March 1, 2010

by Mark Calvey
San Francisco Business Times

“You don’t have a great year without a great decade,” says TSG CEO and co-founder Chuck Esserman. “The 2009 we had reflects the great decade we had since 2000.”

TSG Consumer Partners’ relatively low profile belies its steady performance in building national brands.

The San Francisco private equity firm has invested in several well-known brands, including VitaminWater, Smart Balance spreads and Famous Amos cookies. In its most recent sales, the company has earned a tenfold return on its invested capital, turning $300 million invested into $3 billion at the time of sale.

Last year, as Wall Street was hitting its March lows, TSG invested in several promising consumer product companies, including San Francisco-based Pop Chips and Benicia-based Muscle Milk.

While other private equity firms borrow heavily to make a deal work and hedge funds often seek quick profits, TSG finds itself among the Bay Area’s private equity firms sticking with successful small companies and growing them into big ones.

“We’re driving our returns by good old-fashioned growth,” said Hadley Mullin, a managing director at TSG. “That approach has served us well in the downturn.”

For its strong track record and willingness to write investment checks as the Great Recession wore on, TSG Consumer Partners has been named the San Francisco Business Times 2009 Dealmaker of the Year.

“You don’t have a great year without a great decade,” said Chuck Esserman, CEO of TSG, who co-founded the firm with Gary Shansby in 1987. “The 2009 we had reflects the great decade we had since 2000.”

Ignoring noise in the marketplace

The firm chalks up its long-term success to its ability to focus on consumer products, avoiding distractions like the technology sector or the dot-com boom — and bust.

“We feel we’re getting better every year in the focused world of consumer-branded products,” said James O’Hara a TSG managing director. “All the experience, industry relationships that we developed in the 1990s, served us well in the 2000s.”

That might be something of an understatement, given the 17-fold return it made on its investment in VitaminWater. TSG sold its 30 percent stake to India’s Tata Group for $677 million, which turned around and sold it a year later for $1.2 billion as part of Coca-Cola’s $4.1 billion purchase of Glaceau, maker of VitaminWater and SmartWater. No wonder visitors to TSG’s offices today are offered VitaminWater.

TSG differs from the traditional venture capital model that allows a home-run investment to make up for several strike-outs.

“We have a portfolio of companies, but for the entrepreneur this is their one shot,” Mullin said.

VitaminWater, like most products the firm eventually invests in, was discovered as Esserman and Shansby walked the supermarket aisles.

The firm recently offered a glimpse into just how methodically it goes shopping. TSG assigns “category captains” to oversee consumer product lines, such as outdoor products or food. The captains keep up with the trade press, attend trade shows, walk stores around the country and build relationships with the buyers who stock store shelves.

Every Friday, TSG’s category captains gather at the firm’s headquarters in the Transamerica Pyramid to compare notes and assess potential investments.

It may take years for TSG to get an opportunity to invest in a company. Such courtships are common among so-called growth private equity firms like TSG and Summit Partners. As seen by TSG’s former stake in the maker of VitaminWater, the firm doesn’t require majority control to cut a deal.

“The owners have wonderful businesses, and it’s often hard to strike a deal,” O’Hara said. “But it’s worthwhile to invest the time, because if you manage it right, a strategic buyer will pay almost any price for the company.”

“We don’t necessarily invest at a low valuation, and often it’s a high valuation, but we’re still able to achieve extraordinary returns,” O’Hara added.

The firm’s six partners, four in San Francisco and two in New York, take a strong liking to companies in an industry category coming to market with a unique angle or innovation, but with limited distribution.

“A lot of the businesses we invest in have a lot of distribution opportunity, or what we like to call ‘white space,’” O’Hara said. VitaminWater was mainly distributed in the New York City area while Pureology, a shampoo for those using hair coloring, had limited availability in salons.

“They do a good job of supporting their portfolio companies,” said Brent Knudsen, founder and managing partner of Partnership Capital Growth, a capital advisory firm in San Francisco. PCG represented the maker of Muscle Milk in securing the TSG investment. He noted that TSG helped provide a larger line of working capital to fuel the company’s growth without requiring the company to get additional capital at a bank.

TSG places little if any debt on a portfolio company’s books to make an investment happen. That’s a big advantage as private equity firms that rely on large amounts of debt for deal financings are sitting on the sidelines or nursing portfolio companies flirting with bankruptcy.

As he leads a firm in close touch with consumers, Esserman does not believe shoppers will return soon to the spendthrift ways of recent years.

“The economy is going to continue to be difficult over the ensuing years,” Esserman said. “A lot of people have lost their jobs and job creation will be a continuing issue.”

As if to underscore Esserman’s forecast, consumer products giant Procter & Gamble said this month that it lowered its long-term earnings growth outlook and Campbell Soup, often a recessionary favorite, indicated it may have to cut prices to get shoppers to continue reaching for its red-and-white label.

“It’s going to be a long time before we get back to the days when people were so much more willing to spend as they felt wealthier from their real estate portfolios and 401(k)s,” O’Hara said.

Of course, Esserman and his team remain optimistic.

“While the economy remains challenging, there are still opportunities to find good companies,” Esserman said.