Food Transparency 2017

WINTER 2017

HeadwatersMB.com

THE RISE OF A NEW FOOD INDUSTRY MANDATE:

Trust, Truth and Transparency

THE RISE OF A NEW FOOD INDUSTRY MANDATE: TRUST, TRUTH AND TRANSPARENCY | 1

Many concerns are weighing heavily on the minds and hearts of consumers today, and among them are the availability of healthy foods and the impact food has on their health and wellbeing. In this environment, one concern has surged in importance – the demand for greater transparency from food companies.

Today’s food industry is in the midst of an extraordinary revolution that is as disruptive as it is dynamic. As outlooks and lifestyles veer further away from questionable diets and unrealistic weight-loss fads, consumers have become increasingly aware of the importance of transparency and the food choices they and their families are making.

Consumer priorities now range from clean eating and labeling to farming, processing and sourcing practices, as well as the humane treatment of animals. Additional influences that are awakening new consumer values include the mounting distrust of legacy Big Food companies and the importance of serving as citizens of the planet. The cumulative effect is a measurable and unmistakable impact on the demand for healthy food products, and changing consumer shopping behaviors and purchase decisions:

• Nearly all consumers (94 percent) believe it is important that the brands and manufacturers they purchase products from are transparent about what is in their food and how it is made.1

• Only 12 percent of consumers rank brands as their most trusted source of food-ingredient information. Yet, nearly 70 percent believe the brand or manufacturer is responsible for providing consumers with ingredient information.2

• Sixty-five percent of consumers purchased goods or services from socially responsible brands in the past 12 months. Additionally, 32 percent are planning to spend more with socially responsible brands in 2016, including 41 percent of 18- to 24-year-olds and 38 percent of 25- to 34-year-olds.3

Food companies large and small that recognize and support consumers’ priorities can win their long-term loyalty and capitalize on the competitive advantages of consumer-focused business strategies and leadership. They also have a genuine opportunity to become part of the massive consumer shift that is dramatically transforming the food industry and ultimately, brand performance and marketplace position.

“Today’s food industry is in the midst of an extraordinary revolution that is as disruptive as it is dynamic. As outlooks and lifestyles veer further away from questionable diets and unrealistic weight-loss fads, consumers have become increasingly aware of the importance of transparency and the food choices they and their families are making.”

– BILL HARRISON, MANAGING DIRECTOR, HEAD OF CONSUMER INVESTMENT BANKING, HEADWATERS MB

2 | THE RISE OF A NEW FOOD INDUSTRY MANDATE: TRUST, TRUTH AND TRANSPARENCY

Road to Transparency

As these priorities have become more strongly embraced by mainstream consumers, the demand for and sales of healthy products have climbed to record levels.

In a recent Acosta survey, The Why? Behind the Dine, US diners affirmed the importance of feeling good about the food they are eating.

These widespread consumer attitudes and behaviors have transformed a once niche advocacy group into a powerful marketplace force that demands food companies offer not only healthy products but also product and process transparency. Also, while in many cases Millennial voices are resonating strongest when proclaiming their food-related positions and opinions,

% US DINERS – EATING HEALTHY ATTITUDES

Thinking about the last year, please indicate how much you agree with each of the following statements. (% Agree Strongly/Agree)

Source: The Why? Behind the Dine (2nd edition), Acosta

It’s important for me to feel good about the food I’m putting into my body

I actively seek out nutritious foods that are good for me

I usually look for healthy options when ordering at restaurants

I’m very health conscious

I’m eating smaller portions than I was last year

I eat healthy meals, even though they may be more expensive

I’d like to eat healthier, but I can’t afford it

65%

49%

47%

45%

43%

37%

31%

“Forty percent of consumers believe the food system is headed in the right direction, up from 30 percent in 2012. Those who believe the food system is on the wrong track has dropped by 11 percent in the last two years.” – A CLEAR VIEW OF TRANSPARENCY AND HOW IT

BUILDS CONSUMER TRUST (2015), THE CENTER FOR FOOD INTEGRITY (CFI)

a number of industry studies indicates that consumer concern regarding food consumption spans age brackets, geographic regions and income levels.

