Thread by @ryan_caldbeck

1/ For most of recorded history consumer PE have printed money. OK that’s not true- but according to Cambridge Associates they have *averaged* a 22% IRR over the last 15+ yrs. Life is changing rapidly for those PE firms.

Life is about to get tougher. Here is why.

2/ First lets talk about what drove the strong performance of consumer PE. Historically it actually wasn’t the Personalization of the Consumer (which is driving the innovation and disruption in the space today).

3/ Candidly the great PE performance from 2000-2016 had nothing to do with these things talked about in this TweetStorm:

https://twitter.com/ryan_caldbeck/status/974045873377239040

4/ PE firms have loved consumer because when a CPG company *used* to hit $10m in rev, a few things happened:
-The company would spit out cash flow like Silicon Valley hasn’t seen since……well ever.
-The things were stable as heck. Failure rate during that period was super low.

5/ As a result you used to be able to buy a >$10m rev consumer co. with at least half leverage. Pause on that.

In private investing you can make money in 3 ways:

A) Multiple expansion
B) Debt pay down
C) Growing the company

6/ So.... if you buy a co. with half leverage, grow it at 10% a year for 5 yrs and sell it for the same multiple, you’ll make 3x your money. Turns out that’s a lot easier than unicorn hunting, and on avg returns are meaningfully better than tech vc across entire portfolio.

7/ But that cash flow and stability has been replaced by a massive thirst for growth. Companies -and investors – are responding to extraordinary demand from public CPG companies that want growth.

8/ The CPG strategics are outsourcing their innovation. Investing nothing into R&D and then buying companies that are growing quickly. Their stale legacy products are losing share- they need growth.

M&A market las yr was >$300b according to PWC.

9/ As the acquirers focus on buying growth, so do the emerging challenger brands. The emerging brands are focused on growth at the expense of profitability.

10/ They used to be cash flow machines but now they are roughly breakeven. That eliminates ability to use leverage for the PE firm. Cash flow breakeven companies also tend to have greater go to 0 risk. (bump hits - not much room for error)

11/ The founder of a top consumer PE firm told me recently:

“10 years ago all of our companies had meaningful cash flow. Today we don’t have a dollar of cash flow across our entire portfolio.”

12/ Let’s be clear- that point isn’t a cyclical one. The portfolio is actually doing very well according to their plan. It’s just a different investing strategy. Mid-market consumer PE used to drive much of their returns through financial engineering. Now….all hail growth.

13/ So what does that mean? Well before we jump their let’s go back to the Personalization of the Consumer. As consumers demand their own unique products, their tastes are fragmenting.

14/ Carry this out to the next logical step. As tastes continue to fragment, the “winners” in any category will naturally be smaller and smaller.

15/ While perhaps you used to be able to believe a “winner” in [yogurt] could get to $1b in sales, today that company will flatline perhaps at $500m.

Tomorrow it may be more like $300m.

16/ As winners get smaller, it puts pressure on the mid-market consumer PE funds – now growth investors. If you cant make returns through financial engineering, and your exits will be smaller…..how do you get a +return by investing into co. that already has $100m in revenue?

17/ Oh....and proportion of smaller exits is increasing.....

18/ Layer in that 10 years ago 95% of their investments would return >1x and today that number is dropping rapidly -because of the lack of stability.

19/ So in mid-market consumer PE the winners are smaller and there are more losers. That's bad right?

20/ Well at least the large strategics are dipping down and acquiring brands earlier, while also starting corporate "venture" funds that are really growth equity funds focused on >$10m in rev.

Wait that's bad for the consumer PE as well.....

21/ So how does this play out?
Expect:
A) Some mid-market consumer PE firms to drift off into the sunset.
B) Some to start earlier stage funds to try and get into the right deals earlier
C) Formal/informal partnerships w/ earlier stage funds- a bit like tech vc & growth equity

22/ Let's be clear- consumer is still an amazing place to invest. The shifting dynamics just mean you need to get in earlier (<$10m rev) and be disciplined on price/capital structure. But when you run a $750m+ AuM fund.....there isn't much room for error given current landscape.