, Pierre Fabre sold most of its ownership stake to a private equity firm. Physicians Formula has continued to grow since gaining its independence in 2003. The company has increased its market share in concealers from fourth to second place industry-wide.

Private equity firms can provide an important alternative to consumer product companies that seek independence from a corporate parent. Given the expanding economy, consumer product companies have an enormous opportunity to build shareholder value -- and private equity companies can play an important role in helping them.

-- Sonya Tarnow Brown is a Vice President of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. She is also on the Board of Physicians Formula. She can be reached at 617-824-1086 or via e-mail at sbrown@summitpartners.com.