Authenticity, sustainability and transparency have never been more important for consumers and for the food brands they look to when making purchase decisions across product categories.


A 2015 Deloitte survey, Capitalizing on the Shifting Consumer Food Value Equation, analyzes both Traditional and Evolving drivers of consumer behavior. Traditional drivers include taste, price and convenience, while Evolving drivers focus on health and wellness, safety, social impact, and transparency.

The survey shows that approximately one-half of consumers weigh Evolving drivers more heavily than Traditional drivers. It also reveals that Evolving drivers, when compared with Traditional drivers, equally represent geographic regions (Midwest, Northeast, South and West), ages (18 to 34, 35 to 49 and 50 to 80) and annual income brackets (less than $25K, $25K to $75K, more than $75K to $100K and more than $100K). Notably, the survey found slightly higher Evolving-driver levels among survey participants located in the West and earning more than $100,000 per year.

The diverse consumer demographic uncovered by the Deloitte survey is of paramount significance for food companies. It demonstrates that consumers, regardless of their geographic location, age and income, are now prioritizing the Evolving drivers of health and wellness, safety, and other factors that extend beyond taste, price

and convenience. What this means for food companies is that in order for them to maintain market share and grow, they will need to address these new consumer priorities.

Among the ways food brands are responding to health-driven consumers, and in the process moving progressively closer to transparency and consumer engagement, is by proactively informing consumers of food ingredients. In some cases, brands are also advising consumers on why specific products are good for them nutritionally, and setting new standards for quality in research, consumer advocacy and disclosure. Additional approaches are company website sections dedicated to nutrition and ingredient information.

“Forty-seven percent of US consumers look at the ingredients list before purchasing a packaged-food item in 2015, compared to 40 percent who made a similar claim in 2014.”– INTERNATIONAL FOOD INFORMATION COUNCIL

(IFIC)

EVOLVING DRIVERS ARE STILL HIGHLY RELEVANT ACROSS INCOME GROUPS

Source: Capitalizing on the Shifting Consumer Food Value Equation, Deloitte

<$25k 51% 49%

$25k-$75k 51%49%

>$75k-$100k 51%49%

>$100k 54%46%

TRADITIONAL DRIVERS

EVOLVING DRIVERS Health and wellness, safety, social impact, and transparency

Taste, price and convenience


methods, consumer feedback, and other social and environmental issues.

Digital “soap boxes” now serve as vocal and influential platforms from which consumers

are broadcasting their own opinions as well as those of public-health activists, watchdog groups, media pundits, celebrity nutritionists, and self-appointed gurus and evangelists. The outcomes are rewards for food companies’ perceived “good behavior” and punishment for perceived “bad behavior.”

According to a recent survey performed by The Center for Food Integrity (CFI), A Clear View of Transparency and How It Builds Consumer Trust, the responsibility for demonstrating trust-building transparency in the most important food-production areas rests first and foremost on the shoulders of food manufacturers – not farmers, grocery stores or restaurants. Areas of greatest concern to survey participants are food’s impact on health, food safety, the environment, labor and human rights, animal wellbeing, and business ethics.

Food companies earn trust when they consistently, authentically and proactively live up to their healthy-products commitment in all aspects of their business, and remain in lockstep with consumers’ evolving priorities. In the process, they can positively influence purchase decisions and become strategically positioned to excel in the healthy-food sector.

However, with the rise of technology and social media, and the empowerment they bestow on consumers, particularly on Millennials, maintaining consumer trust requires more than tried-and-true engagement strategies. Here are three top reasons why:

There is greater consumer diligence when investigating the extent to which food

companies live up to their healthy-product claims. Consumers are also being more empowered in their research each year by the Internet, social-media networks and smart-phone apps that can range from HarvestMark and ShopNoGMO to True Food and GoPure.

