Frutarom Backs Away From Large M&A, Citing Expensive Valuations

(Bloomberg) -- Israeli flavor maker Frutarom Industries Ltd., which this week announced the purchase of a French competitor, is shelving plans for large deals to focus on smaller companies with cheaper valuations, according to its chief executive.

The company aims to nearly double its sales in four years, with acquisitions playing a key role in that push, Ori Yehudai said in an interview in Frutarom's Herzliya office. Industry consolidation has driven up valuations, making bigger targets less attractive, he said, days before Tuesday's announcement that the company would buy France's René Laurent SAS for $21 million. 

“There aren't many large targets. You can count them on two hands,” Yehudai said. Frutarom has abandoned a plan to list shares in the U.S. to fund such big deals, he added.

The ingredients market is dominated by four companies, led by Givaudan SA and Firmenich International SA, both based in Switzerland. The strongest companies have been buying smaller competitors to drive growth amid economic downturns in emerging markets such as Russia and Brazil. 

Commando Staff

That strategy has driven up the price of deals, sometimes to as much as five times annual sales, according to Duncan Fox, a Bloomberg Intelligence analyst. In its own acquisitions, Frutarom pays about seven times earnings before interest, tax, depreciation and amortization, Yehudai said.

Frutarom's “commando” M&A staff is currently doing due diligence or negotiating purchase prices with about 20 small family-owned or founder-run companies.

"When we talk about doubling our size every four or five years -- which we were able to do in the last 20 years -- we don't need to do large acquisitions," Yehudai said. "We acquired $220 million of revenue in the last two years and we will buy $150 million more every year. We're producing nice cash flow." 

The René Laurent deal is Frutarom's 21st since the beginning of 2015. Among them was the purchase of Austrian flavor company Wiberg GmbH for about $130 million in December 2015, the largest deal in Frutarom's history.

The company says acquiring other companies will boost sales by 75 percent to $2 billion by 2020.

Though they laud its skill in buying companies, analysts have questioned Frutarom's ability to integrate the new businesses. The company's EBITDA margin has stayed flat at about 18 percent since 2013, according to data compiled by Bloomberg. That trails market leaders such as Givaudan, International Flavors & Fragrances Inc. and Symrise AG.

Yehudai said Frutarom's focus is on serving their small customers, not necessarily squeezing every dollar out of the business model. 

“Mid-size local customers don't get the same level of service and attention and support that the big food companies get from our big competitors,” he said. “We can give them this kind of support."

Growth Areas

More than 75 percent of Frutarom's 40,000 customers are small, local businesses, which Yehudai says will help the company grow faster than its peers. The private-label sector -- local farmers and manufacturers who sell food that's then branded by grocery chains like Lidl Ltd. and Tesco Plc -- is growing by 5 percent a year, as opposed to 2 percent for larger food brands like Nestle SA, according to Yehudai. Private-label customers generate about a quarter of Frutarom sales.

"The bigger companies aren't growing at the moment and the smaller ones are," Gil Dattner, equity analyst at Bank Leumi Le-Israel Ltd., said in a phone interview. "Frutarom has good exposure to growth areas, and management has a good track record of acquiring companies when the valuations aren't very high."

Still, Dattner has a sell rating on Frutarom because he believes stocks generally are overvalued. Frutarom shares were up 4.3 percent this year as of 3:40 p.m. Tuesday in Tel Aviv, compared to a 5.3 percent drop in the TA-35 index. Frutarom stock fell 6 percent in 2016, its first losing year since 2011.

Yehudai wants to ramp up dealmaking in Asia and double operations there to about 15 percent of sales within the next two to three years. Frutarom bought its first company in India in 2015, and Yehudai says the company has identified some 400 potential targets in China. Emerging markets accounted for about 40 percent of revenue last year, exceeding Western Europe for the first time, according to Yehudai.

"Emerging markets should be over 50 percent" of sales, he said. "It's impossible to want to grow 5 percent internally when you have half of your sales in Western Europe, which isn't growing at all."

To contact the reporter on this story: Yaacov Benmeleh in Tel Aviv at ybenmeleh@bloomberg.net.

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Michael S. Arnold, Amy Teibel