The past several years have seen strategics, venture capitalists, and private equity firms spending billions snapping up beauty brands. There was lots of talk about a “beauty bubble” heading into 2019, but activity remained strong and investment bankers said their pipelines were full heading into the new year. We reached out to the experts to get their perspective on last year, and predictions as we head into 2020.
1. What trends/themes will dominate the conversation with respect to beauty and wellness M&A activity in 2020?
Ilya Seglin, Managing Director, Threadstone: I would expect the “clean” theme to remain big and investment activity around this category to continue—in beauty and broader wellness. However, I think the focus is shifting to brands that can actually scale within this category. We are going to move to the world of the haves and the have-nots (the haves being brands that have influencers with marketing megaphones and/or distribution partners that can help grow sales; the have-nots being brands with good, efficacious products but no apparent strategy to break out in the crowded space).
Another category where I would expect to see activity is celebrity brands. I think we will see a lot of launches of beauty brands in this category in 2020. Some will work, some will be a bust. But there is a lot of money being put to work in this space.
The third one is activity around the rest of the beauty supply chain, primarily in contract manufacturing/packaging. The number of players who would like to invest in the beauty space is only increasing and many are looking at areas in the sector where valuations aren’t as crazy as they are for brands. Contract manufacturing is also an area within beauty that lends itself to consolidation/platform building. There will be more activity here.
Vennette Ho, Managing Director, Financo: Beauty and wellness are not trends; they’re the new normal. We believe just being “clean” is no longer a good-enough proposition for consumers and for acquirers—in a few years, clean will be the expectation, not the exception. Therefore, we believe the real focus on wellness is evolving to a broader conversation that goes beyond simply formulations. We believe we will be seeing more brands focused on ease, simplicity, and sustainability. This “less is more” philosophy is beginning to run through all aspects of beauty and personal care—fewer and better products, less waste, sustainable packaging.
Rich Gersten, Partner, Tengram Capital Partners: Convergence of beauty and wellness, will the regulatory environment for CBD change, will clean ever be defined, will makeup trends change, how will valuations change, if at all, based on industry growth and number of buyers, will DTC-only businesses have to raise capital in down rounds.
2. It’s no secret that valuations in beauty and wellness deals in 2019 have hit the stratosphere. Word on the street is that the best assets are trading at valuations approaching 10x revenue. Where do you see valuation multiples shaking out in 2020?
Ilya Seglin, Managing Director, Threadstone: I think part of the reason multiples in 2019 got as absurd as they did was the number of assets that were in the market that had a very attractive combination of scale, profitability, and growth momentum as well as a credible and believable path for future growth. I don’t see as many assets like that coming to the market in 2020. So I think multiples will reflect the quality of assets we will see trade.
Rich Gersten, Partner, Tengram Capital Partners: Will depend on supply and demand. It will depend on the “demand” for investments (e.g., number of PE buyers and strategics) compared to the quality of supply (number of quality companies seeking capital). There remains a lot of demand at all levels right now. Macroeconomy factors will influence as will underlying growth of the beauty industry (by category segment). There are enough businesses currently owed by PE buyers that the supply side will be active for some time
3. Given how rich valuations have been in recent transactions, how do you see the role of financial investors evolving in 2020?
Ilya Seglin, Managing Director, Threadstone: Despite the rich valuations we have seen, it seems like only more people want to participate in the sector, not fewer. I think the evolution will come more in terms of where the activity is going to be—probably more in the growth investment area (smaller funds) rather than large investments.
Vennette Ho, Managing Director, Financo: Beauty has always been a hotbed for M&A activity; it’s an industry built on entrepreneurial spirit and strategics’ need to acquire. Beyond “traditional” private equity, we are beginning to see new types of investors entering the beauty market at a much earlier stage, including venture capital and early-stage family offices. Versus PE firms, these early-stage investors tend to be less afraid of risk and less valuation sensitive. By definition, not every highly valued early-stage company will be able to maintain momentum or multiples in the long run; however, we believe the best brands and businesses will always be able to rise above and outperform expectations.