Consumers’ investigative efforts are reaching beyond food company backgrounds to

include product ingredients, labeling, sourcing

Platform of Trust

“Brands that meet customer expectations for product information, and deliver that information instantly, develop a new dynamic of convenience, trust and long-term value.” – 2016 LABEL INSIGHT FOOD REVOLUTION STUDY

1.

2.

3.

Best practices for building consumer trust in an environment seemingly overrun with skepticism and doubt are founded on both the security consumers experience from full ingredient disclosure and a kinship with the company that is formed through shared values. In fact, internal sustainability groups are winning as much applause from food companies as they are from consumers. These groups respond directly to consumer diligence and help guide food companies as they continually meet health and sustainability commitments.

Additionally, food companies are expanding their compliance departments to ensure they are in sync with regulatory demands and marketplace changes, and offering more consumer-engagement opportunities to demonstrate transparency.

Trust is food companies’ anchor for success, making its pursuit and retention a mission-critical goal.


Good for Business, People and the Environment

These brands are usually mission-driven in their marketing and consumer messaging, which often resonates with consumers. In the process, brands are able to grow from the competitive opportunities and financial rewards that the healthy-food sector has to offer.

Though each food company is unique in its product offerings, market-entry strategy and goals, they all

share a universal DNA – the ability to understand and meet the complete range of consumer expectations, from health and nutrition claims to animal and environmental protection.

The following three companies stand as real-life examples of how transparency, and the consumer trust that follows, can be catalysts for growth, success and corporate citizenry.

KIND, whose products are better-for-you fruit and nut-snack bars, was founded in 2004 with eight bar varieties and now offers more than 22 bars and six Healthy Grains snackable clusters.

KIND has taken a number of steps that have led to strong performance and market differentiation, including using transparent packaging so that consumers can see the contents of the product when displayed on store shelves. The company also focuses its branding and marketing efforts around the KIND belief that “there’s more to business than just profit.”

For example, rather than rolling out a traditional product-sampling strategy, KIND selected brand ambassadors who distributed coupons to the public in a wide range of US cities. Members of the public could then redeem their coupons for KIND bars as a reward for their random acts of kindness. The marketing strategy was an unequivocal success. It not only honored kindness, a principle on which the company

was founded and named, but also emboldened the authenticity of the KIND brand.

Although KIND remains privately held, in 2012 it reportedly generated $120 million in revenue, with private equity investor VMG Partners selling its minority position for approximately $200 million in 2014.

KIND

Each year, food brands launch better-for-you products that gain both significant consumer traction and loyalty as well as brand awareness.


In 2009, Freedom Foods solidified its position as a leader in its region in the GMO- and allergen-free segment by constructing a 25,000-square foot production facility in New South Wales, Australia that is completely free of wheat, barley, triticale, peanuts, soy, dairy, eggs and sesame seeds. Additionally, most of the company’s product ingredients are carefully sourced from family farmers in the Murrumbidgee River basin area.

Freedom Foods’ 2016 revenues reached $127 million USD, 81 percent greater than the company’s total sales of $70 million USD in 2015. The company’s impressive growth and presence in Australia demonstrate that the demand for better-for-you foods is increasing globally. Today, over 80 countries around the world have organic regulations and the US accounts for only five percent of the world’s organic acreage.

Honest Tea was founded in 1998 with a mission to bring to market a bottled-tea beverage that was less sweet than its competitors and used organic ingredients, all while adhering to fair trade practices of improved trading conditions, sustainability, and social and environmental standards.

By 2006, Honest Tea had revenue of $13.5 million and was selling approximately 1.5 million cases of product per year. In 2008, Coca-Cola purchased a 40 percent stake in the company for $43 million. Coca-Cola purchased the remainder of the company in 2011 for an undisclosed amount. It is estimated that Honest Tea’s 2015 sales were $160 million.

Freedom Foods is an Australian food company that for more than 30 years has been producing nutritious and allergen-free food. Today, its better-for-you product line includes cereals, bars, snacks, spreads and beverages.

