In the current environment, finding additional capital to fund growth can be challenging.
In a recent Grant Thornton global study, 53 percent of Australian food and beverage executives highlighted the need for additional capital to fund growth. We acknowledge this can be challenging in the current environment and have highlighted five key considerations when seeking to finance growth.
Agility requires investment
Product innovation and flexible supply chains are key to unlocking growth potential. Securing funding for these areas should be top priority in any financing strategy.
Investing in agility minimises exposure to the pressures of the retail supermarket and opens up new potential revenue streams. Australian businesses are heavily exposed to retailers and are vulnerable to changes in the supermarkets' strategies. The agility of the business to adapt quickly to these changes often determines the success or failure of their product.
The real growth starts with food and beverage producers that reduce their reliance on supermarkets through product innovation and securing new channels to market.
While product innovation is occurring in certain areas such as healthy eating products, Australian businesses could do more. Our global survey indicates that Australian F&B businesses spend just under 1 percent of sales on research and development compared to their North America counterparts who spend double that amount.
A changing funding landscape
Pricing within the banking sector has remained relatively stable, creating growth opportunities. We're seeing many F&B companies typically sign up to short term debt cycles with an average of three year terms. This limits the ability to capitalise on new market opportunities, which often require funding well beyond this timeframe.
More non-bank lenders are entering the market, with hedge funds, credit funds, specialist agriculture funds and private equity looking to put capital to work.
Non-bank lenders tend to offer longer-term non-amortising fixed rate debt with tenors as long as six to 10 years. This type of debt can be attractive as it eases pressure on working capital and allows cash to be reinvested towards growth rather than making amortisation payments. There is, however, a trade-off as additional premium is payable for the increased flexibility.
We recently assisted a client source debt funding from an alternative capital source to make an acquisition which resulted in a significant uplift in its competitive market position and ultimately earnings profile. Whilst these funds come at a premium to traditional debt, it was significantly cheaper than the cost of missing this opportunity to create a step change in their business.
A joint venture is another alternative growth strategy allowing growth without having to borrow additional funds. Australian F&B businesses can benefit from entering into joint venture partnerships to grow their distribution and customer networks, whilst simultaneously sharing the risks with other joint venture partners.
Private equity looking to deploy capital
Our M&A research on activity in the Australian F&B sector revealed that whilst private equity buyers only participated in a relatively small proportion (14 percent) of total F&B deals in the period 1 January 2011 to 30 June 2014, they were much more prevalent in the larger deals.
One of the largest transactions in this sector was Bright Foods Group's acquisition of a 75 percent stake in food distribution company Food Holdings Pty Ltd from CHAMP Private Equity for A$516 million.
PE firms currently have significant un-invested capital to deploy and are therefore competing with trade for attractive assets.
The return of the IPO
Our study also highlights a total of 90 new companies listed on the ASX over the 18 months to 30 June 2014, compared with 100 in the preceding 18 month period. However total value of funds raised in this period was more than a five times greater than the preceding period. Not only that, but the total amount raised from new listings on the ASX in the financial year 2014 was higher than in the boom years immediately preceding the GFC; a very encouraging sign of improving market conditions.
Australia had only one significant F&B listing throughout the observed period being that of Bega Cheese Limited with a total offer size of $35 million. The company has since been trading at a premium to its offer price.
There were three other significant IPOs for F&B businesses in 2014 with the most significant raising being Huon Aquaculture (Salmon) raising $133 million. Bellamy's Australia (infant formulas) raised $25 million and Australian Dairy Farms Group (fresh milk) raised a further $9 million. All of these companies have good exposure to the Australian majors and perhaps more interestingly have strong growth prospects through export into the Asian markets.
What is the tax impact?
Whatever the form of funding obtained there will be tax implications to be considered. Australia has recently tightened its thin capitalisation provisions restricting the level of debt foreign controlled or Australian outbound entities are able to have in Australia. The safe harbour ratio has been reduced from 75 percent to 60 percent of relevant assets, with interest deductions denied in respect of excess debt.
There are a multitude of other tax issues to consider in the context of debt funding, such as whether the relevant financial arrangements are considered "debt", which attracts interest deductions, as opposed to "equity". Similarly withholding taxes and gross up clauses will become highly relevant for a non-resident lender. Foreign currency denominated loans will also give rise to potential assessable/deductible FX gains or losses.
In the context of IPO's or other share placements, the deductibility or otherwise of capital raising costs can cause issues, as with the recovery of input tax credits on such costs. It is also necessary to consider the impact of share issues on the availability of any tax losses purportedly carried forward in any corporate entity.
Unlocking growth potential
When prioritising projects the best place to start is investing in agility and product innovation which could open up new revenue streams. Consider the alternative funding sources available and the tax implications thereof. Now is a good time for savvy food and beverage companies to capitalise on growth through alternative funding options available amidst the changing landscape.
Tony Pititto is partner and national head of food and beverage at Grant Thornton Australia.