Natural Products: In Focus on Wall Street

What once was lost now is found.

The year 2001 was an eventful one for many reasons, but for the natural products industry, it led to a rekindling of interest from both private and public investors. The investment cycle for this industry last peaked in mid-1998 and began to decline for two primary reasons. The first, and most obvious to those in the industry, was the rapid deceleration of demand for nutritional supplements, which has played havoc with the entire natural products industry during the last three years. The second, and likely equally important, was the shifting of nearly all new venture capital and public-equity investment into the technology sector, which saw its own peak in the spring of 2000.

The subsequent and viciously significant decline in valuations of the technology sector drove capital, both public and private, in search of new areas of growth. Since spring 2000—it should come as no surprise—the natural-products industry has outperformed the technology sector on Wall Street.

A look across some of the larger public equities in the U.S. natural-products industry illustrates the strong stock performance this year: NBTY Inc. (NBTY) is up 130 percent year-to-date, Whole Foods Market (WFMI) is up 60 percent, and United Natural Foods (UNFI) is up 50 percent. The higher public valuations, consistently strong annual growth and youth of the overall sector, especially considering the declining fundamentals and valuations of the technology sector, have led to renewed interest from private-equity investors.

It is difficult to quantify the increase of private-equity capital now earmarked for natural-products investment, but we believe that it has increased significantly. As an investment bank focused on this sector, my company witnessed this interest simply by the volume of private-equity inquiries. In early 2000, it was rare for us to get an unsolicited call from a private-equity investor unless it was from a mainstay of the industry. Today, however, it is equally as rare for us to go more than a couple of days without a handful of unsolicited calls from private-equity firms that are new to the natural products sector and doing initial research on the industry.

The rising private-equity interest is easy to understand. As the markets peaked in 2000, money poured into private-equity funds in search of the next eBay. The subsequent burst of the technology bubble and the realization that the Internet would not put the rest of us out of business in less than a year led to a near halt of new-technology investment and a piling up of uninvested private capital.

We anticipate, barring any significant changes in the equity markets, that 2002 could be the best year for new equity investment, both public and private, in the natural products market since the mid-1990s. The youth and fragmentation of the industry provides an opportunity for rollups, and the rising consumer demand creates opportunities for new entrants and larger players. The nutritional supplements industry should be the exception, because continued weak consumer demand and rampant overcapacity still imply that consolidation of existing players must occur prior to new capital entering this market. Rather, we anticipate natural and organic foods specifically, but also natural personal care and other natural consumer products sectors, will be the recipients of new capital. I am personally excited about the prospects for 2002 and eager to see the next progression in the industry.

Scott Van Winkle is an analyst for Boston-based Adams, Harkness & Hill.