Honest Tea

Freedom Foods


Truth behind the Talk

However, there are hot-button concerns that provide fertile ground for discussion and debate, from the most heated and divisive to the most rational and inclusive, by the media and general public. These often spirited exchanges can confuse consumers and, in some cases, undermine their confidence in the sector.

The following is a discussion of four top consumer concerns and the influence they are having on today’s healthy-food sector.

“Natural” Claims The healthy-food sector includes unregulated “natural” products. However, “natural” has yet to be defined by the US Food and Drug Administration (FDA) or any other authoritative organization, leading to research-supported consumer uncertainty and skepticism over product claims. Consumer Reports’ National Research Center discovered that 62 percent of consumers already buy natural products and the group would also be willing to pay more for these items if they understood and trusted the natural claims. A clear majority of this group – 87 percent – agreed they would pay a higher price if the natural label met their expectations.

“Non-GMO is the fastest-growing food-label claim, with 15.7 percent of new products introduced in 2015 making “Non-GMO” or “GMO-free” claims – an increase from 10.7 percent in 2014 and 2.8 percent in 2012. Similar strong growth is seen in organic products, with 13.5 percent of new products making organic claims in 2015, up from 10.7 percent in 2014.” – MINTEL’S GLOBAL NEW PRODUCT DATABASE (GNPD)

In comparison, the US Department of Agriculture (USDA) has created strict certification requirements and a national, uniform qualification standard for organic products, though organic products have historically generated a less positive consumer response than natural products. Despite general skepticism, there has been tremendous growth in the organic market, with sales of organic products surpassing $40 billion annually. Additionally, a 2016 Organic Trade Association survey reveals that 47 percent of US families are “very familiar” with the USDA organic logo, up from 27 percent in 2010.

Establishing and maintaining consumer trust is a never-ending priority, and requirement, for brands that are leading in the healthy-food sector.


MANY NEW ATTRIBUTES ARE NOW PART OF CONSUMERS’ DEFINITION OF SAFETY

Source: Capitalizing on the Shifting Consumer Food Value Equation, Deloitte

Truth in Labeling In the midst of a “We Want to Know What’s in Our Food” movement, where consumers are demanding more product information, labeling has become a greater concern. Market Research Group’s recent Packaged Facts Consumer Survey found that 39 percent of consumers actively purchase grocery products with “GMO-free” on the labels. However, during a time when food companies are not required by law to list every ingredient, some companies use misleading claims to convince health- and socially conscious consumers to purchase their “healthy” products.

Criteria not traditionally considered as part of “safety” definition

Free of harmful elements

Clear and accurate labeling

Clear information (ingredients/

sourcing)

Fewer ingredients, processing, no artificial

Nutritional content

62%

51%47%

42% 41%

For example, some brands are committing Economically Motivated Adulteration (EMA), or Food Fraud, that involves an undeclared substitution or addition of an ingredient(s) for financial advantage. Other companies are using more specific “free of” claims in product packaging that often identify certain unwanted ingredients while including other ingredients that consumers want to avoid.


Mistrust A measurable level of mistrust clouds the opinions of consumers across demographics, which undermines the credibility of food-product health and safety claims, and results in consumer reluctance to purchase healthy products. The roots of consumer mistrust can be traced to a number of causes.

For example, although Genetically Modified Organisms (GMOs) were generally viewed as safe by food manufacturers, and not disclosed in food products’ ingredient labeling when introduced in 1990, controversy and consumer outrage began to occur in 2013 when safety concerns heightened. Also, a 2016 Stanford University study, a first-of-its-kind national sample and published in Environmental Research, unveiled a link between canned foods and exposure to hormone-disrupting chemical Bisphenol A (BPA). The highest BPA levels, in descending order, were found in canned soups, canned pasta, and canned vegetables and fruit, otherwise seemingly healthy choices.

“More than one-third of consumers (37 percent) would switch brands if another brand shared more detailed product information.”– 2016 LABEL INSIGHT FOOD REVOLUTION

STUDY

Marketplace Identity The benefits of healthy products can become diluted, or in some cases even lost, due to a large selection of similarly labeled products, such as “natural,” “green” and “organic,” among others. What follows is confusion for consumers and a lack of product differentiation for food companies.

