Kellogg Conference Notebook: Keynote by Chuck Esserman, TSG Consumer Partners

The following was written by Joel Stanwood, a 2nd year MBA at the Kellogg Graduate School of Management. Joel has worked with two private equity growth-oriented funds, focusing on consumer products and healthcare/financial/business services. Prior to Kellogg, Joel served in strategic, operational, and general management roles at Siemens, was recruited into the firm’s international management development program and is certified as a Lean Six Sigma Black Belt.

Keynote: Chuck Esserman, co-founder and CEO of TSG Consumer Partners

The 2010 Kellogg Private Equity and Venture Capital Conference was pleased to welcome Chuck Esserman, head of TSG Consumer Partners, to deliver the Private Equity Keynote Speech. TSG was founded in 1986 as the first PE fund solely focused on investing in middle-market, branded consumer product companies. The firm has raised five funds, and currently has $1.4 billion in capital under management. Given the overall theme of the conference, “Partnering Through Uncertainty: Unlocking Value in a Changing Landscape,” Esserman explained the unique TSG approach to unlock value.

He began by suggesting that TSG’s investment approach appears to look like a primer on how NOT do to private equity deals. However, the strategy has performed consistently well through multiple economic cycles. For example, the usual private equity investment philosophy is to seek firms with attractive purchase valuations (the lower the better), exchange downside protection for upside potential, avoid companies with low market share and seek a controlling ownership block.

In contrast, TSG will pay top dollar for great companies, will exchange upside opportunity for downside protection to avoid negative investment returns, maintains focus on small and medium size companies that may have negligible market share (but always clear, differentiated consumer benefits), and is indifferent between purchasing a majority or a minority ownership stake. Furthermore, TSG uses little or no leverage, invests all company profits (or more) in growth, and will patiently court companies for years, if necessary. TSG will even provide interim marketing counsel and operational assistance….for free.

Somehow doing everything “wrong” has worked out quite well for TSG and its investors. On average, TSG portfolio companies increase annual operating income by 35% annually during the investment period, and portfolio operating income grew by 18% and 19% during the “Great Recession” years of 2008 and 2009, respectively. As a result, the cumulative enterprise value for recent investment exits was $3 billion, compared to only $300 million when purchased. Furthermore, TSG’s funds are oversubscribed: the firm turned down over $1 billion in LP commitments during its latest fund-raise.

The TSG team likes to find products that many would-be suitors dismiss as fads. Examples include Vitamin Water beverages, Smart Balance “better-for-you” foods and PureOlogy premium hair care products.

Esserman concluded by sharing some more general private equity insights. First, specialized operational expertise matters more than financial expertise, and that is true now more than ever. Second, restricted access to bank debt should be viewed as a positive thing, since it encourages reinvestment into company growth and reduces investment risk. Third, private equity fund returns will be increasingly correlated with growth rates of portfolio companies, and capital structures will need to change significantly. Finally, structured equity investments versus leveraged buyouts will become increasingly common for the foreseeable future.

As for TSG, expect the firm to stick to its knitting: Continued focus on strong brands in the lower and middle market, cautious approach to leverage, and hands-on partnership with the best management teams in the industry.