Coca-Cola pays hefty price for Huiyuan Juice

ChinaÆs largest inbound M&A deal this year sees Coca-Cola shell out $2.4 billion to strengthen its position in China's growing juice market.
The Coca-Cola Company yesterday announced that it intends to purchase China Huiyuan Juice Group. The worldÆs largest drinks company will make a cash offer of $2.4 billion to acquire the Hong Kong-listed, but China-based, juice maker in what will be the largest inbound M&A deal in China this year, as well as the biggest ever in its food and beverage sector.

Coca-Cola has entered agreements to purchase a 64.51% stake in the company from two major shareholders: Huiyuan Holdings, which owns 41.53% of HuiyuanÆs share capital as of the last trading date; and French food group Danone, which holds 22.98% of the company. Coca-Cola is also offering an exit to all minority shareholders through a general offer at the same price and intends to delist the company if successful.

The offer is aggressive at HK$12.20 ($1.56) per share, a 195% premium to the closing price on August 29, which was the last trading day before Huiyuan was suspended from trading. The offer price is nearly double the high of HK$6.52 from May 5, which marks HuiyuanÆs highest share price in the past six months.

Royal Bank of Scotland is acting as financial advisor to Coca-Cola. Goldman Sachs is advising Huiyuan while UBS is advising Huiyuan's controlling shareholder, Huiyuan Holdings. RBS had no comment, while Goldman Sachs did not respond to requests for comment.

The deal is still subject to relevant regulatory approvals in China.

Private equity firm, Warburg Pincus, which owns convertible bonds in Huiyuan in the name of Grace Gourmet, has agreed to convert these bonds and sell the resulting equity which amounts to 6.37% of a fully diluted share pool. Once these bonds have been converted, Huiyuan Holdings will hold 38.45% and Danone will hold 20.96%.

Other investors with significant holdings include Fidelity with 8.1% and T Rowe Price International with 1.03%.

For calendar 2007 Huiyuan posted revenues of Rmb2.7 billion ($394.5 million) and a profit after tax of Rmb640.2 million. On a trailing basis and based on an equity value of $2.4 billion, Coke is paying an aggressive six times revenues and 26 times profit.

But Coca-Cola is paying for the future. Huiyuan grew revenues by 29% from 2006 to 2007 and in the same period profit after tax increased a whopping 189%. Nielsen research estimates suggest that the firm ended 2007 with a market share of 42.6% for 100% juices and a share of 39.6% for nectars, making it the market leader in China in both categories. Analysts have remarked that HuiyuanÆs obstacle to growth is distribution, which Atlanta-headquartered Coca-Cola obviously hopes to plug using its own well-entrenched network.

The deal comes with a short, non-compete agreement û Zhu Xinli, who indirectly controls Huiyuan Holdings, has agreed to not compete with Huiyuan Juice Group over the next two years in any industry apart from the milk business. The non-compete also specifically excludes Zhu "continuing to operate his business that produces, supplies and distributes recyclable containers, external packaging and raw materials for juice production".

Zhu will relinquish his current position as chairman of Huiyuan, but will remain involved as the honorary chairman.

The stated aim of the acquisition is for Coca-Cola to further develop its drinks portfolio in China and for the company to use its expertise to improve HuiyuanÆs products for Chinese consumers. Coca-Cola has already launched Minute Maid Pulpy (orange pulp) in China and the product is doing well, especially in urban centres.

Acquisition synergies are forecast in operational and cost efficiencies, especially with HuiyuanÆs production footprint and Coca-ColaÆs distribution and raw material purchasing capabilities, the two firms said in their joint Hong Kong stock exchange filing.

However, a J.P. Morgan research report issued earlier this week suggests that HuiyuanÆs strength in the juice sector lies in the part which produces the raw materials for juice making, which is not part of the listed company Coca-Cola is currently acquiring.

ôWe believe it makes sense for the [Huiyuan] group to acquire the parent companyÆs raw material base in due course,ö says the report, going on to speculate that the first stage of such a process might involve the listed company acquiring the production of orange concentrate. J.P. Morgan, which has a sell rating on the stock, further suggested that Huiyuan's juice sales could suffer from the inflationary pressures China is currently facing.

No clarity was available on whether Coca-Cola intends to continue to source raw materials from the unlisted company owned by the Huiyuan founders, though it is quite likely that they have insisted on such an arrangement during the limited period of the non-compete. After that Zhu Xinli may be free to launch another brand and absorb its own production. This will also give Coca-Cola time to develop alternative sources of supply.

Coca-Cola's takeover will enrich the coffers of Huiyuan's strategic investor, Danone, which acquired 22.2% in Huiyuan in June 2006 for $137.25 million. It invested another $100 million in HuiyuanÆs initial public offering in February 2007 to maintain its stake at the same level. Danone is now receiving $527.4 for its $237.25 million investment, an excellent financial return for cash deployed on an average for less than two years.

For Coca-Cola this is the second largest acquisition in its history and the first mega-deal since Muhtar Kent succeeded Neville Isdell as CEO on July 1. In May 2007, the company spent $4.1 billion to acquire Energy Brands, a New York-based company which owned the Glaceau range of enhanced water brands known as vitaminwater.

The Glaceau deal was accretive to earnings in the first full year û indeed, one of the things Coca-Cola told analysts at the time of the deal was that it would drive incremental value for Coca-Cola shareholders.

In contrast, the Huiyuan transaction will be dilutive by three to four cents in the first year after completion and will be accretive only from the third year onwards. The difference between the Glaceau and Huiyuan deals lies in their target markets û Glaceau gave Coca-Cola a new product in a mature market, North America, while Huiyuan allows it to enter a new category in one of its most critical emerging markets, China. Coca-Cola is betting big on China and only time will tell if its gamble pays off.

Not unexpectedly, HuiyuanÆs share price soared towards the HK$12.20 offer price when it resumed trading yesterday, gaining 164% to close at HK$10.94. Coca-Cola's shares, which are down from a high of $65.59 in January, closed yesterday at $51.66 û down 0.6% on the day.
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