Among the ways companies can bring clarity, identity and transparency to their product offerings are through unique ingredients, specific target marketing and branding. Companies that are focused on sustainability and community-improvement differentiate themselves by increasing their authenticity and aligning values with today’s consumers, who seek companies that offer more than low-priced better-for-you foods.


Big Food Dilemma

Consumer mistrust of the food system is giving rise to a number of new marketplace perceptions, trends and behavior. Among the most prominent is consumers’ growing belief that their food health and safety priorities would best be met not by the Big Food brands that have been relied on, in many cases for generations, but rather by smaller brands.

A large and growing number of consumers are branding Big Food companies as less in tune with their voices and overly profit-driven. According to the Natural Marketing Institute, a commanding 72 percent of Americans believe that most food and beverage manufacturers are focused on profit rather than on health.

Conversely, smaller food companies are being lauded for their strong devotion to consumer advocacy and health, and for their commitment to shared values and the public interest. A recent New Hope Network survey indicates that 67 percent of consumers had a “great deal” or “quite a lot” of trust in small companies, while only 21 percent had the same degree of trust in big businesses. One of the leading reasons for this perception can be traced back to supply systems.

“In the last five years, the top 10 branded food manufacturers lost 4.3 percent of market share mainly to smaller and mid-sized companies.” – COMPANIES STEP UP EFFORTS TO REVEAL MORE

DETAILS ON FOOD YOU EAT, THE WALL STREET JOURNAL, MARCH 13, 2016

Big Food companies are often laboring under monolithic, outdated legacy supply systems that were developed decades ago, while smaller companies’ systems are generally newer and more aligned with consumers’ demand for transparency. The result is nimble systems that can better accommodate the rising market for better-for-you foods.

Acceleration in Acquisitions While Big Food brands continue to dominate sales, a recent Fortune Special Report: The War on Big Food shows that some may be struggling, with the top 25 US food and beverage companies having lost an equivalent of $18 billion in market share since 2009. What has followed is a strengthening migration to, and a host of new opportunities for, small companies, and a flurry of mergers and acquisitions by Big Food companies of smaller brands that allows for market entry with more convenience and less risk.

Dealogic reports that in 2015, food merger and acquisition activity was responsible for more than $116 billion worth of deals between US companies, which stands as the largest dollar amount in at least two decades. Also, by the middle of 2016, disclosed food and beverage deals were valued at more than $43 billion, which although less than the $74 billion worth of deals during the same period in 2015, nonetheless ranks as the second-highest level overall since 2008.

There are a number of food-industry acquisitions that have captured the attention and interest of large and small companies alike, both within and outside the food sector, as well as among investors and members of the media.

Each year, food brands launch better-for-you products that gain both significant consumer traction and loyalty as well as brand awareness.


GROWTH BY ACQUISITIONDanone’s Acquisition of WhiteWave Foods In July 2016, Danone announced the acquisition of WhiteWave Foods for $12.6 billion, or 26.6x EBITDA. The acquisition represents a 24 percent premium over WhiteWave’s 30-day average closing price of $45.43, and the largest deal to date in the natural and organic foods industry.

Danone believes the acquisition will create a unique global leader strongly aligned with consumer demand for healthier and more sustainable food and beverage options. The acquisition also provides Danone with a foothold in the fast-growing plant-based sector through the WhiteWave Silk, Alpro and Vega brands.

The company estimates that the acquisition would likely make Danone, with its Stonyfield, Horizon and Wallaby brands, the largest buyer (by tons) of organic milk in the US. Plant-based alternatives to milk and yogurt are growing at an 11 percent Compound Annual Growth Rate (CAGR) in the US, while organic dairy is growing at eight percent.

Pinnacle Foods’ Acquisition of Boulder Brands Pinnacle Foods announced in November 2015 that it would acquire Boulder Brands, a US food company based in Boulder, Colorado. Boulder Brands is known for its better-for-you brands such as Smart Balance, Udi’s, Glutino, Earth Balance, EVOL and Best Life.

