L Catterton: Tipping the playing field

Building a bespoke operating model and reinforcing a distinctive culture in which people can perform their best is the path to maximising value for specialised private equity firms and generalists alike, explains L Catterton’s Scott Dahnke

This article is sponsored by L Catterton

Scott Dahnke

Three decades after it was formed, L Catterton has carved a sizeable niche as the world’s largest consumer-focused private equity firm. The group invests via middle market and growth strategies on five continents.

Scott Dahnke, co-chief executive officer at the firm, outlines the trends shaping the consumer sector globally and explains how private equity firms can find new levers to increase portfolio company value.

2019 marks 30 years for L Catterton. Looking back on the past 30 years, how has the private equity industry evolved?
The biggest change has been the maturation of the private equity industry, and the impact that’s had on the competitive landscape. Like most maturing industries, we’re seeing that there are two principal models for success – specialise or scale. The population of truly generalist, middle market funds is shrinking.

Additionally, more money than ever has come into the market and dry powder has been on the rise for years. As we all saw, it hit another record high in 2018. When capital becomes a commodity, it’s not easy to consistently deliver high alpha irrespective of market conditions, as we look to do. Therefore, we believe you need to have an arsenal of competitive advantages that are going to help you create real value.

You often refer to your approach to value creation as ‘structural alpha’. What does that mean?
It’s about tipping the playing field to your advantage, in multiple ways. We do that through our consumer focus and resulting deep insights, our global reach and expertise, our operating resources and execution, and our affiliation with key strategic players in the consumer arena, most notably LVMH.

Perhaps most importantly, we seek to maximise the impact of these advantages by creating a consistent culture – both internally and externally – across all geographies. Naturally, you need to hire great people, but you also need to nurture a self-reinforcing culture and a community where they can maximise their talents – so effectively, one plus one can equal three.

In our parlance, structural alpha is about building a set of competitive advantages in our business model and then promoting a performance-oriented and collaborative culture, where everyone is working consistently within that model to maximise value.

So how does structural alpha work in practice?
For any one investment, there are multiple levers we can pull to generate outsized returns. For example, at Ainsworth, our insights around the pet food category’s consumer trends informed us to double-down in the food, drug and mass channels on the super-premium brand within their portfolio, Nutrish, which turned out to be the right decision. Similarly, our operating expertise served us really well – our operating team went in and helped increase production capacity by 70 percent and decrease costs by more than 30 percent.

For an investment such as Elemis, which we sold to L’Occitane for $900 million earlier this year, we leveraged our strategic partnerships and global reach to support expansion from the UK into the highly attractive US beauty market. These are just a couple of examples of leveraging our structural alpha ‘toolkit’ of competitive advantages to drive returns. Our objective is to select the right value-creating tools to deploy in each investment to help the management team maximise value.

What impact does sector-focus have in your value creation?
The data suggests that in the consumer investing arena, sector-focused firms on average achieve a 20 percent higher MOIC than generalist firms. That isn’t that surprising to us, as the consumer space is much more dynamic than most folks think. The past isn’t always prologue.

Our entire business model is built around not only being focused on the consumer sector, but also being focused exclusively on growth. In fact, many of the things that we do either wouldn’t make sense for a firm that wasn’t focused on investing in on-trend consumer assets, or wouldn’t be economic absent our global scale. Our model is very bespoke.

This approach enables us to do a lot of research and develop pattern recognition, leveraging unique insights around consumer behaviour and trends. It is about “skating to where the puck is going”. We also seek to focus on consumer verticals where we have the deepest insight and often, proven success, so that we can pursue a highly developed investment thesis. To continue with my example of the pet food vertical: our first pet investment was made in 2004 (Wellness Pet Food, where we grew earnings seven-fold), and we have been actively investing in that space since. We exited  Wellness in 2008 and acquired Nature’s Variety that same year, which experienced similar growth in the raw pet food space. We held Ainsworth for four years before selling to JM Smucker’s for $1.9 billion, and we are currently applying our learnings at two pet food companies in the UK – Inspired Pet Nutrition and Lily’s Kitchen – and three more in the US, which are Canidae, I and love and you, and JustFoodForDogs. We have similar examples in other categories, including beauty, e-commerce, restaurants, health and wellness, and more.

What shifts have you seen in the consumer sector and where do you see it going?There have never been as many opportunities for emerging brands to grow, and the corollary is that we’ve never seen as much of a threat to incumbents. The power dynamics are really shifting, with increasing control being shifted from the retailers and brands to the consumer.

