Dream beer deal loses froth

Promise of boom after SABMiller takeover fails to fly

PREMIUM


A group of men, apparently cast by an advertising agency to look like either Eddie Murphy or Patrick Swayze, are sharing a joke while holding cans" and bottles and mugs of Lion Lager. Back in the winter of 1989, this was front-page news. Nelson Mandela was still behind bars and SA was a belligerent, isolated place when SA Breweries started making multiracial advertisements.
SAB was challenging the laager mentality — with a lager. And getting those beers in the hands of all potential consumers was the thing the brewer knew exactly how to do.
Founded in 1895 to cater to the demand of Joburg’s thirsty fortune-seekers and listed two years later as the JSE’s first industrial stock, the brewer had for nearly a century known only one market. But it knew that market inside-out.
Though apartheid was still officially in force in 1989 its days were numbered. Soon the Berlin Wall would fall, pulling open the Iron Curtain and forcing South Africans to the negotiating table. A return to the global community was a golden opportunity for SAB. It would take the company a little more than a decade and a string of acquisitions to become the second-largest brewer globally.
Another decade-and-a-half later — by then it was an established giant called SABMiller — it was the biggest takeover target in corporate history when Anheuser-Busch InBev (AB InBev) came knocking with a $106bn takeover offer in 2016. The deal promised $3.2bn worth of every management consultant’s favourite word: synergies".
Investors were wowed by AB InBev CEO Carlos Brito’s promises that rather than cutting costs, it would use the platform to grow. "We don’t have any duplication to deal with in SA," Brito told the FM in 2016.
"That’s not the issue here. The issue is much more about how we can grow the business, how we can grow the global brands we’re going to be bringing here."
Investors who swapped their SABMiller shares into AB InBev got access to a company that sold eight of the top 10 beer brands in more than 150 countries — including Budweiser, Brahma, Stella Artois and Corona — with 175,000 employees.
Only, it’s been a dreary disappointment. Since AB InBev began trading on the JSE on October 11 2016, the stock has fallen 36% to R1,192 today — better than the R930 it touched in January, but dismal nonetheless.
While it’s true that $2.9bn in "synergies" has been delivered since SABMiller became part of its larger rival, something strange also showed up in the brewing giant’s annual results for 2018, released last month. Out of more than 50 markets, SA was flagged, along with Brazil and Argentina, as one of the worst performers in the portfolio.
What happened? How is it that the largest takeover deal in brewing history left such an immense hangover for AB InBev, and the formidable Brito, who has developed a reputation as a ruthless cost-cutter?
Back in 2016, as Brito was putting the finishing touches to the takeover, the 55-year-old Brazilian told the FM that SA was still a key part of his plan, despite an apparent slowdown here.
"The fundamentals in SA have not changed. The population; the demographics; the middle class; the GDP growth; the natural resources — all these things are still there, before and after. These things don’t change overnight," he said.
Only, it got worse from there. Feeble economic growth of less than 1%, high unemployment of around 37% (at the wider definition) and rising fuel and electricity costs took a toll on disposable income. And while it’s true that load-shedding, state capture and shoddy service delivery are enough to drive many to drink, fewer people were cracking open a beer.
This was painfully evident in AB InBev’s financials for 2018.
In SA, earnings before interest, tax, depreciation and amortisation (ebitda) actually dropped, by "low single digits". And its profit margin was one percentage point lower too — as the cost of selling its beer rose, thanks to hefty fuel price hikes.
Brito spoke of a "challenging year" in SA, where SAB had experienced "mid-single-digit volume declines" while revenue was "flattish". It was, as the company put it, "below our expectations".
Across the whole business, the brewer didn’t do that badly — sales were up 4.8% to $56.4bn, while earnings grew 7.9% to $22bn.
This, along with Brito’s reputation for wringing value out of a stone, is why analysts are so ridiculously effusive about AB InBev’s trajectory, despite the poor JSE performance since it listed in Joburg. Of 35 analysts who cover it, 23 rate it a "buy", nine a "hold" and just three describe it as a "sell". On average, they expect its share price to rise 10.5% on the JSE over the next year to around R1,325 a share.
Casparus Treurnicht, a portfolio manager at Gryphon Asset Management, says it all comes down to the SA consumer’s low disposable income.