Rich Gersten, Partner, Tengram Capital Partners: Cannot predict. VC firms are aggressively playing and driving higher values. It will be interesting to see if those valuations hold as follow-on capital is needed. There are still a lot of financial investors looking to deploy capital in the sector which could prop up values in the short term.
4. Which categories and trends will be most attractive to strategic acquirers in 2020?
Ilya Seglin, Managing Director, Threadstone: Strategics look to buy innovation (true product innovation as many have been failing on that internally) and consumer engagement, particularly with younger demographics. Brands that are differentiated in these categories will have strong strategic interest in them.
Vennette Ho, Managing Director, Financo: We believe that skincare will continue to be a robust area for activity; in particular, given consumers’ increasing demand for transparency and ingredients, we are seeing an increased focus on brands that can demonstrate efficacy and real clinical results. We believe haircare will continue to be active, as hair health and wellness are closely related. Finally, we believe this is a good time for investors to be taking a fresh look at color—despite broader trends, there are a few brands out there that are bringing a new perspective to the industry—and it’s only a matter of time before the category recovers.
Rich Gersten, Partner, Tengram Capital Partners: Skin and haircare remain strong. It will be interesting to follow the “influencer” brands to see if they catch on with investors and strategics. Wellness and clean will continue to be attractive but may need to be more clearly defined.
Prelude Growth Partners believes that clean brands (across skin, color, and hair), brands with a clear sustainability message, and/or brands with a multicultural appeal will be attractive. Aside from this subcategory, Prelude believes that brands with distinctive, high-quality products that are beloved by consumers will continue to attract strategic interest.
5. Given the sheer number of transactions in 2019, do you see deal activity slowing down in 2020 as strategics seek to digest and integrate deals from 2019?
Ilya Seglin, Managing Director, Threadstone: Not necessarily. There is still so much PE money chasing beauty. Not to mention some of the PE-owned assets that need to be monetized. As far as strategics, I think they will always find bandwidth for brands that make strategic sense for their portfolios.
Rich Gersten, Partner, Tengram Capital Partners: There will always be buyers for high-quality well-positioned brands.
Prelude Growth Partners anticipates that deal activity will remain strong in 2020, as strategics continue to optimize the shape of their brand portfolios to meet the demand of the modern consumer today and for decades to come.
6. Despite rich product gross margins, the increasing cost of marketing, brand building, scale-up, and customer retention has left some of the most-buzzed-about assets in the red. Will profitability be a major factor in deal activity in 2020?
Ilya Seglin, Managing Director, Threadstone: Absolutely. I think the days of spending money on growth without any regard for profitability are behind us. Most beauty brands will need to become beauty businesses as well to attract capital / get sold.
Rich Gersten, Partner, Tengram Capital Partners: People tend to overlook profitability because pundits talk about revenue multiples. Reality is revenue multiples are highly correlated to profitability. It will be interesting to see what eventually happens to Charlotte Tilbury and Glossier as I understand those businesses are not profitable but are commanding high valuations.
Prelude Growth Partners believes that sustainable profit models are imperative. In the early years, brands may invest in building talent and driving marketing “ahead of the curve”—as long as the underlying business model for the brand is profitable.
7. How attractive are assets that are inextricably tied to a prominent founder, influencer, or individual? Does a “key wo(man)” help or hurt a brand’s M&A prospects and valuation?
Ilya Seglin, Managing Director, Threadstone: Always a balance. We live in a world where consumers are engaging with brands that have founders/influencers/real people driving the brand story. That’s where the growth has been. On the other hand, investors or acquirers like to invest in teams to minimize the “key woman/man” risk. Companies that optimize this equation are the ones who are able to drive better conversations with investors and strategics.
