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Winna Brown

You’re listening to the EY Next Wave Private Equity podcast. I’m Winna Brown and I’m your host.

Today I’m joined by my fellow partner Lindsey Kiely and Senior Director Bhakti Nagalla, who are leaders within the EY-Parthenon – Consumer Industry Sector, specializing in strategy and transactions for consumer and private equity companies. Now ladies, the consumer sector has seen so much change over the last few years as consumer buying habits and indeed people’s lifestyles have changed. The fabric of society has evolved with more two-career families, fewer children, more urban dwellers and a focus on pets and luxury goods. Private equity has certainly been watching these trends and adapting their investing strategy. Once again, though, the pandemic is responsible for accelerating trends that were already evolving in the background. I’m excited to have both of you on the podcast to explore the world of private equity consumer investing. Thanks so much for joining me today. 

Lindsey Kiely

Thanks, Winna. Thanks for having us on the cast. 

Bhakti Nagalla      

Brown

So perhaps we can start by describing the current consumer sector landscape. Bhakti, maybe you can outline which consumer product categories or operational models have really taken off over the last year and what role, or if any really, did the pandemic play in this growth?

Nagalla  

The segment of consumer wellness and pet health really took off. I know, I personally upgraded my pet’s food but also started giving my toddler vitamins. And so, we’ve also seen these personal anecdotes really play out meaningfully in the market. We’ve studied pet health more than a few times over the last year and it’s interesting to see that traditionally, vitamins and supplements in the pet category were focused on curative need state in areas such as hip and joint pain. But recently, some digital brands have really seen some success by creating the preventive care segments, with topics such as immunity, allergy, calming. And we’ve also seen these scenes play out in children’s vitamins as well. When we were looking for analogs, when we looked at the point of sale data in children supplements, we also saw a strong performance which is great to see.

And then actually, going back to my earlier point of how I upgraded my pet’s food, I think this is a trend that we’ve seen not just in the last year, but as well as historically. We’ve always seen pet humanization continue to drive price points. But I think especially in this past year, as people spent more time with their pets, it’s a greater part of the consumers’ mindshare. And they’ve also spent more time, just researching products, and this resulted in continued sort of bolstered growth in the premium segment of the pet category. We estimate it’s around 50% today and we expect that to continue to take share in the market. 

Kiely

What’s interesting with pets is that COVID-19 has really caused some significant changes in underlying category fundamentals. The most notable around this is just the number of households that own pets. Before COVID-19, we already had this pre-existing trend of millennials delaying children, having pets instead. As COVID-19 came on and people were spending more time at home, all demographics found the time and desire to have a pet. A lot of that pet purchasing also is being done online so we’ll touch on e-commerce later, and that’s a huge trend within COVID-19. Interestingly, because of this increase in pet ownership, there’s now a shortage of adoptable pets. We did some work with pet shelters and found out that one of their key issues for better for worse is that they’re running out of adoptable animals, which is a fantastic side benefit of the pandemic. And as we look forward, I think in this category, certainly we expect that there will be a rise once people’s lives get back to “normal” when folks are not spending as much time at home. A rise in things like remote video monitoring, doggie daycares and potentially even more of those calming supplements for all the separation anxiety that both humans and animals are experiencing.

Another category we’re seeing, I know you’re asking about categories that have seen operational models take off during the last year, is certainly anything related to the home. As I mentioned people are spending more time at home, so this is probably one of the more interesting and potentially predictable trends of the pandemic, so they want to jazz up their home. When I think about things like patio furniture or building structures outside your home, there’s a real question and concern about pull forward demand in those categories. Pull forward spend, which is to say if someone bought a patio furniture set during the pandemic, potentially that’s someone who was going to buy it two or three years from now but just accelerated that purchase due to the pandemic. And therefore, those particular categories are going to face decrease demand two to three years from now because that person is no longer going to buy in that time frame. That’s been a real question that investors have been asking and trying to understand.

What’s interesting is that it certainly varies by category. Many of the categories we’ve looked at have only seen that pulled forward demand affecting the next year or maybe two, so well within a hold period of an investment. But it continues to be a question that we’re asking as we think about those categories. 