What this has led to is brands needing to be far more differentiated. Meanwhile, the key metric for branding has changed – it is no longer primarily about brand awareness, it’s about brand meaning. Consumers now want brands that they feel define them. Our business partner, LVMH, has a built a remarkable and global business leveraging this insight, among others.

We’ve also seen a huge shift in distribution, and I’m not just talking about e-commerce. Five or six years ago, few would have said the fastest growing element of the restaurant industry would be food delivered to your home – but today it’s almost de rigueur for consumers to order online and pick up in store, or have food delivered. If restaurants can be disintermediated in this manner, you can only imagine how other categories will be impacted by consumers becoming increasingly time-stretched and convenience-orientated.

How do you keep improving your value creation approach?
We have built our own algorithms to ensure that we build on past successes and, candidly, learn from our missteps. We also look at our own case studies and those of our peers – what has worked well and what hasn’t, what were the underlying drivers, and what we can learn from those real-world cases.

We have also been honing our management assessment tools, so we can go through a detailed talent assessment for management teams. It goes well beyond referencing and gives us a sense of individual strengths and weaknesses, how each of the individuals fit into that team, and how they will work with us. This also enables us to identify opportunities for improvement much more quickly and to ensure that we have – where possible – the best team right out of the box.

We’re also increasing our focus on ESG within our portfolio companies. The shift towards brand meaning goes hand-in-hand with consumers becoming more scrupulous about a wide range of ESG-related topics, so it’s crucial that we know how our businesses and brands are doing in that regard and how they can improve.

Much has been written about the convergence of technology and the consumer. How are you thinking about that convergence in terms of where the future of value lies?
We have seen that consumer products integrated with technology are driving a larger portion of our sector’s growth. Technology is impacting virtually every part of the consumer landscape today, whether it be how consumers research a product, how they select a product, or how they choose for it to be ordered or delivered.

We are working on new initiatives that are intended to leverage synergies between our knowledge and that of the VC and tech communities. We learned from our discussions with VCs and tech entrepreneurs that many consumer tech companies are led by engineers who have developed a brilliant product offering from a technology standpoint, but generally do not have the experience with various go-to-market strategies, branding, or marketing. And, in almost all cases, lack the ability to capitalise on the potential for global reach and expansion.

We see the opportunity to marry our consumer skills, experiences and global reach with their tech capabilities and understanding. These types of innovations will keep us at the cutting edge in terms of insights into the consumer tech landscape, with benefits across all our fund investment strategies.

In 2011, L Catterton invested in natural children’s cough brand Zarbee’s. Seven years later, Zarbee’s Naturals had secured itself as the market share leader in the natural paediatric cough/cold category and was sold to Johnson & Johnson. What was the opportunity in Zarbee’s Naturals?
Our research showed that families – particularly mothers – wanted chemical-free products for themselves and their families, specifically young children. We began to look at specific categories and saw that there was no all-natural, trusted national brand recommended by paediatricians that a parent could reach for any time their child had a cold, cough or flu. It just did not exist.

After scouring the consumer landscape for potential brands that could become leaders in this nascent category, we targeted Zarbee’s – they were just a four-person team at the time. In a nutshell, the concept was to build Zarbee’s beyond its flagship product – drug-free children’s cough syrup – into a suite of all-natural products covering all age segments and health and wellness product categories, and that’s exactly what we did.

What did you focus on during the hold period?
Our key value creation levers were talent expansion and leadership development, product innovation, branding and marketing, and distribution growth.

Shortly after our acquisition, our in-house talent team helped Zarbee’s bring new, highly-experienced talent into virtually every critical function within the company.

In terms of product development, we expanded the brand in two age directions, entering both Adult and Baby. We also expanded beyond the brand’s cough heritage, adding immunity, vitamin, wellness, allergy and sleep products to the range. We tweaked the positioning and expanded digital marketing to drive paediatrician recommendations and grass-roots advocacy. At one point Zarbee’s had more Facebook followers than any other brand in our portfolio, a huge feat given the scale of some of our brands, and further proof of how important this category is to mothers.

Finally, with the support of our industry relationships, we were able to expand distribution from one major account to all major accounts across several channels – Mass, Drug, Grocery, Discount, Club and e-Commerce.

The result of all of this was over 15x revenue growth, and a strong and commensurate return on invested capital.

What are the lessons for the future?
The Zarbee’s story underscores the importance of the management team, which was critical to success. It also highlighted the ongoing opportunity in natural, “better for you” products. We have several investments in our portfolio that are oriented towards this trend. The Honest Company, which focuses on all-natural baby and beauty products that keep families safe, is a great example. For us, there is no question that there is pattern recognition. This enables us to wait for pitches that are clearly in our strike zone before we swing.