"We can all agree that the consumer is in generally bad shape," he says. "We see our retailers also taking strain as consumers spend less, and when they spend [they do so] more carefully. When AB InBev is raising prices to stabilise revenues, it means something has to give." That something, says Treurnicht, is volumes.
But this isn’t the whole story either.
AB InBev suffered stock shortages over the festive season. The FM spoke to liquor retailers who say that their biggest supplier dropped the ball at the most important time of the year — something strangely uncharacteristic for a company that has operated like clockwork for over a century.
Asked about this, Brito told investors: "There was a supply constraint in the fourth quarter; I had to bring in beers from afar."
"Afar" might sound a bit more exotic than it really was. Brito later explained it simply meant bringing in beer from other parts of SA. As it stands, AB InBev has seven breweries in the country, all of which were built by SAB.
But the group also had "big time" supply disruptions in the second quarter of last year, Brito said.
Better planning might have helped. In SA, Christmas is the one obvious period of high beer consumption, as the warm weather and general wind-down to the year create perfect conditions for enjoying a cold one. Easter is the other important period, helped along by a host of public holidays grouped relatively close together.
AB InBev now says it is addressing the bottlenecks to prevent the festive season’s supply problems from resurfacing when it’s time for curried fish and hot-cross buns. But the fact is, the shortage also had something to do with AB InBev’s global strategy.
Two years after swallowing SABMiller, the maker of Budweiser is now pushing a global drive towards "premiumisation" — selling fancier drinks to the more well-heeled.
If you listen to Brito, he’ll talk about how this is a natural assault on the top end of the market, as global disposable income is expected to nearly double in the next 13 years to $43-trillion. But many industries — from mobile phones to pet food — are also chasing this top dollar. So far, wine and spirits have played this game better than beer.
But Brito sees an opportunity for his portfolio of brews to rake in serious profits from consumers willing to pay more for products that carry a certain "status".
So the company has established a business unit called the High End Co, through which it targets the well-to-do in 22 countries, including SA — by flogging fancy beer in classy establishments.
The unit is responsible for 10% of AB InBev’s global revenue, but more importantly, it accounts for 30% of the company’s revenue growth. This segment is also expected to grow five times faster than the core business and be twice as profitable to boot.
As a result, AB InBev has been pushing the brands it sees as desirable in markets where these brands have not had much mileage before. This is why South Africans are seeing far more Bud, Stella Artois and Corona on the shelves of their local liquor outlets than ever before.
"We have been focused on increasing our market share in the premium segment and we estimate that we gained about 10 percentage points of market share in this segment this year," Brito said, referring to SA.
AB InBev is overindexed — MBA jargon for "too exposed" — in the value and core segment of the SA market and under-indexed in premium.
But the market on Africa’s southern tip has its own dynamics. And one of SAB’s secrets to success, over several decades, was keeping its thrifty consumers happy. If you shun the customers who have bought Black Label, Lion and the flagship Castle Lager, you alienate the market.
It is worrying precisely because flat volumes are not the norm in SA, where SAB had a reputation for aggressively competing on price, making mainstream beer affordable and desirable to first-time consumers.
"SAB was renowned in the old days for pricing below inflation," says Investec Asset Management analyst John Thompson.
Some believe AB InBev may have tried to tinker too much with SAB, in a bid to cut costs. Back in 2016, Brito told the FM: "People talk about cost-cutting — I call it efficiency. It takes a different spin because we talk about efficiency in our company so we can invest more in the marketplace."
AB InBev’s owner, the Brazilian private equity company 3G Capital, has a fearsome reputation not just for ballsy takeovers ($480bn in takeover bids) but also for ruthless cost-cutting.
As Fortune magazine put it some years ago, the brewer’s executives are "not known for their gentle demeanour". After the company took over Budweiser, the free beer benefit for staff was halted overnight, and executives aren’t even allowed to think of travelling in anything but economy class.
In an article this month highly critical of 3G’s tactics, The Economist said it was failing to "get the mix right between slashing expenses and investing for growth, while maintaining an appropriate level of debt".
The problem is, these tactics won’t work so well at a company that’s already carrying very little fat.
Thompson says SABMiller’s operations in SA were already particularly lean when AB InBev took over.
So if AB InBev aimed to unlock synergies by making cuts in SA, it might have gone too far. A layer of expertise seems to have been lost. "If you cut too much, you tend to eventually cut into the bone," Thompson says.