Nagalla  

Yes, I would agree with that, Lindsey. But even in the context of pull forward spend, I think there’s still some good degree of category expansion opportunity left within home products. I think what we found last year is that the supply chain couldn’t quite keep up with consumer demand and some categories within home, and so the consumer might have been discouraged by the wait or back in stock time. Last year, we worked with a U.S. manufacturer of outdoor home products who saw their ship time move from one week to four months. Likewise, also saw a drop-off and conversion on their direct to consumer brand website. What we found is that these consumers might potentially come back this year. Finally land that patio set that they couldn’t quite get last year.

Another category that’s just done well over the last year is just in-home entertainment. People are spending more time in their homes and so they are spending more time on in-home activities. Now, we’ve all read the articles on streaming, but we’ve also seen good performance in harder-to-track categories such as toys, games, sporting equipment. And I think that these categories, more so than some of the other categories we’ve talked about like consumer and pet health, may be more at risk for those pull forward spend concept that Lindsey alluded to earlier. I think one example is when you look at a category such as sporting equipment: a parent that bought a new bike or helmet for their kids this year as a point of excitement, because they’ve been in homeschooling for the last 12 months, they probably wouldn’t have intended to actually buy that this year. They would have perhaps upgraded two years from now. But it’s a clear example that there’s a lot of bikes and helmets and baseball bats that are probably not going to be purchased maybe two years from now. There’s also this concept in this category of new entrance, so folks that wouldn’t have bought a baseball bat, also by a baseball bat this year.

Kiely

A couple other, when you think about in-home entertainment, in-home entertainment takes a few different phases. Hobbies like, baking and crafting and gardening also saw significant upswings and participation. You know, how many of the folks listening to this have or had a sourdough starter in their refrigerator at some point during this pandemic. And the key question for these and a lot of these other newly discovered activities or hobbies as Bhakti mentioned is how much of that persists post-COVID-19. In some cases, those hobbies have already been riding pre-COVID-19 trends. One great example is the grandmillennial trend, where categories from clothing, to home décor, to hobbies are being affected by millennials’ desire to sort of relive and recapture some of the era of their grandparents. Things like baking, mending and quilting are really becoming more popular. But really understanding whether consumers are willing to change to accommodate these acquired activities once life returns to normal is going to be key to understand the future for this in-home entertainment.

Nagalla  

Yes, agree. And speaking of accommodation of new habits, you also have in-home fitness, which some folks who consider entertainment and others a slog, depending on your fitness level. Lindsey here who runs five miles a day is on the entertainment end. 

Kiely

*Laughing*

Nagalla  

There’s a big question on whether these consumers who were attending gyms will eventually return to gyms after spending a couple thousand dollars on gym equipment. And our consumer surveys are saying yes. They will return, but it may take some more time. Well, there’s been some resistance, and it’s the same impulse that drives folks to still wear masks outdoors. There are just some concerns around safety. Gyms have created a sense of community, historically, always. And this community serves a dual purpose of one, motivating yourself to spend that extra time on the treadmill and then two, cultivating friendships. Consumers really do miss their gyms. And so, we do believe that this segment of the market will see a recovery albeit a little delayed.

Kiely

Another category or model rather that I think is perhaps stating the obvious that took off during COVID-19 was the rise of online retail channels and e-commerce, as brick and mortar was obviously not available. What I think is interesting about this is it has taught consumers to purchase new categories online and just taught non-online purchasers to be comfortable buying online. So, you know, we look at categories like home décor, furniture, groceries, where many people would have felt uncomfortable buying those online before the pandemic, they’ve experienced it, they’ve tried it and post pandemic will be more likely to feel comfortable with that online purchase. I think every deal that we look at has this question of how e-commerce will persist post-COVID-19. Obviously, during COVID-19, people didn’t have any choice, but once they do have a choice, how important was that in-store experience? Where are people going to return? What will draw them back to the store? And then, in the out years, will e-commerce return to that same growth rate that experienced pre-COVID-19 and at what new level? Clearly, you’ve converted new people to e-commerce during COVID-19, so you increase the penetration of e-commerce relative to brick and mortar. Where does that penetration stop and start to grow at pre-COVID-19 levels? What does that look like going forward?

