Larry Nelson - his first column

Larry Nelson - his first column

Today, we welcome the editor of Brewers' Guardian, Larry Nelson, into the just-drinks fold. In the first of his monthly rants and raves, Larry considers what Heineken got for its money last week, when it acquired FEMSA's Mexican beer business, FEMSA Cerveza.

Like any marriage, insulated by the happiness of the moment and the promise of better tomorrows, Heineken’s all-share acquisition of FEMSA Cerveza left the proud Dutch husband speaking in excited terms about growth prospects. The mindset was evident from the outset with Heineken’s presentation to analysts on the day titled: ‘Transforming our future in the Americas’.

There are prospects to be sure, with FEMSA’s beer operations concentrated in three of the world’s four largest profit pools: Mexico, the US, and Brazil.

In Mexico, Heineken will bring its considerable marketing expertise to bear, differentiating an overlapping brand portfolio and introducing premium brands to a market largely devoid of such excitements. Heineken CEO Jean-Francois van Boxmeer told analysts that the “enormous basis for developing the Heineken brand” in Mexico was one of the key reasons the company found the FEMSA transaction so appealing.

Heineken and FEMSA are already partnered in the US and Brazil. In the US, the Mexican brands are performing better than their Dutch stablemates, and here Heineken has done great work in the marketing of FEMSA’s Dos Equis, with their long-running and somewhat viral ad campaign centred on ‘The world’s most interesting man'. In Brazil, Heineken already held a minority stake in FEMSA’s Brazilian subsidiary, so at least they should know what they are getting into there.

Or has Heineken underestimated the challenges? The Mexican market is a duopoly, with FEMSA’s in-isolation-impressive 43% market share still dwarfed by leader Grupo Modelo. Mexican consumers have proven remarkably uninterested in imported premium brands. Modelo, which has had access to Anheuser-Busch’s portfolio for years, states in its 2008 annual report that imports accounted for only 1.6% of its Mexican sales, with Bud Light the most popular brand.

In Mexico, FEMSA also offers Heineken a great route market with an exclusive distribution agreement through its 7,000-strong network of OXXO convenience stores. The Dutch brewer believes that this platform can be used to launch Heineken nationally. But there’s an emerging threat here, with noise that Mexican government competition authorities may look unfavourably at exclusive arrangements that block out competitors. (This should resonate with anyone in the UK who still involuntarily shudders when the destructive Beer Orders of two decades past are mentioned.)

In the US, Heineken-FEMSA again has to contend with Modelo, which claims half of all imported beer sales. Modelo’s Corona Extra is the leading import brand, with estimated sales in 2008 approaching 8m hectolitres, equivalent to better than 25% market share amongst imports. In contrast, number-two Heineken comes in at around 5m hectolitres; FEMSA’s best performing brand, Tecate, sells approximately 1.5m hectolitres.

Modelo has consistently outperformed FEMSA over the years when it comes to developing beer exports, and their positions have changed relatively little. Back in 2003, FEMSA claimed 2m hectolitres of exports against Modelo’s 11.8m hl. Five years later, by 2008, FEMSA’s total had jumped to 3mhl while Modelo had grown its total to just over 16mhl. Heineken will have to invest heavily in creative marketing to make headway; Dos Equis suggests they can and Heineken believes that this campaign can be replicated in other markets.

Modelo also has a considerable head start over FEMSA in developing sales in certain European markets such as the UK. Heineken will have obvious distribution advantages in Europe but when it comes to Mexican beers it starts from behind on what could be termed its home turf.

This leaves Brazil, where you have to wonder what Heineken was thinking about when it shook hands on the deal. FEMSA is third-ranked, with output of 10m hectolitres - sufficient to claim just 9% of the market. For the first nine months of 2009 Brazilian beer sales declined by 3.4%, although there has been some revenue gain driven by the strength of the Brazilian real against the Mexican peso.

You may recall that FEMSA acquired its Brazilian operations from Molson Coors for a pittance. A pre-merger Molson got hammered in the market, with its Kaiser operations dropping like a stone in a few short years from a starting point of second-place and double digit market share.

(Interestingly, the situation became so dire that at its 2004 year-end results Heineken announced a EUR190m (US$271.5m) write-off of its minority stake in Kaiser, reducing the carrying value of the investment to zero. The Dutch brewer comes to Brazil with no illusions as to the difficulties of business in a market dominated by AmBev.)

Brazil, more than anything, is what scared SABMiller away from the table. Industry sources indicate that SABMiller did want to buy FEMSA, and entered into lengthy discussions with the company. However, it was concerned about several factors – for example, the possible interest of Mexican competition authorities in exclusive distribution agreements – but  the biggest issue was Brazil.

Has anything changed here since Molson got its fingers burnt? One innovation introduced prior to the Canadian departure was to partner distribution with FEMSA’s thriving Coca-Cola business, cutting costs as well as providing access to additional outlets. Clearly it’s an arrangement still in place today, one that is under study by FEMSA in at least one region in Mexico.

Yet here, too, is a potential weakness. In the sharing of distribution channels you have to wonder which will take priority over the long run, soft drinks or beer?

The price paid by Heineken, $7.6bn when the assumption of debt is included, is pretty much in line with analyst estimates of what it would take to win FEMSA Cerveza. The Dutch brewer clearly outbid the other interested parties.

As such, the clear winner in this transaction is FEMSA, which calculated that a 20% economic share of a global play is better than 100% equity in a handful of markets where there are stronger competitors prepared to beat one’s brains out.

At the time of the transaction, FEMSA chairman and CEO José Antonio Fernández Carbajal said: ”In the context of the reconfiguration of the global brewing landscape, scale and geographical diversification are more important than ever, and this transaction responds to that imperative. Heineken presented us with the most compelling opportunity to transform our brewing assets, enabling us to unlock the most significant value that we have created during the past decade.”

Too right. There’s not a lot of low-hanging fruit here from this transaction for Heineken. The long-term play is that these growth markets continue to do just that and that the Dutch brewer can identify growth opportunities rather than steal market share.

Or, as Dos Equis’ wonderfully concise ‘world’s most interesting man’ would sum up Heineken’s prospects: “Stay thirsty, my friend.”