Pinnacle paid $967 million for Boulder Brands, or 22.1x EBITDA. Pinnacle’s health and wellness portfolio was further expanded by the acquisition, and the company plans to increase EBITDA by approximately 50 percent.

General Mills’ Acquisition of Annie’s In September 2014, General Mills announced its acquisition of Annie’s, a Berkeley, California-based maker of natural and organic pastas, meals and snacks. General Mills paid $821 million for Annie’s, or 38.6x EBITDA. The acquisition is expected to expand General Mills’ presence in the US branded organic and natural-foods industry, with General Mills planning to use its scale to further strengthen the Annie’s brand.


Transparency Mandate

Contact UsTo learn more about how the Headwaters MB team can help you grow from the food industry’s strengthening transparency mandate, please contact:

Hormel’s Acquisition of Justin’s In May 2016, Hormel announced its $286 million acquisition of Justin’s, a maker of natural and organic nut butter and nut butter snacks. Hormel was drawn to the company’s authentic position in the better-for-you snack category, strong management team and health-conscious customer base.

Bill Harrison Managing Director Head of Consumer Investment Banking (917) 596.5533 [email protected]

Leigh Hudson Managing Director Consumer Investment Banking (415) 850.3729 [email protected]

Tyler Comann Managing DirectorConsumer Investment Banking (415) 272.2463 [email protected]

Shaun Kalnasy Director Consumer Investment Banking (404) 502.2946 [email protected]

Coveted consumer audiences across demographics are looking to food brands for products that meet their ever-rising standards for transparency, better-for-you ingredients and global citizenry. The result is a mandate for food companies to factor those standards into their

formulations, production, marketing and management decisions. Only then will they achieve the brand recognition, repeat customers and pricing power to achieve genuine competitive advantage and long-term growth.

Hormel expects Justin’s to grow at low double-digit rates from a starting point of approximately $100 million in 2017 net sales. Justin’s complements Hormel’s SKIPPY brand and Hormel plans to apply its key resources, supply chain, finance and R&D capabilities to further grow the Justin’s brand.

A new reality has dawned on store shelves across the US and it reflects a level of truth and openness that has yet to be seen in the food sector.


Disclosure: This newsletter is a periodic compilation of certain economic and corporate information as well as completed and announced merger and acquisition activity. Information contained in this newsletter should not be construed as a recommendation to sell or buy any security. Any reference to or omission of any reference to any company in this newsletter should not be construed as a recommendation to buy, sell or take any other action with respect to any security of any such company.

We are not soliciting any action with respect to any security or company based on this newsletter. The newsletter is published solely for the general information of clients and friends of Headwaters MB, LLC. It does not take into account the particular investment objectives, financial situation or needs of individual recipients.

Certain transactions, including those involving early-stage companies, give rise to substantial risk and are not suitable for all investors. This newsletter is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

Prediction of future events is inherently subject to both known and unknown risks and other factors that may cause actual results to vary materially. We are under no obligation to update the information contained in this newsletter. Opinions expressed are our present opinions only and are subject to change without notice. Additional information is available upon request.

The companies mentioned in this newsletter may be clients of Headwaters MB, LLC. The decisions to include any company in this newsletter is unrelated in all respects to any service that Headwaters MB, LLC may provide to such company.

This newsletter may not be copied or reproduced in any form or redistributed without the prior written consent of Headwaters MB, LLC. The information contained herein should not be construed as legal advice.

Endnotes 1 2016 Label Insight Food Revolution Study 2 2016 Label Insight Food Revolution Study 3 Is GOOD Still Growing, 2015 Conscious Consumer Spending Index (Good Must Grow)

Headwaters MB is an independent, middle-market investment banking firm providing strategic merger and acquisition, capital-raising, and special-situations advisory services. Named Investment Bank of the Year by major industry organizations in 2014 and 2015, Headwaters MB is headquartered in Denver, CO, with six regional offices across the United States and partnerships with 18 firms covering 30 countries. For more information, visit HeadwatersMB.com.

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