We’re also seeing more D to C, you know, brands that are selling D to C coming to market as COVID-19 has driven an upswing in e-commerce. Your company looks great. It’s a really good time to be on the market and take advantage of some of those trends as you think about your next level of growth and investment. And then brick and mortar retailers are also thinking about how this is changing their operating model and how they leverage the rise of e-commerce. Whether it’s in-store exclusive and experiences to keep consumers engaged in the store, buy online, pick up in store, curbside pickup, or whether it is enhancing their online and their retailer.com capabilities to really meet consumers where many of them are now comfortable shopping. 

Nagalla  

Lastly, I would add that there’s a consumer behavior that’s really taken off in the last year which is contactless payment. The desire to minimize touch really accelerated the tap methods of payment in the US.

Europe have been doing this for ages, but it took the pandemic in the US for it to really catch on. And what we found is that fewer and fewer adults were using printed or minted US currency at all anymore. In 2015, Pew said that around a quarter of Americans made no purchases in cash in a typical week. Now, that statistic has risen to 3 out of 10 Americans that don’t use print or minted cash in a week. I was at a zoo a couple weeks ago with my sons and we went to a gumball machine to get some animal feed. It’s the ones where you have to drop a quarter in and someone had left a note “please make this more accessible, no one uses quarters anymore.” Instead we expect this to continue.

Brown

How did you feed the animals?

Kiely

I know, I had quarters. I had to search my house for 10 minutes looking for quarters, basically.

Brown

It’s like shake the piggy banks. 

Kiely

Yeah. 

Brown

Given the pull forward demand that you described and, you know, thinking about as people go back to the “normal,” how sustainable do you think the growth we saw with the last year in the categories you described, you know, how sustainable do you think that’s going to be moving forward? 

Nagalla  

I think that it’s absolutely the number one priority with the investors right now. Understanding the impact of COVID-19 and the sustainability of that impact. As such, our teams try to conduct a historical diagnostic over (1) what exactly happened the last year – and (2) why it happened. And in terms of understanding what happened, the three variables that we look at are (1) changes in category, participants as Lindsey mentioned, (2) changes in items purchased as well as (3) changes in dollars spent per item. And then we try to assess the sustainability of each of those variables by articulating a story around why something happened. Whether it was an increased love for the home category, whether it was a new pet, such as Lindsey mentioned, or extra dollars that would have been used, that would have gone towards a vacation instead. And so, by understanding why something happened, you’re able to better assess the sustainability of the three drivers that I mentioned earlier.

Brown

How have you seen consumer-focused private equity funds adjust their investment strategies given the growth that you’ve seen over the last year?

Kiely

That’s a great question. Unlike prior recessions, what we’ve observed in this period of the pandemic is that valuations have largely kept rising and the deal market because they kept being extremely competitive. You know, certainly after the early days of COVID-19 when everyone circled the wagons around portfolio companies and made sure that they had enough cash hand to be able to continue operations. Once it became clear what the pandemic was going to mean for everyone, the deal markets opened back up and they opened back up with a vengeance. We are currently sitting on top of several years of successful fundraising. There is continued record amounts of dry powder and there’s lots of competition as that money gets put to work. I think in one aspect, PE funds are really trying to look for an angle or a different way of investing that can help them be competitive in that market. In some cases, we’re seeing things like more proprietary deals and seeking out deals before they’ve hit the market. Being more aggressive for early LOI. You know, I think with a lot of the uncertainty also around how consumer behavior will change in the long term as a result of the pandemic. I know as Bhakti mention, we spend a lot of time trying to predict that, but it is at the end of the day a prediction based on the factors that exist today and what we think will happen tomorrow, that really a lot of funds are trying to think about how they invest in this support structures, that will always be there in the consumer industry versus the brand that may not. Investing in things like contract manufacturing, logistics, transportation, areas that are going to continue to support the consumer industry regardless of how consumers are purchasing and what they’re purchasing and where. And trying to protect a little bit against some of those shifts that we have a certainly not a great, nobody has a great crystal ball to see that far in the future where things are really going to shake out. 

Brown

Would you describe this then and private equities’ approach as a pivot in their strategy or more a reaction to, or an acceleration of trends that had already really taken root and we’re just seeing it solidify and manifest itself? 

