Bidding war for harbin brewery group (china)

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Bidding war for Harbin Brewery Group

(China)

Bidding war for Harbin Brewery Group

Question 1:

Did AB pay too much for a mature business?

We have to look at the strategic importance of this transaction, the competitive nature of

the bidding process, and the scarcity of such premium assets in China. For deep-

pocketed Anheuser, US$765 million was a fair price for the rare chance to grab control

of a major brewery with a 30 percent market share in China's northeast, a beer-happy

region that Anheuser's premium Budweiser brand has yet to penetrate in a big way.

Leading brewery Tsingtao, which has granted Anheuser an option to raise its current 9

percent stake to as much as 27 percent, can also benefit from Harbin's network.

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It is important to understand that the acquisition of Harbin is the scheme that fit into the

broad framework of AB’s overall strategic planning processes. The basic elements of

strategic planning include an assessment of AB’s environment and an analysis of AB’s

resources and capabilities as they relate to the environment.

AB International growth strategy targeting China

AB’s multinational beer strategy is simple : expand the Budweiser brand international

while entering into strong partnerships with top beer makers across the globe.

During the past five years, the Chinese beer industry has expanded more than beer

markets in Europe, North America and South America. Chinese per-capita beer

consumption is only 50% of that in Japan and Korea, and only 20% of that in developed

countries like the U.S. and Canada.

As part of its Brewery Acquisitions and Strategic Alliances, AB became one of the first

international beer markets in China when AB bought the Wuhan brewery in 1995. Since

then, Wuhan’s beer production has more than quadrupled to some 4 million barrels per

year.

In 2004, AB also acquired China’s fifth-largest brewer, Harbin, in northern China where

per-capita beer consumption is double China’s national average. Not only has AB made

Harbin’s brands available throughout most of mainland China, AB has launched Harbin

as an imported brand in the U.S. starting in 2006. Locally produced Budweiser and

Harbin brands are distributed to clients in Hong Kong a well as northern, eastern and

southern China.

In addition, AB also owns 27% of the Tsingtao Brewery, part of a key strategic alliance.

The Tsingtao Brewery is China’s largest domestic brewery and beer exporter.

China beer market growth

U.S. brewer AB is betting rising incomes and an aspiring middle-class in countries such

as India and China will boost its international revenues. International business makes up

less than 10 percent of AB’s total sales but is growing much faster than the U.S. market.

Said Stephen Burrows, chief executive and president of AB Asia-Pacific operations, “We


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have intention to grow in high-potential markets outside the U.S., and India and China

meet our criteria”. Easing regulations and a shift to premium brands will also help boost

profitability in these markets.

Beer is cheaper in China than it is in America, so these operations won't add much to

Anheuser's bottom line. Now if China becomes a wealthier country, Chinese workers will

be able to afford higher beer prices. This would lead to both higher revenues and higher

margins. There is no dominant brewer in China. Anheuser Busch may end up becoming

China's #1 brewer, which is pretty significant when we consider that China has 1.2 billion

people.


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Beer Consumption by Country (2004)

Rank

Rank

in

2003

Country

2004 2003

Total

consumption

(1,000 kL)

Breakdown

by

country

Year-on-

year

increase

Total

consumption

(1,000 kL)

Breakdown

by

country

1 1 China 28,640 19.0% 14.6% 24,995 17.3%

2 2 US 23,974 15.9% 0.9% 23,771 16.5%

3 3 Germany 9,555 6.4% -1.6% 9,711 6.7%

4 4 Brazil 8,450 5.6% 2.8% 8,220 5.7%

4 5 Russia 8,450 5.6% 11.1% 7,606 5.3%

6 6 Japan 6,549 4.4% 0.7% 6,500 4.5%

7 7 UK 5,920 3.9% -1.8% 6,030 4.2%

8 8 Mexico 5,435 3.6% 2.0% 5,328 3.7%

9 9 Spain 3,376 2.2% 0.9% 3,345 2.3%

10 10 Poland 2,670 1.8% -2.4% 2,735 1.9%


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11 11 South Africa 2,530 1.7% 3.3% 2,450 1.7%

