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The acquisition value of a brand.

With the frenzied brand buying of the 1980s over, here are some issues that will be key to determining values in today's acquisition environment.

Ever since Philip Morris sent consumer product manufacturers for cover when it announced massive action to shore up its global Marlboro brand, Wall Street has been busy attempting to calculate the lasting impact on the multiples accorded the shares of consumer product companies. At the same time, many investment bankers have been focusing on the future of consumer product acquisitions.

Although Philip Morris' actions with regard to Marlboro, and Procter & Gamble's similar actions in diapers, seem cataclysmic, the trends that led to these actions have been evolving for some time. Sustainable brand premiums, the inroads of private labels, and the continuing strength of retailers are trends that are creating dislocations on Wall Street as well as in the consumer products world.

However, it must be kept in mind that the power of the retail trade and the strength of store brands have been evident in Europe for many decades. Nevertheless, in the "new" era, the evaluation and analysis of consumer product acquisitions requires much greater understanding of industry and brand dynamics than in the past -- generic investment banking analysis is insufficient.

The 1950s and 1960s represented the "golden age" of brand building. Units were growing strongly in most categories -- some 6% to 10% or more. Armed with Nielsen data and other proprietary data, the manufacturers had the powerful advantage of information and used this resource as leverage in dealing with the trade which, at that time, was not really as sophisticated and informed as it is today.

At the same time, during this period, the media was very concentrated. There were a limited number of national magazines, and the TV networks provided some 99% of the viewing audience. Companies such as Procter & Gamble thrived, with their famous brand system; Procter & Gamble believed that advertising built a long-term franchise and their marketing expenditures were 75% for advertising and 25% for promotion. Procter & Gamble invented the highly successful soap opera, which was avidly viewed by the nuclear age, non-working housewives with the typical 2.5 children -- the perfect target audience for buying Tide and Ivory soap. It was the era companies could -- and did -- build dominant brands such as Tide or Chevrolet.

During this period, companies like Procter & Gamble did not consider bringing out line extensions, fearing that such products would diffuse the consumer perception and the identity of their dominant brands. It was clearly the age when there was no "buy versus build" dilemma -- building a brand was the obvious choice -- and the best consumer products manufacturers concentrated on building brand equities that have stood the test of time.

A recent study indicated that of the top 50 consumer packaged goods brands in the U.S. today, over 37 were the leading brands in the late 1950s or early '60s. It is a remarkable testament to the golden era of brand building and speaks to the fact that dominant brands will continue to prosper.

What Has Changed

Today's environment in the U.S. is entirely different. Unit volume in many consumer packaged goods categories is flat. The pendulum has swung and the trade, having won the information battle thanks to scanners and computers, has the dominant power. In 1980, by way of example, the top 10 department stores in the U.S. controlled 27% of the business; in 1990, the top 10 controlled 51%. The media is splintered, with a proliferation of specialty magazines, and the networks are providing less than 60% of the TV viewing audience. At the same time, the advertising/promotion split is closer to 25/75% today, putting more emphasis on price rather than on brand equity and product differentiation.

Furthermore, there has been a quantum leap in the quality of private-label brands. Eighteen percent of all items sold in grocery stores today are private-label products. In the past, private-label and generic brands were clearly inferior, poorly packaged products. Not so today. The branded goods manufacturers helped bring about this situation by what has proved to be short-term thinking in shifting marketing dollars so dramatically away from advertising into promotion. At the same time, branded goods manufacturers continued to raise prices for their products, raising the price differential between branded products and private-label products.

Over time, consumers have learned that the cost of branded products may not be worth the premium that consumer packaged goods companies have been demanding over private-label products. And, the consumer packaged goods manufacturers have ignored the steady increase of private-label brands. Belatedly, Philip Morris took action to halt generic competition against its core Marlboro brand, but at a cost of $17 billion to its market capitalization. Procter & Gamble followed suit in its positioning of its U.S. diapers.

More Difficult to Build

It is much more difficult for consumer product manufacturers to build brands from scratch in today's environment. Over the past decade, corporations lost billions of dollars in unsuccessful attempts to introduce new brands into the marketplace. Industry statistics show that only one new product in 100 made it successfully through test markets into national distribution. Of these, only one in 10 achieved annual sales of $15 million or more. In addition, the cost of introducing a new brand skyrocketed. For example, in the early 1980s, it cost roughly $15 million to $20 million to introduce a new shampoo and the success rate was 60%. Currently, however, it costs more like $40 million to $50 million to introduce a new shampoo and the failure rate is closer to 90%.

