InBev accelerates takeover schedule of Chinese brewery

China''s biggest ever beer acquisition may not signal an industry profit bonanza.

The world's biggest beer brewer by volume, InBev, announced yesterday (January 25) that it plans to accelerate its takeover schedule for Fujian Sedrin, the largest brewer in South East china. The deal will now be completed by the end of the year, instead of in 2007 as originally announced.

The Belgian company will gain a 100% stake in two stages, turning the company into a wholly-foreign owned enterprise (WOFE). The first stage of the deal involves buying out a 39.48% government-held stake, followed by the remaining 60.52% held by private investors.

InBev already holds a 25% stake in Zhujiang Beer and on full completion of the Fujian Sedric acquisition, it estimates it will control about 12% to 13% of the Chinese beer market.

The acquisition's $730 million price tag will set a new industry record in China, beating the $720 million Anheuser Bush paid for Harbin Brewery in May 2004, following a sharply-fought takeover battle with SAB Miller. (However, it should be noted that Chinese assets have become slightly more expensive in dollar terms following the 1.2% appreciation of the Rmb last year).

Yet, analysts say it is not clear whether the Mainland beer market is becoming particularly profitable. "The striking thing about the acquisition is that InBev clearly thinks the market is maturing to the point where it can make a decent profit," comments Andrew Holland, a food and beverage analyst at Dresdner Kleinwort Benson in London.

"This is one of the very few Chinese acquisitions we've seen where such detailed financials have been released," he adds. "That probably has something to do with the other deals' lack of profitability."

Indeed, the history of foreign beer investments is not especially encouraging. Several foreign brewers exited the Chinese market in the early 1990s following disappointing sales and conflicts with their joint venture partners.

Notwithstanding, China is already the largest beer market in the world, and sales have been growing at around 4% per annum. The beer market's progress is all the more impressive given it has to compete against China's traditional preference for grain spirits.

The volumes of the Chinese market are staggering. SAB Miller produces 26 million hectoliters (HL) in South Africa, where it has a 98% mark share. Yet the company already brews 40 million HL in China, compared to InBev's 35 million HL.

The total US market is around 250 million HL, or one HL per person. It is extrapolating figures like this to the Chinese market (with a population of 1.3 billion) which has caused foreign brewers to foam at the mouth.

In terms of pricing, Inbev has paid the equivalent of 13 times EV/EBITDA (earnings before interest, tax, depreciation and amortization). That appears reasonable compared to the 18 times multiple paid by Anheuser Bush for Harbin Brewery two years ago.

According to InBev, "Fujian Sedrin is one of the most profitable brewers in China, and in recent years has achieved EIBTDA margins of over 30%."

The company's revenue and EBITDA figures in 2004 were $164 million and $57.6 million respectively. A company spokesperson could not comment on how long the company has sustained such margins.

In 2003 (the last year for which figures are available before the company was de-listed), Harbin Brewery recorded earnings of $21 million. Earnings figures were not released by InBev. This is common practice because it avoids confusion caused by different international depreciation and tax rates.

According to Holland's calculations, the company made of a net profit of as low as $13.2 million in 2004. However, he notes that low profitability may be the result of high depreciation, a tactic which reduces the tax burden.

Fujian Sedrin operates three breweries with a market share around 45% in Fujian in 2004, according to InBev and 18% in the inland province of Jiangxi. By volume, InBev will now hold the number two spot in China, just behind market leader Tsingdao Brewery and the top foreign spot.

InBev is following a relatively recent trend of buying strong local brands as a springboard for national expansion. In the 1990's foreign companies such as Britain's Tennants learnt the hard way that exporting unknown, foreign brands to China could be a recipe for disaster - akin to stocking Stella Artois rather than Guinness in an Irish bar.

In addition, many of the provinces InBev covers are poor by international GDP per capita standards. Fujian, the fourth richest province in China, and one of InBev's main markets, has a GDP per capita of $2,000. A great deal of that will come from the provincial capital of Fuzhou and other large cities.

There is a huge gap in China between the urban dwellers in the big cities and the rest. That is to say, the gap between city dwellers and the rest of the country is far greater than the gap between provinces.

However, the InBev approach is province-based, rather than on a city by city basis, according to their spokesperson. InBev thus has a presence in eight provinces, but not in the major cities of Shanghai, Beijing, Guangzhou, Shenzhen or Tianjin.

The beer industry is plagued by systemic problems, and these will likely continue to be a drag on the industry for years to come say analysts. The beer industry exploded in the 1990's after the government encouraged beer drinking to wean people off the fiery grain spirits.

However, demand did not keep pace with supply, resulting in overcapacity and pressure on prices. In addition, many of China's breweries (there are some 700 breweries in total) are small and do not benefit from economies of scale.

Yet they are unlikely to go out of business easily because they are often owned by local governments. Perhaps the ultimate message is that if a company is willing to pay the best part of a billion dollars for a moderately profitable regional brewery, the search for riches will not be over anytime room.

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