12 12 Canada 2,183 1.5% 0.8% 2,165 1.5%

13 13 France 2,020 1.3% -4.6% 2,117 1.5%

14 14 South Korea 1,897 1.3% 2.0% 1,860 1.3%

15 15 Czech Republic 1,878 1.2% 2.1% 1,839 1.3%

16 18 Ukraine 1,729 1.1% 3.9% 1,665 1.2%

17 16 Italy 1,719 1.1% -1.5% 1,745 1.2%

18 17 Australia 1,678 1.1% -0.7% 1,689 1.2%

19 19 Colombia 1,658 1.1% 2.0% 1,625 1.1%

20 21 Thailand 1,595 1.1% 10.0% 1,450 1.0%

21 20 Venezuela 1,525 1.0% 2.5% 1,488 1.0%

22 25 Philippines 1,409 0.9% 15.6% 1,219 0.8%

23 23 Romania 1,302 0.9% 1.5% 1,283 0.9%

24 24 Argentine 1,281 0.9% 4.5% 1,225 0.8%

25 22 Netherlands 1,269 0.8% -1.8% 1,292 0.9%

Note: Total consumption volume in Japan includes that of beer, happo-shu (low-malt

beer) and new genre.

Worldwide total consumption volume (estimate):

Year 2004 2003

Amount 150.392 million kL (up 4.2%) 144.296 million kL


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Question 2 :

Because Harbin’s major competitor is controlled by SABMiller, will a price war likely to

result from the new competitive structure in the region? What will this do to Harbin’s

value?

To answer the question and its impact to Harbin’s value, we need to consider that :

there is still room for further growth in China’s beer market;

segmented markets provide further opportunities for M&A

brand recognition becomes the key for competitive advantage

Still Room for Further Growth in China’s Beer Market

Twenty years ago, beer consumption was not common among the Chinese, who stuck

with traditional alcoholic drinks like distilled spirits and rice wine. In 1986, China’s

Department of Light Industry announced that there would be a significant change in the

national development plan for the alcoholic beverage industry. At the same time, China

was beginning to shift from a state-run economy to a modern market economy as Beijing

unfolded plans for massive and wide-ranging economic reforms.

In the early to mid-1990s, beer consumption in the country rose to an estimated six to

seven liters per capita annually. With a continued rise in affluence, beer consumption in

the country of a now 1.3 billion population has already tripled to approximately 19 liters

per person and will continue to expand in the next decade. Separately, older people (the

majority spirit drinkers in China) are drinking less traditional spirits, replacing these with

beer due to its lower alcohol levels, thus reducing health risks associated with the

consumption of traditional spirits.

As the Chinese economy continues to grow, people will have increasingly more

spending power. Accordingly, with sustained economic growth and continued rise in

living standards, Chinese beer consumption is expected to grow at 12 percent in 2004.

Notably, China has surpassed the U.S. as both the world’s largest consumer and

producer of beer. But with a per capita consumption rate far behind other industrialized

countries (19 liters compared to 29 liters in Hong Kong, 42 liters in Japan, 44.5 liters in


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South Korea, 75 liters in Europe, and 84 liters in the U.S.), we see the market as having

much room for development.

Segmented Markets Provide Further Opportunities for M&A

As the world’s biggest beer producer, China has about 600 breweries with 1,500 brands.

The four leading Chinese beer companies are Tsingtao, China Resources Breweries

(CRB), Yanjing Brewery, and Harbin Brewery.

The beer industry in China is characterized by regional brands. In 2003, the top four

beermakers’ total market share in terms of beer production was only 36.2 percent. Local

breweries often monopolize a given region, but have minimal exposure in regions

outside their home. For example, Zhujiang Beer occupies about 60 percent of the

Guangzhou market, while its market share elsewhere is less than one percent.

However, this situation is slowly changing with the recent rash of M&A activities in the

industry. For example, Yanjing, the only leading Chinese brewery without foreign

investment, bought 38 percent of Huiquan Beer, a large listed Chinese brewer in July

this year. In 2003, the top 10 Chinese brewers occupy 54 percent of the domestic

market share, an 11 percentage points jump from 2002.