During the latter part of the 1980s and first part of the '90s, the question was not whether to buy or build brands, but rather, how much to pay to buy such properties. Multiples continued to climb, because brand purchases were viewed as contributing high incremental profit to a company's bottom line due to its fixed overhead. Acquisition multiples were characterized as a multiple of sales, since that, in essence, was what manufacturers were buying.

In contrast to the rather dismal experience of many late '80s acquisitions and LBOs, most consumer product acquisitions have performed well for their corporate parents. Strategic acquirers were able to justify high prices because of the real synergies of folding consumer brands into a parent's fixed overhead of sales, distribution, and manufacturing. Procter & Gamble's acquisition of Richardson Vicks in 1985, for example, at one times sales seemed very high at the time. In hindsight, that acquisition was one of the most astute of the past decade. P&G now uses Richardson Vicks as the core of its toiletries business: many of P&G's brands are worldwide mega-brands.

However, the go-go days of the '80s, fueled by the auction extravaganza, led to many well-managed consumer packaged goods companies bidding against each other as well as against financial players in a "buying frenzy" we are not likely to see in the near future. Clorox's acquisition of the Pine-Sol business from American Cyanamid, for example, was very dilutive to Clorox. But, even the financially driven acquisitions have resulted in positive value for shareholders. Duracell, when it was divested from Kraft Corp., went in a frenzied auction to Kohlberg Kravis Roberts & Co. for $1.8 billion. Astute strategic acquirers valued the business at much less. As an independent entity, however, Duracell has been able to build its global brand franchise to the detriment of weaker competitors. And, because Wall Street recognized the scarcity value of consumer brands, Duracell's publicly traded common shares trade at a premium multiple to the market averages.

As are many industries, the consumer packaged goods industry is consolidating. The companies that will prosper in the climate of the 1990s are those with:

* Significant advertising and promotional resources to invest heavily in maintaining brand equity;

* Strong clout with the retail trade to maintain and gain distribution and shelf space; and

* Large capital resources to invest heavily in partnering with retailers, through MIS and point-of-sale systems.

Two Tiers

Those competitors without significant financial and marketing resources will continue to find themselves at a competitive disadvantage, resulting in lost sales and brands that will quickly lose shelf space to either the "category killer" or the more profitable store brands. Those brands that are "stuck in the middle" are vulnerable to competition. It is those brands that should be sold before their brand equity, and their value, diminishes. In our opinion, two tiers of consumer brands are developing in the marketplace: mega-brands, for which premium multiples are paid, and also-rans, which decrease in value over time, as the vulnerability of these retail brands becomes more apparent and the brand's sales base is eroded.

The conventional analysis of sales multiples needs to be refined to take into account:

(1) The product's brand equity and its share of market in its category;

(2) The category in which that product competes, particularly with regard to private label;

(3) The company's global presence; and

(4) The company's relationships with the trade.

These issues will be the key to determining what the value of a sales dollar is worth in today's acquisition environment. These issues will determine how profitable incremental sales dollars will be -- therefore, the acquisition value of a brand.

Hercules A. Segalas is Managing Director and head of the Consumer Product Investment Banking Group at PaineWebber Inc. He started his career with the Procter & Gamble Co., and worked for P&G for 10 years in both the U.S. and Europe. He came to Wall Street in 1968, forming William D. Witter Inc., an institutional research firm. In 1988 he joined PaineWebber to form the Consumer Product Investment Banking Group. Joan Y. McCabe is First Vice President in PaineWebber's Investment Banking Department, specializing in consumer products companies. Prior to joining PaineWebber in 1987, she had been with Drexel Burnham Lambert Inc. and Kidder Peabody & Co.
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Title Annotation:Building Brand Strength
Author:Segalas, Hercules; McCabe, Joan Y.
Publication:Directors & Boards
Date:Jun 22, 1993
Previous Article:Banking on a single brand name.
Next Article:An antitrust guide to brand acquisition.

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