If so, this could have limited the brewer’s room for manoeuvre when competing on price. Consumers who are used to buying quarts of lager in returnable bottles are tempted to shop around for the best deal. Especially when the economic pressure on this market is "disproportionate", as AB InBev puts it now.
Other smaller brewers have noticed this recent vulnerability at SAB and are seeking to exploit it.
Of course, SAB is still the powerhouse monopoly locally. Though its market share has dropped slightly from the early 2000s, when it held as much as 98%, it’s still by far the largest.
This is despite a wave of imports, and then another international brewer setting up production capacity close to the country’s largest base of consumers.
Before 2006, SAB brewed Amstel under licence in SA. The green bottle with its golden collar was immensely popular and represented something of the prosperity that the first few years of the new century brought with it. But Amstel is owned by Heineken, and in 2006 Heineken abruptly ended the 40-year-old licensing deal. SAB then made a flurry of plans to keep that part of the premium market — it pushed Hansa Marzen Gold, Peroni and Pilsner Urquell, with notable success.
But Heineken also wasted no time in announcing its own plans for a brewery at Sedibeng in Gauteng, which opened in 2009.
A decade later, Heineken sees SA as one of its star performers worldwide, through brands like Amstel and Sol, but also through ciders like Strongbow, not to mention the popularity of its original Heineken premium lager and the regional brands Windhoek and Tafel.
Though it doesn’t give much detail, Heineken says it grew volumes in SA by double digits last year, when it reported results in February. "Our business in SA delivered strong growth for Heineken as the brand leads the premium segment," it says.
Growth was so rapid that the company had to import more malt barley products and is planning to open new malting plants in the next two years.
Last month, dropping a hint clearly aimed at AB InBev, Heineken’s CFO, Laurence Debroux, said: "It is very rare that a monopoly is not a bit complacent." This is why the Netherlands-based brewer evidently decided on the long and painful process of disruption.
Besides promoting Strongbow and keeping a tight grip on Amstel, the company has also been aggressively targeting status-conscious value consumers with its 650ml Heineken bottles, an industry insider told the FM. It is upping its game in a field that could be best described as the "classy quart" sub-segment. It has also bought local brewer Soweto Gold. "Heineken is definitely trying to go after that market," says Sanlam Investments portfolio manager Marlo Scholtz.
"And if you have as big a market share as SAB, you are bound to lose some of it around the fringes to new challengers."
But Heineken still does not see itself as being able to compete nationally across SA.
"We do not have, obviously, a national policy, because you would need much more breweries and SA is too large a country to operate out of one brewery," said CEO Jean-François van Boxmeer last month.
He was reticent about any further expansion plans, saying any such move would be announced through the appropriate channels. But, he added, "if we need a second brewery, we will build it for sure".
Still, AB InBev’s global "premiumisation" strategy puts it on a collision course with a rejuvenated Heineken that senses blood.
AB InBev seems to have already made a few missteps. SAB spent years building premium brands like Peroni and Pilsner Urquell in the local market. One former SAB manager (who spoke on condition of anonymity) questions the wisdom of now parachuting Budweiser and Stella Artois in to service those same customers.
Also, SAB’s unrivalled success has been Castle Lite — a beer with fewer calories. It was first launched in 1994, aimed at SA women, but soon took off with beer-boep-conscious men as a premium brand. However, AB InBev’s strategy to introduce a 910ml resealable bottle would more likely undermine the brand’s premium credentials than broaden its appeal, says the former manager.
"Premium is showing good growth, but you can only milk so much from that market," says Treurnicht. "We are also seeing a bit of cannibalisation as people move from the core portfolio to premium.
"If there were better GDP growth locally, I’d be more optimistic, as a bigger proportion of the population would start to consume in this market together," he says.
But don’t expect this any time soon.
Much now hinges on how AB InBev approaches SA’s Easter season — traditionally a bonanza for beer sales. It will want to prove it has fixed the supply snafu that left it punch-drunk in December.
SA is no longer the home market for a global brewer, but rather just one unit in an immense global portfolio. Its former strategic importance — as the cash cow with which to conquer the world — has gone.
But Brito, as steely an operator as there ever was, will be loath to let SAB’s former glory spoil the picture for much longer.

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