Kiely

I think that actually the question kind of applies to two areas. And I’ll give two answers, which are very similar. On the private equity fund side, I think that it has been more an acceleration of existing trends and looking for advantages in terms of supporting the fundamentals that underpin the industry. In addition, there’s a lot of investment in the front-end brands, but I don’t know that the pandemic necessarily caused a significant pivot as much as just an acceleration of that. Certainly, an acceleration of trying to find new angles and new ways to compete in what has become an incredibly frothy and competitive market. Another places the question I think is applicable is around just the trends in terms of what’s transacting, where there’s been an acceleration of investing behind existing trends versus hard pivots. I think there have certainly been a lot of existing trends that we have seen that are garnering investment, certainly channel trends, the growth of e-commerce, non-traditional categories going online. From a category perspective that has certainly been the case. There are some categories that in the pandemic saw a hard pivot. At home, fitness is a great example. I know Bhakti talked about that earlier. This wasn’t really a trend before COVID-19, certainly it was happening, you know, Peloton had been released. There were others that were following and trying to basically start that industry, but it got a huge juice when the pandemic hit. And then, the question really, is what happens and is they’re softening and reversion as we get back to normal? It’s a great question. I think applicable across a lot of things that we’re seeing in the industry, and really that acceleration of trends is mostly what we’ve seen, where I would say there were hard pivots wherein areas of consumer behavior or of investor behavior that just completely changed because of COVID-19 in a way that no one could have seen coming. 

Brown

Sounds like there’s some more niche or quirky kind of categories that maybe the consumer-specialized private equity firms might be starting to dip their feet into. 

Kiely

There are and I think a couple of my favorites that I’ve seen. There’s quite a lot within the food space, as that space continues to evolve with packaged food and beverages. You know we’ve seen the rise of plant-based everything. Certainly, plant-based meat has been something that’s on the consumers awareness for a long time but seeing that shift into dairy and into other types of animal products. Seeing unusual types of healthy snacks – kale chips, beet tips – eco-friendly cleaning products, certainly a lot of categories that have seen, that have erupted recently where there’s been investment.

I think, perhaps, my favorite may be unexpected or unusual categories, have been around hobbies, and I think that to me it’s just because it was not an area that I particularly thought of as right for investment, but certainly around the pandemic and even pre-pandemic, but accelerated by the pandemic is the amount of time people spend on leisure and looking to try to see where you could capitalize on that. More people are spending time outside making gardens, or doing crafts and those are things that, you know, maybe wouldn’t have traditionally hit the transom, but are actually very attractive areas for investment.

Nagalla 

Our favorite new consumer segment that Lindsey and I love to talk about are the “grandmillenials”. The millennials who are now engaging in hobbies that typically we associate with grandmothers such as quilting. 

Brown

I like that. Just thinking that those are interesting areas. So do we think things such as gardening and crafting are trends that are going to continue once you know, people go back to normal and aren’t as home as much?

Nagalla 

That is the key question I think, as we’ve looked across hobby categories. What we found is that segment of the population that adopted these hobbies during COVID-19, whatever they were, they do expect to continue into actually carve out time from their lives once you get back to “normal” to pursue them. Others frankly will just drop them. They don’t have time to spend on their garden or on other hobbies once they get back to normal. But what’s interesting is that category or that while segment rather consumers discovered that this during COVID-19, they are much more likely to return when they do have that time and space open up in their lives. So once the kids are back in school and you’re commuting back to work and your time is precious on nights and weekends, you may not have time for those hobbies, but as your life starts to slow down and you open up that time they are top of mind. Clearly, that is a much longer term that is beyond really anybody’s investment horizon, but it does bode well for thinking about the future health of those categories, and enthusiasm that consumers have.

Brown

Agnostic of COVID-19, what are some other trends that you’re starting to see that are driving pockets of growth in the market and how are the retailer’s responding to that? 

