Playing the barbarians off against the barbarians

Harbin Brewery management have played a clever and very lucrative game by playing Anheuser off against SAB Miller.

Harbin management must be rubbing their hands with glee following the stunning HK$5.58 per share mandatory offer Anheuser Bush (AB) has put forward to pay for their brewery. It seems they are now due to pick up yet another cash bonanza after playing two barbarians off against each other.

The two foreign bidders are pitted against each other for a brewery with a domestic market share of only 4% and profits of HK$190 million ($24.3 million) in 2003, down 10% on the previous year.

If it succeeds, AB will pay $720 million for the privilege of owning Harbin, while SAB will be strategically back to square one, though cash-rich thanks to its current stake in the brewer.

Management, on the other hand, will make money in at least two ways. Firstly, they have put options worth 5% in Gardwell, a SAB vehicle, which owns 29% of Harbin.

Under the terms of the deal, the put option could be worth up to HK$110 million compared to a cost price of HK$5 million. This would net management 2200% of upside.

However, exercise of the put option is conditional on certain triggers being met. These include SAB increasing its stake in Harbin to over 35%, or selling out to another bidder.

Many analysts suspect management will make money from the second scenario and SAB will walk away with the $124 million difference between the price it bought into Harbin and the price offered by AB.

Management will also profit from 53.57 million shares they own via two share option schemes, one of them a pre-IPO option scheme. The strike prices are an HK$1.85 and HK$1.5 and it has already been arranged they will sell these shares, representing 2.1% of the company, to AB at HK$5.58.

Harbin management will not only make a very healthy cash profit from the potential takeover, but will also achieve all their business goals as well. Principly this involves defeating SAB Miller's attempt to create the only synergy many analysts see, namely folding Harbin into China Resources Brewery (CRB), in which SAB holds a 49% stake.

The reason synergies are so compelling, say analysts, is because CRB and HB are competing fiercely in the North Eastern regions; CRB through its snow flake brand and HB through its own 'Harbin Beer' brand. So folding the two companies into one would eliminate the price war and enable a new focus on brand building.

But that is precisely what Harbin Brewery is adamant it will not do.

The reason price has been such a factor is that the North East, despite a glorious manufacturing past, is now one of the areas most painfully afflicted through the closure of heavy industrial state-owned enterprises. Given that unemployment hits people in the pocket, the bulk of Harbin Brewery's revenue come from the cheapest element of its offering range.

HB sells three categories of products: Original, Classic and Premium, targeting the mass, middle-income and premium markets respectively. According to the HB's annual report, 81.8% of total turnover came from the most down market segment.

Indeed, growth in the Original sector actually increased by 32% over 2002, which is not a sign that the better quality, more expensively marketed beers are making any impact on consumers. Classic and Premium products contributed 18.2% to turnover.

HB's regional bias is not even over the whole of the three North Eastern provinces, with 60.8% of the group's total turnover coming solely from its home province of Heilongjiang. Again, despite plans to the contrary, expansion nationally does not seem to be increasing very fast, given that the North East's contribution to turnover actually increased 17.5% over 2002, to 88.7% of the total.

As for AB, if its bid is successful, it will have a powerful base in the North East of the country, where beer consumption is one of the highest in China. However, it will be acquiring a brewery engaged in a bitter price war with CRB, and a long way from its other investment in Qingdao brewery. AB currently has a 10% stake, with the possibility of increasing it to 27% through a convertible bond.

The takeover tussle raises important questions about the nature of consolidation in the beer market in China. One of these appears to be the development of a bitter battle between Chinese brewers and foreign brewers.

As one foreign observer in China says, "The foreigners always think that they can drive consolidation by snapping up Chinese assets. But Chinese brewers have no interest in being subsumed under the wing of some alien multinational."

But while HB has avoided integration with its much bigger rival CRB, it is surely only a matter of time before it faces a similar problem with other interlopers trying to build a national presence - such as Qingdao or Yanjing Beer. It will be interesting to see how often HB can repeat its hitherto brilliantly successful tactics.