Looking Ahead: Health and Beauty M&A After Shelter in Place

After weeks of COVID-19 stay-at-home orders across the U.S. and globally, states and countries are beginning to restart their economies in limited ways. Yet, until measures are taken to restore confidence in our ability to battle COVID-19, all facets of the economy will continue to be impacted to varying degrees, including the health and beauty sector.

Here, Kelly McPhilliamy, a managing director in the Consumer Group, along with William McBride, a vice president in the Consumer Group, discusses health and beauty as consumers emerge from sheltering in place, as well the opportunities being created.

Resilience, Creativity and Partnership

“These are extraordinary times that present tough challenges for health and beauty brands,” says McPhilliamy. “However, beauty consists of everyday staples as well as indulgence items and has been very resilient through past recessions. I’ve been amazed at the level of creativity, innovation and partnership I have seen in the industry in this environment.”

McPhilliamy adds that while COVID-19 has created a host of challenges, it has also accelerated several ongoing growth trends:

Faster adoption of e-commerce (especially mobile). Shelter in place is driving e-commerce growth beyond its already strong trajectory. Specialty beauty retailers such as Ulta and Sephora are leveraging loyalty programs and e-commerce investments to drive digital sales, while Amazon is expanding its beauty offering in prestige and professional segments. Many brand holdouts that had resisted selling via Amazon are seeing its value more clearly while other channels remain closed.

Digital-first brands ­winning. With more time at home, consumers are researching and discovering brands, products and ingredients online, which benefits digitally savvy companies. Digital-first brands that had been winning online pre-COVID-19 are seeing market share gains in the current environment. Digital capabilities have been a particular interest area for strategic buyers and remain a priority.

Consumers seeking products that are better for them and the environment. A pre-COVID-19 Nielson study revealed that three-fourths of Millennials are “definitely” or “probably” changing their consumption habits to reduce their impact on the environment. Now, intensified attention on personal health and hygiene will fuel even greater demand for clean and safe product options. It’s a call to action for brands pursuing sustainability advancements.

Increase in the use of augmented reality (AR) and other technologies. With trial being an essential part of the selling process for certain categories like cosmetics, the inability for consumers to try products in stores is leading to rapid consumer adoption of AR try-on apps, and to AR integration with online tools. As stores reopen, brands and retailers will need to adjust to a limited or no-touch environment, changing both testing and selling methods, which opens the door for new AR uses.   

Opportunities Amidst the COVID-19 Battle

There’s no question that health and beauty, like other consumer industries, has been hit hard by COVID-19. But McPhilliamy and McBride see potential amidst the challenges.   

Consumer spending on vitamins, minerals and supplements is up significantly as more people focus on building healthy immune systems and sickness prevention. The category has experienced record sales in the last two months not only in immune-boosting products, but also in areas like stress relief and broader health and wellness. This could lead to a long-term shift in habits as new users adopt permanent lifestyle changes. 

Health attributes of products are being promoted as consumers constantly look for products that deliver additional benefits such as sun protection, anti-pollution skincare or immune system support. Multiuse products have already taken hold in the cosmetics space, with many products delivering skin care benefits. This trend has now spread across the entire health and beauty landscape.

There is pent-up demand for service-based beauty, but the growth of do-it-yourself (DIY) beauty will create lasting routines. DIY hair, nails and skin products, at-home treatments and telebeauty services are experiencing strong growth as consumers are forced to take health and beauty care into their own hands. Some will continue these routines as shelter in place subsides and they carefully watch their discretionary income. But pent-up demand will drive a return to service operations for parts of the beauty routine consumers are unwilling to give up. 

Mass beauty will get a lift as consumers discover quality in food, drug and mass merchant (FDM) distributed products. Because FDM merchants are the only retailers open during the business shutdown, consumers have turned to FDM for the health and beauty products that are part of their daily routine. McBride notes that “if consumers are satisfied with the quality and selection in FDM, many could stick with these products when other shopping options reopen. Even prestige shoppers may do a mix of shopping that includes FDM and other brick and mortar.” McPhilliamy adds that “past recessions have shown that health and beauty sales within mass channels rise during difficult economic times as consumers look for value in their everyday products.” 

Institutional investment in health and beauty companies has created stronger backing to withstand today’s challenges. In recent years the number of U.S. private equity firms invested in health and beauty has grown by leaps and bounds. This gives many businesses a much stronger financial position than in prior downturns, helping them buffer the challenges they may face. We expect founders to continue to seek financial partners after facing the unique challenges of this pandemic.

Chinese demand is returning as consumers and businesses get back to work. Pent-up demand as China opens its economy is creating very strong sales in luxury beauty, with e-commerce performing well while brick and mortar is recovering more slowly. This is consistent with the market signals Harris Williams is collecting and synthesizing regarding overall market recovery in China, and is a good indicator for what’s to come in health and beauty as other countries ease restrictions.

Implications and Opportunities in Health and Beauty M&A

The rapidly shifting health and beauty sector and consumer environment emphasize the need for companies to weather the storm, be nimble and adapt to change. “Taking care of the brand, employees, customers and supply chain is the first order of business,” says McBride. “Then, find ways to address trends in the market where possible. Unfortunately, the unprecedented circumstances companies have to navigate are likely to cause a shakeout within the industry as some brands struggle to deal with the current conditions and evolve to meet tomorrow’s challenges.”

However, there will continue to be opportunities. High-quality brands, and those that are connected to growth areas and to consumers through online channels, will continue to be in demand as M&A activity resumes. Private equity will seek investments in strong brands, as well as those that are suffering near-term liquidity challenges yet have the potential to emerge as winners following the pandemic. Strategic buyers may take a short pause as they focus inwardly before returning to M&A. McBride recalls that “Historically, many consolidators have backed off some on M&A during recessions, but not in total or for too long of a period. Strategic buyers continue to view M&A as a key value driver, a source of external R&D, and a way to bring new brands in-house as a next pillar of growth. Ultimately, strategic buyers will still be interested in great assets regardless of the market environment.” 

In a post-COVID-19 world, business models will become more important. “We expect business models to come under greater scrutiny by buyers, particularly as it relates to direct-to-consumer customer economics and profitability dynamics,” notes McPhilliamy. “Growth remains the arbiter of success, but the focus on profitability and execution capabilities will intensify.”

Conclusion

While there are areas of health and beauty hit hard by COVID-19, others are benefiting from opportunities created by this unprecedented challenge. Going forward, buyers will place a premium on companies that are fundamentally strong, especially those with distinct brand positioning, high consumer engagement, well positioned distribution with room for growth, and high-quality, profitable business models.

McPhilliamy is cautiously optimistic: “Despite what we are seeing right now, the health and beauty sector remains fundamentally strong, and we fully expect M&A to continue after this current pause. The level of growth and innovation coming from independent brands right now, coupled with anticipated demand from the strategic and financial buyer universe, bodes well for M&A going forward.”

Published May 2020

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