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Following Beam’s special shareholder meeting today, Suntory will now assume control of Beam. However, the key question is, how can this Japanese company with such huge debts make the acquisition of a company with serious weaknesses, such as a narrow geographical spread and 40% of its portfolio accounted for by low value and low growth brands, pay off?
Suntory will inherit some good brands, such as Jim Beam, Sauza, Courvoisier and Maker’s Mark, but it will also inherit a large number of brands such as Larios Gin, DYC and Windsor Supreme which are at best stagnating and in many cases seeing volume declines, as well as having lower profitability. Such brands account for over 40% of Beam’s portfolio.
While Japanese-centric Suntory has become more internationally focused through this acquisition, it will still be reliant on a small number of markets due to Beam’s narrow focus. 73% of volumes will come from two markets, the US and Japan, with the next three biggest, Spain, Mexico and Canada, accounting for a further 13%. Only 9% of volumes will derive from emerging markets, with a large proportion of this coming from Mexico, where Beam has been performing poorly thanks to high volumes of low-growth brands.
A large amount of this weakness has been inherited and is long term; however, this has been exacerbated by Beam’s current narrow focus on a few key brands in a small number of markets.
A key example of this is its flagship brand Jim Beam, with 85% of the brand’s volumes deriving from its three biggest markets, the US, Australia and Germany. This compares with 65% for Brown-Forman’s Jack Daniel’s brand, whose three largest markets are the US, the UK and France. Equally importantly, over 2007-2012, only 45% of Jack Daniel’s 10 million litre growth came from its three main markets. This compares with over 90% for Jim Beam’s eight million litre increase over the same period, with 57% of overall growth coming from the US.
Equally importantly, nor has Beam’s acquisition strategy looked to broaden its geographical spread. Its biggest has been Pinnacle, a US-focused flavoured vodka, which after years of rapid growth seemed to have slowed in 2013, while Cooley Distillery only has sizeable volumes in Germany and was bought to exploit the rapid growth of Irish whiskey in the US.
At some point, the returns based on this strategy are going to slow, and unlike its rival Brown- Forman, Beam will not have the geographical spread to take up some of the slack. Additionally, as Beam has been slow off the mark in terms of geographical diversification compared to its rival, it is likely to struggle to make an impact due to the huge benefit of first mover advantage in smaller whisky categories, such as bourbon/other US whiskey or Irish whiskey.
The question is whether the current management team, which has been very effective at implementing the current strategy, can change accordingly. However, even if there were to be a change in strategy and greater efforts to expand internationally, with Suntory’s high debts, will it have the money to expand, especially geographically?
With debts estimated at six times EBITDA, this is a key question. Pernod, when it acquired V&S in 2008, had an equally high debt to EBITDA ratio, announced a policy of selling off €1 billion worth of assets and also generated cash by cutting prices. In the US, Pernod reduced the price of Absolut by US$2 a bottle post-acquisition to help boost revenues, although a contributing factor was general discounting during the ‘Great Recession’.
In terms of generating cash through price cuts, Beam has already been doing that on key brands such as Teacher’s and Courvoisier in the UK, so it is questionable as to how much more room there is without completely devaluing the brands. While in terms of selling off brands, many of the non-core brands are either relatively small, have little growth potential and possibly would not raise huge amounts of money.
Pernod also had the benefit of being able to generate extra revenues following the deal by pushing the Absolut brand through its existing distribution network, such as in France, and boosting its existing brands such as Jameson and The Glenlivet in the US.
The Suntory/Beam deal will offer fewer synergies or opportunities to benefit from each other’s distribution network. There will be some cost savings from sharing distribution in Australia. Both companies are weak in each other’s core markets. Suntory’s focus on the mature Japanese market will not enhance Beam’s portfolio greatly. Nor will Suntory’s Japanese whisky brands get any uplift from Beam’s existing distribution, as the Japanese company does not have any spare stock to do that and has apparently been withdrawing volumes for current export exports to meet Japanese demand.
Pernod Ricard also had the fortune of being able to pay down its debts relatively quickly thanks to loose monetary policies globally. Suntory has certainly benefited from that in allowing it to make the bid, but how long the period will last is debatable, with economies recovering globally, at which point how cheap will its loans be?
One of the reasons given by Suntory’s Beam acquisition boosters is that it gives it a foot in the door in international spirits, but that is questionable. With the exception of the pending divestment of Whyte & Mackay, many of the major international spirits categories are already consolidated.
In terms of other assets that could conceivably come to the market, the options are very limited. International companies mooted as takeover targets, Grupo Cuervo and Brown-Forman, all heavily overlap with Beam’s portfolio and will be heavily competed for. Stolichnaya could be a possibility but there are huge issues regarding ownership, as Pernod found.
As a private company and with Japanese banks being very tolerant of high corporate debt, a default or selling off of its brands is unlikely. Nevertheless, competitors could be happy as they will face a weak company with potentially limited financial capacity, although that could be tarnished slightly by the prospect of heavy discounting from Suntory to generate cash to pay down debt.