Show me the merger!
The pages of the world's drinks press resemble the columns of a Hollywood gossip magazine at the moment. Stars and bit-part players are quickly linked together in rumours of wedlock only for the participants to just as hastily deny any possible coupling. Take the blockbuster-making Southcorp for example. Industry followers lapped up rumours it was courting the diminutive but elegant Rosemount, only to have Rosemount laugh off the stories as preposterous. And yet, only a week later we find it was all true. Southcorp's advances had only temporarily stalled, an argument over the size of the dowry no less.
"More deals are expected given the long term challenges of the consumer branded product industries"
And the Southcorp deal is just the latest in a long line of rumoured and actual romances in the drinks world. Like characters in a Woody Allen film, companies have never been more unwilling to face the threatening world alone. The value of annual global M&A activity in 1999 (across all business) was estimated to be running at over $2.2 trillion (Source: Thomson Financial Securities Data 1999). Deals have included all the major drinks companies from Diageo to Pepsi, and the drinks business has accounted for no mean slice of this value, so its no surprise consolidation dominates the headlines.
With all this activity, you would be forgiven for thinking that the rationale behind the drive to acquire was set in stone and its benefits a proven antidote to the problems of slowing organic growth in the drinks business.
The latest research by just-drinks.com shows that growth in the world's top 112 spirits brands was only 1.54% last year (source: Premier Brands League, just-drinks.com 2001). And with this sort of pressure, it is difficult to disagree with a recent report on the global branded consumer products industry, by Dominion Bond Rating Service (DBRS), which concludes: "Future growth in sales and earnings will be difficult for companies that do not make acquisitions. Although there has been a substantial amount of M&A activity this year, more deals are expected next year given the long term challenges of the consumer branded product industries."
The pressure on the world's drinks companies to merge is great. Benefits from M&A include a decrease in competition and increase in bargaining power with retailers from the combination of leading brands, while diversification into new markets and/or geographic segments can bring increased stability, growth and reduced risk. Furthermore, there is of course the attraction of cost-cutting synergies.
Tim Buckley, an analyst with investment bank Salomon Smith Barney (SSB) says: "The reasoning behind M&A differs across deals/sectors. If you look at the wave of M&A in the western European beer sector, the consolidation is really about consolidation so as to reduce capacity/costs so the companies can remain viable in a declining volume market overall.
"In brewing globally, M&A is more about utilising the excellent cashflow that results. Unless a firm has a shareholder friendly attitude that includes share buybacks, brewers will need to 'acquire' growth because organic growth is generally limited. Kirin's purchase of 45% of Lion Nathan is a classic example. We believe Kirin made this acquisition to re-gear its balance sheet, given the alternative was growing pressure to achieve capital return."
Buckley continues: "In wine, the industry is extremely fragmented. The much speculated merger of Southcorp and Rosemount would bring synergies to the combined business in Australia, but more importantly would accelerate the global push of Australian wine exports in the US, Germany and Asia."
A report in 1999 by KPMG entitled Mergers & Acquisitions - unlocking shareholder value the keys to success, said that confidence in M&As has never been higher as a means to drive growth. KPMG's report surveyed the top 700 cross-border deals by value between 1996 and 1998. The survey results show that one year after a deal was completed, as many as 82% of respondents were convinced their transaction was a success.
However, the reality is almost an exact reverse. Indeed KPMG estimated that only 17% of the M&As completed added value to the combined company. "In other words," KPMG states, "83% of mergers were unsuccessful in producing any business benefit as regards shareholder value."
Coca-Cola CEO Douglas Daft's new mantra "think local, act local" is a reflection that bigger is not always better. "TCCC's experience [is] that aggregating bottlers across different cultures /countries brings very limited synergies. CC Amatil has gone from buying up territories all around the globe in the early mid-1990s to spinning off its European assets in 1998, and now in January 2001, even selling off one of its key Asian assets (the Philippines) back to San Miguel," explains Buckley.
The drinks industry is caught in between a rock and a hard place. According to DBRS, although companies will find it difficult to grow without acquisitions, "for those that do enter into acquisitions, future growth is still uncertain." It continues: "Achieving synergy benefits will be difficult and are unlikely to be enough to mitigate long-term challenges."
In fact synergy benefits on average were low on deals in the past 18 months at only 1.5% of sales (Source: DBRS). This is a reflection of the difficulties of merging two companies, but it is also a sign of the high-risk strategies companies are pursuing in order to achieve growth. Many of the M&A deals have been driven by a desire to diversify into new, potentially faster growing segments or markets rather than to acquire in the same category. Obvious examples include the Cadbury/Snapple and Pepsi/Quaker Oats deals as well as the beer and spirits companies' drive to acquire significant wine divisions. While cross category deals offer many benefits they also carry more risks and fewer synergy benefits.
"M&A's success depends upon the company's motive for making the move and also the management's ability and knowledge of the target and target's home market," says Buckley. "I think Foster's move into the UK (by acquiring Courage) was a real failure. Foster's knew nothing of the UK beer market. As a result it paid too much and bought nothing new to the equation in terms of real synergies. Furthermore, when it tried to acquire S&N in order to facilitate industry rationalisation, Foster's lack of knowledge of the political process in the UK and absence of political clout meant its attempt was a costly failure."
"In contrast we are a lot more optimistic about Foster's more recent acquisition of Beringer Wines. Only time will tell, but the fact that Foster's had a very clear understanding of both the specific business of Beringer Wines and general market in the US, Europe and Australasia, is promising," he says.
"A number of possible merger candidates remain and further M&A activity is expected in the future"
It is an old cliché but the question boils down to whether bigger is better. With the increasing power of retailers, slow population growth in developed markets, high competition among branded manufactures and difficulties of introducing new products, growth for drinks companies without acquisitions will become increasingly difficult. "While the beverage, food processing and tobacco industries have witnessed significant consolidation already, a number of possible merger candidates remain and further M&A activity is expected in the future," concludes DBRS.
However it is significant that many of the higher growth companies in the drinks sector in the past two years have been the smaller players. "BRL Hardy, Orlando Wyndham and Rosemount are three examples where being initially small, nimble and focussed has been a far better result for shareholders. Rather than seeking growth through time consuming and costly acquisitions offshore, each of these firms has focussed on the global opportunities for organic growth. And all three generate well above cost of capital returns and strong organic growth," says Buckley. "By contrast, while Foster's expansion activity has generally gone quite well, there have been real setbacks by being too big in too many sectors."
Ironically though, it is the very success of these smaller, focussed, independent companies that makes them the prime targets of an obsession for consolidation, whether healthy or not, that shows no sign of letting up.
Objective measure of success in unlocking shareholder value through M&As 1996-1998
Business aims behind merger or acquisitions 1996-1998
Source: KPMG's survey of the top 700 crossborder deals by value 1996-1998
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