Vennette Ho, Managing Director, Financo: Founders are the heartbeat of the beauty industry; their vision and passion are what continually pushes our industry forward. A terrific brand founder is absolutely an asset; however, the best brands recognize that they are creating something that has much more meaning beyond any single individual. M&A prospects and valuations are not impacted as long as the company’s culture, operations, and authenticity extend beyond the individual through to the brand’s entire ecosystem.
Rich Gersten, Partner, Tengram Capital Partners: I believe “authentic founder stories” matter. That may suggest influencer brands are riskier. I do not think it is black or white when it comes to helping or hurting a brand’s prospects.
Prelude Growth Partners believe that founders are critical to building the next generation of powerhouse brands. Today’s consumer wants to understand who developed a brand, and why. How does that brand’s values fit with the consumer’s values? We believe authentic founder stories are accretive to brands. Depending on the brand, this could simply show up on the “about us” tab of a brand website, all the way to being a brand with the founder’s name on the package.
8. In 2020, is there still a discount on brands with high Amazon sales concentration? How about Sephora, Ulta, or QVC?
Ilya Seglin, Managing Director, Threadstone: Amazon’s theme seems to remain the same: too little is bad, too much is bad. Everyone has realized that Amazon sales don’t help build brands, but do help with cash flow. So needs to be a balance. As far as other channels—don’t believe there are discounts/premiums for those per se. It’s all about what channel makes strategic sense for the brand and the growth potential and profitability of those individual channels.
Rich Gersten, Partner, Tengram Capital Partners: It will be interesting to see how investors view Amazon as a channel. Today, I would discount for that concentration. I would also discount a large QVC concentration. As for Sephora, Drunk Elephant, and Tatcha, would suggest a Sephora concentration can drive a premium, not a discount.
9. What trends surfaced in 2019 that will inform the investment environment in 2020?
Ilya Seglin, Managing Director, Threadstone: Significant uptick in activity around contract manufacturers/platform building.
Rich Gersten, Partner, Tengram Capital Partners: Growth vs profit and impact on valuations. Is CBD an area safe to play in? Will investors keep investing in smaller and smaller businesses? Some small deals clearly have happened (e.g., Stripes in Kosas) … is DTC attractive or not?
10. What were some of the most important or interesting deals from your perspective in 2019?
Ilya Seglin, Managing Director, Threadstone: Kylie Cosmetics—WTF! Drunk Elephant—why didn’t she get a billion?
Vennette Ho, Managing Director, Financo: Financo was incredibly fortunate to have led many of the landmark beauty deals in 2019. Drunk Elephant transformed the industry, opening up the conversation around clean-compatible ingredients to the everyday consumer; the sale to Shiseido gives it an opportunity to really spread that message and mission globally. Unilever’s acquisition of Tatcha was a beautiful transaction on so many levels; it was not only the acquisition of one of the fastest-growing brands in skincare, but the companies’ aligned commitment toward social change enables it to make a much greater impact even beyond beauty. The sale of Devacurl to Henkel and Drybar Products to Helen of Troy were a recognition by the industry that haircare is a quickly modernizing, consumer-centric category. Devacurl ignited a passionate community that recognizes that hair can be a reflection of self and empowerment. Drybar is an iconic brand in haircare, synonymous with happiness and confidence. Olaplex, which we sold to Advent, is a revolutionary brand and technology with incredible advocacy around the world. Despite being one of the largest and fastest-growing brands in the space, the brand has only begun to scratch the surface of its potential with a mere seven SKUs. Finally, Maesa (which we sold to Bain Capital) has cracked the code as a real brand incubator. The company is able to achieve what many larger strategics have struggled to do—create real, authentic brands within a broader platform structure. 2019 was an incredible year for beauty M&A, and we are excited for what is to come in 2020!
Rich Gersten, Partner, Tengram Capital Partners: This Works and Canopy Growth! Of course, Drunk and Tatcha and the entry of Colgate in a big way to professional and prestige beauty (Filorga).
The BeautyMatter Beauty Deals: M&A Transactions 2019 captures transactions and insight across the beauty and wellness landscape and value chain.
Photo: Marcus Spiske via Unsplash