January, 2010

by Mike Nave
The Beauty Industry Report

Over the last 15 years, the professional beauty industry experienced significant merger and acquisition activity, spearheaded by large global personal care product companies, such as Proctor & Gamble, L’Oréal and Shiseido. Until that time, the salon industry was a quiet, overlooked marketplace. Now, those days are past, and today, many salon brands have become more visible and attractive to prospective investors and acquirers. One of the companies that has also been making investments in beauty companies quietly and under the radar is TSG Consumer Partners (TSG). TSG is an investment fund focused on branded consumer products and has been involved in many of the fastest growing and most innovative consumer brands in several sectors. I have known Alex Panos, a managing director of the firm, for years and am delighted to share my interview with him.

Beauty Industry Report (BIR): What is TSG? Tell me about its history.
Alex Panos (AP): TSG is an investment fund, focused on branded consumer products—primarily beauty, food and beverage. We were founded in 1987 as an alternative to both venture capital and leveraged buyout firms. Venture capital groups provide capital to new companies, but make dozens of investments at a time (too many). Leveraged buyout firms are focused on fewer investments, but use debt to drive their financial returns (hence the word “leverage” in their name). We tried to take the best of each and avoid the worst. We focus on companies that are growing and profitable. We make fewer investments and do not rely on debt to drive our returns. We are focused on driving value through sales growth and strategic value. It seems to have worked so far!

BIR: How much capital do you manage and who are your investors?
AP: We are currently investing our fifth fund, called “TSG5”, which has $900 million in committed capital. Our investors include state pension funds, universities and a number of wealthy individuals. Many have been with us through several funds. I also invest a significant amount personally in each deal.

BIR: What is your role in the firm?
AP: I am a partner and managing director in our New York office. I spent 10 years in San Francisco then came to NY two years ago.

BIR: How would you describe TSG’s mission?
AP: We want to help great entrepreneurs be even more successful. We also want to build great consumer brands with products that enhance people’s lives.

BIR: What kind of companies do you target?
AP: We target companies that have high margins, unique points of differentiation, good growth potential and strategic value. We look for companies that have at least $15 million in sales, and many of our investments are much larger.

BIR: Are there many companies that meet that threshold in the beauty sector?
AP: Not too many, but enough to make it interesting for us. I am always surprised by how large and profitable certain companies are. We also meet many companies that are smaller—but we want to know them early—and we find a way to be helpful to them as they develop. Companies can grow into our target size within a couple of years.

BIR: How do you finance your deals?
AP: We typically “over-equitize” our deals – so we use very little debt, if any. When we have a great brand that is responsive to marketing and can expand distribution, we want to support that growth. We need a healthy balance sheet to achieve this.

BIR: What investments do you have in the beauty sector?
AP: We are the leading investor in the sector with stakes in five beauty companies over the last 5 years: PureOlogy, which we sold to L’Oréal; Perricone MD (skin care); Pevonia (skin care); Alterna (hair care) and Smashbox (makeup). Women’s Wear Daily just ranked TSG #81 in their recent Top 100 Beauty Companies list.

BIR: Tell me about the PureOlogy transaction.
AP: Jim and Cheryl Markham were building an extraordinary business with unique products. With our transaction, they were able to take meaningful dollars off-the-table, then be even more courageous with their business and pursue even more growth over the next several years. It was a way to “monetize” and then “recreate” wealth. Together with TSG, they sold the business to L’Oréal for a top-tier price.

BIR: What does TSG bring beyond capital?
AP: As we did with PureOlogy, we commit a team of people that supports each of our Partner Companies on business development, operational and financial projects. We bring strong relationships with major retailers and distributors. We can recruit executives, if needed. We also share certain resources among our companies.

BIR: You used the phrase “Partner Company.”
AP: Yes. I believe language is important. I never say “Portfolio Company.” That would change the hierarchy and nature of the relationships I have with our founders and management teams.

BIR: How do you find deal opportunities?
AP: We actively identify deals on a direct basis. We pick a category, then visit all of the best companies in that category. I typically know an owner long before an investment opportunity arises. I am here when they are ready. I also often “earn” my way into an investment, by helping a company for years before I actually make an investment.

BIR: Do you only take majority stakes?
AP: Many of our recent deals have been minority stakes. It’s often the best way to partner with companies that would otherwise not do a deal. As long as we share common business and personal values, it matters less to me who has the majority.

