Last week Mars bought Hotel Chocolat for an eye-watering £534m. It’s a deal that would stand out at any point, but one that’s particularly notable in a year in which large food-and-drink M&A deals have almost completely dried up.
On the face of it, the price seems… steep. £534m is a 170% premium to Hotel Chocolat’s closing stock price the day before the deal was announced. That’s a great deal for HC’s shareholders – not least its founders, Angus Thirlwell and Peter Harris, who stand to pocket £144m each. But lots of commenters have implied that it’s not a good deal from Mars’s perspective, or that spending half a billion pounds on a somewhat distressed business that reported a loss in its last accounts is an act of corporate insanity.
Now, businesses panic and make terrible decisions all the time. I certainly wouldn’t argue that a decision is a good one simply because it was made by a large corporate. But it’s like Chesterton’s fence: if you can’t make an argument for why a decision could have been a good idea, you probably have no business arguing that it was a bad one.
In trying to argue that it was a good idea, there are two broad questions to answer. First, was the acquisition itself a good idea, separate from the valuation? And second, was the valuation reasonable?
The acquisition would be sensible for HC if their prospects were better within Mars than they would be if they continued as an independent business. And it would be sensible for Mars if spending the money on this acquisition were to generate better long-term returns than investing it in something else in the business (or just returning the cash to shareholders) would.
These are arguments that both businesses have had to make to their respective shareholders. The general thrust (made in Mars’s rule 2.7 filing) is that, in order to grow, an independent HC would need to invest a lot in building their own global supply chains and manufacturing capabilities. This is capital-intensive, risky, and would depress HC’s profits for a significant period of time. As a double whammy, an independent HC would be a small, undiversified and risky proposition for lenders and investors, which means it would have to make all this investment with capital that was comparatively expensive to acquire. That would at best mean slow, tough growth for years to come, and created the risk that it would run out of cash before ever properly taking flight.
These drags on HC’s future prospects are removed almost in one fell swoop if it becomes a part of Mars. Mars has a well-established global supply chain that HC can immediately access, has been manufacturing chocolate at scale for decades, and – given it’s a $45-billion business – has access to pools of cheap capital that HC could simply never tap.
From Mars’s perspective, its portfolio lacks a premium option, something to go toe-to-toe with Lindt, or Yıldız’s Godiva, or Mondelēz’s Hu. For a large, mass-market generalist like Mars, building a focused, premium brand from scratch is difficult. But buying one once that brand has done the hard work of pushing forward the frontiers of a category and when they’re ready to embrace the mainstream is a no-brainer. Of course, as a privately held business (still 100% owned by the family of the founder!), they don’t have the short-termist whims of fickle and flighty shareholders to deal with, and can afford to make long-term bets.
So: a sensible acquisition for both sides. What then of the valuation, the bit that seems most bonkers on the face of it? To justify it, you have to be able to make one or both of two arguments: either HC was undervalued by the market before the deal, and the deal price represents something closer to the fair value of the business; or the deal itself unlocks value that was unachievable beforehand, and the deal value simply reflects a reasonable splitting of that upside.
The most prominent person I’ve seen advance the former argument is outspoken Hut Group founder Matt Moulding. He claims that the UK is such an investment backwater that any UK-listed company inevitably trades at a significant discount to its true value. London, he points out, actually lags behind Indonesia, Turkey and Romania in the value of its IPOs this year. Moulding’s argument is that HC shares were trading at below their IPO price, despite massive growth over the years, because of some structural issue with UK markets. “Today,” Moulding wrote, “it’s the norm for investors to want huge discounts to invest in UK listed stocks versus UK private companies, or overseas public markets.”
I’m not sure I buy that.1 HC was trading at 508p early last year – that’s 3.5× the IPO price. The decline to 100p is recent, and reflects 18 months of profit warnings, HC shuttering its US business, a poor performance over the crucial Easter period, and the business declaring an operating loss in October. That low price is not due to anything structural; it’s just a manifestation of shareholder anxiety for the future viability of the business.
That’s the essential way to frame it, I think. The recent trading price represents the market’s belief that the last year of HC’s trading showed where it was headed in the future. The sale price represents a bet by Mars that the business could return to where it was a couple of years ago, and that it’s worth now what the market thought it was worth then. It’s simply a question of who’s right.
To me, the last year was a blip: the result of Covid, inflation, and all the other macro oddness we’ve experienced, but also the result of a capital-hungry business not having the cash it needed to do things properly, and facing the uphill struggle of creating a global supply chain from scratch. Teaming up with Mars changes that picture completely.
If it was a sensible acquisition at a reasonable valuation, the only question that remains is why the founders were able to capture so much of the difference between the recent market cap and the final sales value. Why didn’t Mars drive a hard bargain, and pick up a business that they clearly considered to be worth ~£500m for a more typical ~40–50% premium to the market value – so £215m–£230m?
That’s where the founders have really shone. Holding a majority of shares privately, they were able to hold out for a valuation they believed in and maintain their confidence in the potential of the business they’d built. It probably helped that there were other potential suitors: Nestlé’s portfolio is conspicuously lacking in a premium option, for example.
Mars wasn’t Thirwell and Harris’s only option, but I suspect it will turn out to be a brilliant home for their business. I always keep Dan Davies’s phrase in mind: “if you don’t make predictions, you’ll never know what to be surprised by.” My prediction is that Hotel Chocolat will thrive under the stewardship of Mars. I think it will function for Mars like Nespresso has for Nestlé, giving them a premium, differentiated, bricks-and-mortar retail experience and D2C business that allows them to talk to a completely different kind of consumer on a completely different kind of occasion. I think we’ll look back in five years’ time and think that £534m was a bargain.