Kiely

I would say one trend that we’ve seen really take off and this is pre- COVID-19, but we saw this bump a bit during the last year, was just the growth in mass huge price points. Consumers really want that premium product, but at a lower price and we see a lot of brands delivering on that demand and responding. And so, this trend is particularly supported by both demographic and channel shifts. These mask huge products are especially popular among younger consumers and they’re more likely to be purchased online versus food, drug, mass channels that are more for mass products and specialty and department channels that are more for premium products. It’s important for premium brands to align on whether they want to play downstream potentially or protect their positioning by playing in the channels that they have historically played in. Another trend I would comment on is just that consumers are just becoming more savvy. They’re spending more time researching products online and that’s increasingly part of our research. We spend more time trying to assess a brand’s online presence both in terms of sentiment in terms of volume as well during our diligence work. 

Nagalla 

Retailers are also making you know their own moves during this period as they’ve responded to these consumer trends. We’ve seen a couple of areas where retailers have pushed changes or push trends forward. One is around private label and the other is D to C in direct-to-consumer. On the private label side is certainly has always been a topic of interest. I think even prior to COVID-19, there have been notable changes in the quality and positioning of private label by retailers. They’re investing more, they have better quality products. Consumers have responded to that and understand that higher quality and trust that higher quality. They are increasingly willing to buy private label as a substitute for branded products. What’s interesting and one of the questions that we are always asking when we’re in a category where there is significant private label presence is what is the cap on private label? Does that take over an entire category or is there some percentage at which that is sort of the ceiling for private label? And they’re usually always is. The retailers are very cautious about leaning too heavily on private label because it’s important for them to maintain a diverse selection of brands for consumers to choose among. So, while private label is growing, we do find that it will grow to a point that most categories and not grow much beyond that.

The second area where retailers are really, investing is around D to C and trying to understand how that landscape is changing and how they can play. So, the retailer’s themselves are not only investing in their retailer.com websites. But also thinking about how they interact with brands that are also thinking about the same thing and investing in D to C and how you walk that balance as a retailer and as a brand around wanting to own that relationship with the consumers.  

Certainly, retailers understand that brands do want to create that, but they also need to protect themselves. So, we’re seeing the rise of things like, you know, exclusive products or other things that help protect both the retailer’s D to C efforts as well as the brand’s. 

Brown

When you think of D to C efforts, there’s clearly an increased focus on ESG across the population, across the world. How do you find that that’s manifested in consumer buying behaviors? And how have consumer companies and retailers responded to that or have they?

Nagalla 

We find the ESG is important to Millennials and Gen X and that’s been played out in the consumer feedback that we’ve seen. But it’s unclear, if incremental improvements in ESG factors drive willingness to pay or wallet share. For example, in a category like personal care, you see themes such as clean, natural, organic really taking off. But at the end of the day, we’re finding that consumers are still prioritizing efficacy in value for price, especially considering how challenging some of these descriptors natural are to audit. And so, generally, our advice here to brands is really the brand has a right to exist based off from primary KPCs such as efficacy and value for price. Perhaps brands can differentiate themselves in a very crowded category with a strong ESG positioning.

Brown

Interesting. And so ladies, we’re do you see all the trends that we’ve talked about today in the consumer sector taking us?

Kiely

It’s an interesting question and one that I think combines viewpoints across categories, across retailers and retail types and channels. I think one area where we can all agree is that we’ll continue to see great growth on e-commerce and that shift. You know, and brands and retailers are going to have to figure out how to play nicely together as that continues to grow. And as consumers have the choice to buy from retailer.com and from marketplaces and from brands directly, you know, that will certainly continue to grow. I think a lot of the consumer behaviors that have been adopted during COVID-19 are going to persist to some extent.

The question is to what extent, but as you’ve mentioned, a couple of times it is unlikely that we will revert to what the world looked like before. There will be small changes, whether it’s in the way that we work, the amount of time we spend at home, what we value, you know, spending time with family, prioritizing our health and mental well-being. A lot of those shifts will occur. I think what we saw during the pandemic was certainly unique, but some of that’s going to persist going forward, and to the extent that investors can see some of those trends that have that staying power and invest behind them. I think there is a lot of success to be had. 

Brown

Excellent. Well, very interesting conversation, ladies. Thank you so much for taking us through all the changes and trends that you’ve been seeing over the last year through the pandemic, but also beyond that, you know, where the consumer sector is evolving to. Appreciate you taking the time and looking forward to seeing a lot of what we spoke about today, actually unfold. 

Nagalla

Thanks, Winna.

Kiely

Thank you so much. It was a pleasure speaking with you today.

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