London-based SABMiller, maker of Miller Lite, holds a 49 percent stake in CRB. In

September, CRB acquired the China brewery assets of Australian company, Lion

Nathan. In 2004, SABMiller lost a bidding war for Harbin Brewery, China’s fourth-largest

brewery, to rival Anheuser-Busch. Also in September 2004, the world’s fifth largest

brewery, Denmark’s Carlsberg acquired 34.5 percent of Wusu Brewery in Xinjiang

Province, its fifth acquisition in China in 2004, completing its strategic layout in western

China. In November 2004, British beermaker, Scottish & Newcastle, the world’s sixth

largest brewer, completed its purchase of Chongqing Brewery, becoming its second

biggest shareholder with a 19.51 percent stake of its total equity.

Clearly, the trend is towards the consolidation of the industry into the control of a

handful of major companies.


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Brand Recognition becomes the key for Competitive Advantage

Of the 1,500 Chinese beer brands, there are very few premium names. Regional brands

usually use a single-brand strategy, meaning both high-end and low-end products from

the same brewery carry the same brand name. This strategy hurt many breweries

because consumers were not able to distinguish between top-quality and lower-end

products.

As a result, price wars became the only way to win consumers, hurting

profitability and destroying consumers’ brand loyalty. It is important to note that

Chinese consumers are highly brand conscious. And the more affluent the consumer,

the greater his or her need for association with premium products.

In this environment, being the (most) famous beer brand in China or name

recognition constitutes a valuable intangible asset, to form a strong national

brand. Being consumer recognition, will enable it to reach economies of scale with

relatively less capital, and gave it significant competitive advantages over its rivals.


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Conclusion : price war will not take place in near future BUT PRICE INCREASES

WILL BE LIMITED.

VALUATION

With a big component of the growth can be attributed to beer consumption increases,

while price increases will be limited, using P/E ratio as Harbin’s valuation measurement,

high P/E will not be sustainable in the long run, due to growing competition and

narrowing margins.

Question 3:

Exhibit C is Citigroup’s valuation of Harbin at the start of the bidding war. Analyze their

valuation of HK$6.02/share compared to the HK$5.58/share Anheuser-Busch finally

paid.

Harbin's future growth will depend on

2% growth due to inflation

0.58% growth due to population increases

0.9% China volume growth

1% growth due to profit margin improvements

For a total growth rate of 3.9%.


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Valuation Analysis:

Harbin's earnings yield (earnings per share / share price) is about 6.1%. I've looked

through about 10 years of data, and Anheuser's free cash flow has been about 90% of

its net income. However, during this period, the company was growing at a higher rate

(leading to high capital expenditures) and spent a lot of money on cost cutting. In the

future, I expect free cash flow to be slightly below net income. Perhaps 95% would be a

good estimate. This would give Anheuser an earnings yield of 5.8%. Adding this to our

3.9% growth estimate, we get an expected return of 9.7%. Different growth estimates

would lead to a different expected return, so let's look at a few scenarios:

If profit margins only contribute 0.5% to growth, we get an expected return of

9.2%. If margins contribute 2% to growth, we get an expected return of 10.7%.


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Suppose preferences shift away from beer and domestic volumes fall by 1% per

year. Profit margins would likely fall. Perhaps they would decrease by, say, 0.5%

per year. Then, the elements of growth would be: 2% annual price increases,

0.5% growth due to international operations, -0.75% growth due to volume losses

(volumes would fall by 1% in America, which represents about 75% of

Anheuser's volume, so the impact on growth would be -0.75%) and -0.5% growth

due to profit margin decreases. Our expected growth rate would be only 1.25%

per year, which would lead to a long term annual return of 5.8% + 1.25%, or

about 7%.

The company has gained market share pretty much continuously over the long

term (although this trend has reversed itself over the past year or two). In 1990,

Anheuser's domestic market share was 43.4%. In 2004, it was about 50%. This

equates to roughly 1% in growth per year. Due to the economies of scale

inherent in the beer industry, Anheuser's profit margins would increase more than

otherwise. If market share gains add 1% growth, and profit margin gains add 2%

(rather than 1%) to growth, then our expected return jumps to 11.7%.

If Anheuser's international operations show only 1% volume growth, our

expected return will fall by 0.3%, to 9.4%.

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Economy & Finance

Bidding war for harbin brewery group (china)