Craig Sabina, McDermott & Bull’s Active Outdoor & Sporting Goods Practice Chair, recently had the opportunity to sit down with Tim Burke, Castanea Partners’ resident Outdoor industry enthusiast and leader of the firm’s investments in the sector. While there is no doubt that the Active Outdoor & Sporting Goods business and many others have been transformed by the emergence of professional private equity investment, we are fortunate to have Tim and his team helping us all get better at what we do.
McDermott & Bull (MB): Please share your thoughts on the state of the Outdoor & Sporting Goods industries.
Tim Burke (TB): At Castanea, we are focused on opportunities in the Outdoor industry and are very selective in the broader Sporting Goods market. We believe the Outdoor sector remains a very attractive place to invest, with the opportunity to back inspired founders that have built highly technical products and developed really passionate and loyal consumer bases. We also have a lot of experience working not only with the larger format retailers in the Outdoor sector, but also with the independent channel that is often the lifeblood of the industry.
The macro trends in this market are solid, as people of all ages seek out an active and healthy lifestyle. We are finding several sub-sectors with demographic tailwinds driving increased participation and engagement. There are parts of the market where participation is declining, and others that are simply just too niche for us, but by and large, we plan to be significant investors in the sector.
While we on occasion can find the same characteristics in the broader Sporting Goods sector, we are being much more selective there. The retail landscape is obviously going through some meaningful dislocation, and the competition for shelf space is often dominated by powerful multi-billion-dollar players. The big guys suck up a great deal of oxygen.
More specifically regarding our investment focus, we look for companies with revenue of $20-$150M that have shown significant growth, or at least the potential for significant growth. This poses a bit of a challenge, as these sectors are often bifurcated, with several very large ($250M+ revenue) companies, and hundreds of businesses that are just too small for us. Our primary focus is on the management teams, as we seek to back folks with integrity, but also the talent and experience to manage a high growth business. The good news is that in this sector you don’t need to worry about the management team members’ authenticity, as they are usually enthusiasts and heavy users of their products. We look for businesses with strong (40%+) gross margins, as that indicates to us that they are selling a truly differentiated product for which the customers are willing to pay a premium. Finally, while it’s nice to find a business that is also quite profitable, we are more than willing to back a company that is at a stage of its development where profits are being invested in team building, brand building, etc.
We are willing to explore hard goods, apparel and footwear businesses. While each have their respective and unique challenges, we believe all three product categories provide real opportunity for growth. Hard goods companies, to generalize, can exhibit slower turns and lower gross margins, but often can more readily distinguish themselves on a performance basis (versus the whims of fashion) through a “hero product,” and often command a high ticket. Apparel and footwear businesses can often scale meaningfully if/when a technical product is adopted into broader use occasions (i.e. Becomes a “lifestyle brand”), but we have a healthy respect for the merchandising challenges that accompany building apparel and footwear businesses.
MB: How do you view retail & e-commerce channels as they relate to the industry?
TB: Today it is highly unlikely we would invest in a purely wholesale brand. We have found that pure direct-to-consumer companies are either having a hard time scaling profitably, or have already raised capital at lofty valuations. We are most interested in omni-channel brands that have demonstrated the ability to sell effectively at wholesale and have a strong DTC (web and/or owned retail) effort.
Within the wholesale channel specifically, we look for brands with sufficient pull from the trade to enable them to control their own destiny. They can do that in a multitude of ways, including “shop in shop” partnerships with their independent and large format retail partners, in-store marketing programs, creative terms, etc. There really is a way to forge a mutually beneficial wholesale relationship, even if these younger brands need to invest resources or capital to help fund these efforts. We have found a significant return on these investments for our brands. These smaller companies can often be more nimble and creative than their larger competitors.
One significant challenge that brands in the retail channels face is the increased proliferation of private label brands. Retailers are dedicating much more of their shelf space to their own brands. The only way to combat this is to be a top 2 or 3 brand with demonstrated consumer pull that the retailer simply must carry.
MB: How is the role of Private Equity evolving in the industry?
TB: I am, of course, a little biased, but when founders and private equity investors have shared passion and chemistry, the outcomes can be very solid. Private equity investors bring a ton of resources, deep strategic capability, and useful pattern recognition within this industry, and often in related consumer sectors that create relevant insights. For example, we have several investments in the beauty and personal care sector, where companies are pioneers in social media and the emerging world of influencer marketing. We are taking some of these lessons and applying them to the Outdoor sector. The less sexy part of the value we hope to add is in the critical back office functions. Usually we are backing teams with very strong brands and cool products, but we are called on to lend support in areas where we have significant resources like operations, finance, and distribution.
Of course, for us the bad news is that as more private equity firms target the Outdoor and Sporting Goods sectors, valuations have gone up meaningfully. Bad for us, but good for the companies in the space. We would just encourage owners, whether they are selling a minority or majority stake, to take as much time as they need to ensure the fit with their investor partner is extremely solid.
MB: How would you define the leadership and talent pool in the industry?
TB: In this industry, we never have to worry about owners “walking the walk.” Outdoor industry companies are typically led and run by passionate founders who “get” their customer’s needs, and recognize unique market opportunities. So often they absolutely nail it because they are the customer they hope to serve.
One challenge in this sector is that the leaders of these businesses often don’t have a multitude of different company building successes in their past, and the company they are running is usually the biggest and only business they have ever run. And another is that leaders are sometimes loathed to hire anyone from outside the industry. But we have seen the leadership pool in the sector continue to grow nicely and have confidence that we can continue to find great folks with whom to partner.
MB: Anything else you would like to share?
TB: Just that we are honored to be investors in this segment and to be trusted partners to the people that are building the next great brands in this industry.