BIR: What specific type of investments are you targeting in the beauty sector today?
AP: We value companies that are focused on the more profitable distribution channels, such as specialty retail, spa, salon, internet and television shopping. We are also looking for companies with product innovation.

BIR: What challenges do you see in the coming years for small-to-mid-size beauty companies in the professional channel?
AP: The consolidation of distributors creates a challenge for sure. Getting focus from distributors and salons is getting harder and harder. Innovative products become even more important, as do relationships with stylists and estheticians. The better companies are investing in training, helping beauty professionals be more successful in their own business- they build loyalty that way. Diversion is also a challenge.

BIR: What financial metrics are most important to you when evaluating a business?
AP: Sales, gross profit and EBITDA are obvious ones. Historical sales growth and some visibility into the future are also important. We favor high gross margins to provide us the dollars we need for marketing. We also look at Free Cash Flow, which is EBITDA less any capital expenditures and increases in net working capital.

BIR: What about the less obvious metrics?
AP: There are many. We look at Sales Per Point of Distribution—a high level of “velocity” is very important to us. It’s a good starting place. Then we have the basis to invest in distribution expansion. We look for strong loyalty, measured by repurchase rates. We also research how often stylists recommend a product to their customers, and how often consumers recommend it to their friends.

BIR: What else is important to you?
AP: I look for founders who are passionate about their business and for companies with a pipeline of innovative new products. We also favor businesses that have been built over many years with many small customers, “brick-by-brick”. In the case of companies that work with distributors, we favor those that have collected data on their end retail accounts and even have a relationship with these accounts. That customers’ list is gold for the long-term, and something you can take with you, if you ever change distributors. Moreover, I encourage companies to build a relationship with the end-consumer. (In the case of hair care, that could mean stylists, too.) We love companies that communicate with consumers and other constituents directly via email and events. We also look for companies that have strong media that drives sales. That could be via editorial on new products or via a charismatic founder.

BIR: What is it about the professional beauty industry that attracts you?
AP: It has some of the most dynamic entrepreneurs I have ever met. Many started as hairdressers and then built very large businesses. Farouk Shami at Farouk Systems is a great example; I admire him a lot. This is also an industry that welcomes—even craves—new products. That is good news for what I call “challenger” companies. It’s an industry that is not only for the incumbent big players.

BIR: What are some notable TSG successful investments outside of beauty? Are there any lessons you can apply to the beauty sector?
AP: We have invested in such beverage brands as vitaminwater, Muscle Milk and Mona Vie and food brands such as Terra Chips and Smart Balance. We try to apply what we have learned across sectors. One example is the local marketing activities of vitaminwater. They launched city-by-city and coordinated PR, events, and distribution to really work together. When you heard about the product, it was on the shelf for you to buy. They were also very systematic in how they marketed products to different “influencer” groups—a form of network analysis, similar to how pharmaceutical companies market new drugs to groups of doctors.

BIR: What is the common quality?
AP: All of these companies are selling branded consumables. We like companies that can build an installed base of users—people who essentially come back to you for a refill— and to see what else you have, because they are hooked! Also, many of the products we invest in have what I call “badge” value, where a consumer is buying the product because that product tells the world something about who he or she personally is.

BIR: What other common threads are there in your strategy?
AP: We like companies that compete with the “Big Guys.” The beauty sector certainly provides us with that situation, as do the beverage and snack sectors. Each has large companies with significant market share. And these “Big Guys” occasionally get a bit complacent, and they often move slowly. That creates meaningful opportunities for entrepreneurs—and TSG.

BIR: Tell me about your involvement with The Wharton School of Business.
AP: I received both my BS and MBA at Wharton and valued my experience. I just endowed a Research Fund for Marketing at the school. The marketing professors are brilliant and are doing phenomenal work around consumer buying behavior and how and why certain brands break through.

BIR: What should entrepreneurs look for when considering an investment partner?
AP: Talk to several people with whom they have invested. Look for someone who shares your business and personal values. Ensure they become a fiduciary for you too—not just their own investors. Make sure there is alignment around exit—both the timing and to whom. Find out how well they really know the industry and what specific relationships they have. Make sure they bring value beyond money. You want the right mix of someone who is value-added and stays out of your way. Otherwise, it might be better to just keep the business in the family.

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