Inbev’s Growth Strategy in China: Targeting Clustered Territories

Headquartered in Belgium, InBev commanded leading positions in 20 major markets globally. In order to rd establish a strong foothold in China, on 23 January 2006, InBev acquired 100% stake in Fujian Sedrin Brewery Co. Ltd. Fujiian Sedrin was paid €750 million for this acquisition turning it into a wholly foreign-owned enterprise. The beer market in China was the world’s largest in terms of volume and growth. In 2006, the total sales of the Chinese beer stood over €36 Billion growing at 10.7%. World’s Largest Beer Markets and Their Growth Rates
350 300 250 200 150
2% 6% 242

Production (m illion hectolitres)
312 10% 9%

Grow th (%) over 2005

6% 3% 97 91 63 -1% -3% 61 58 35 30 1% 3%

104

100 50 0 China USA Brazil Russia

12% 10% 8% 6% 4% 2% 0% -2% -4%

Germany

Japan

Mexico

UK

Spain

Poland

InBev was already one of the major players in the Chinese beer market with 36 million hectoliter volume sold in 2005, and this alliance made InBev a leading player in the economically developed regions of south eastern China, where per capita beer consumption was among the largest in China. This deal was completed in two phases, ahead of its anticipation. Firstly, InBev acquired 39.48% stake from the state. Secondly, 60.52% was acquired from other shareholders and by the end of 2007, the entire 100% stake was transferred to Inbev. The acquisition of Fujian Sedrin was an important part in InBev’s China strategy. Fujian Sedrin had been the largest brewer in South Eastern China. Sedrin operated in Putia and Sanming in the Fujian province and in Nanchang in the Jiangxi province. According to InBev, Sedrin had a 45% market share in Fujian during 2004. By acquiring Fujian Sedrin, InBev would not only gain a market position in Fujian, but also in Jianxi province. After the acquisition, the production was aimed at 35 million hectoliters in China. Per Capita Consumption Across the Provinces Geographical Synergies of Inbev

Acquiring Fujian Sedrin was an important step towards connecting the network between Inbev’s existing market between east and south China. Inbev had 18 breweries in Zhejiang, Guangdong, Hubei, Hunan and Jiangsu provinces, located in those two clustered territories in the eastern and southern region of China. Sedrin was an established player in Fujian and Jiuanxi. The Fujian province was an economically developed region along China’s southeastern coast. Its neighboring provinces were Zheijiang towards the north, Jiangxi towards the west and Guangdong towards the south.

The acquisition would strengthen Inbev’s leadership position in China’s highly fragmented beer market, which was largely dominated by the local players. This would create an operational synergy of €110 million for Inbev. Moreover, Fujian Sedrin had been a consistent profit earner with an EBITDA over 30% in 2006. Inbev expected many benefits through the deal (e.g. the economies of scale in production, distribution and marketing). Acquiring InBev was also a step towards strengthening its position in China where arch rivals like AnheuserBusch and Sabmiller had a constant presence. Moreover, acquiring a brewer in a developing economy would give Inbev access to its supply chain that would result in reduced costs.

Inbev would also gain substantial synergies from the product mix of both the firms. Prior to acquiring Fujian Sedrin, Inbev was already the third largest breweries consortium in China. It had formed strategic alliances with Nanjing Beer Plant, Zhujiang Brewery, Chinese Beer Business of Malaysia’ Lion Group, Shiliang Beer, Huashi Brewery, and K K Brewery Co. InBev had acquired 24% share in Zhujiang in 2002. In 2004, it acquired 70% share in Zhejiang Shiliang Brewery and complete ownership of K.K Breweries in Zhejiang province in 2005. All these had given Inbev a substantial portfolio of premium, core and value products. Fujian’s huge share of core products will only enable Inbev to consolidate more in the premium segment of the market.

However, Inbev’s €750 million acquisition of Fujian Sedrin raised different views. A large number of experts opined that the acquisition was a wrong decision as the Chinese beer market was with low profitability and high dominance of local brands. This acquisition also raised concerns whether the revenues would match the investment made by InBev. The analysts were of the view that, the synergy value of €110 million was highly inflated one, as it would not be possible for the merged entity to reduce commercial spending, as the products of Fujian Sedrin and Inbev catered to different business segments in different geographical regions. Moreover, the proposed €70 million production cost synergy was not a direct impact of the acquisition. They argued that, these savings were meant to happen due to the future business growth of Inbev China. If values of these two synergies were ignored, then the total value of synergies stood at around €30 million. Spending €750 million for a company which was then valued at €500 million, thus viewed as a gross miscalculation.

All figures are in $ ‘000 Sales Operating Cost Operating Profit Depreciation EBIT Interest PBT Tax @30% PAT EPS Synergy PV of Synergy Equity Debt D/E Cash Non Cash Assets Net Assets Market value of Equity Number of shares Value per Share

Inbev 200,000 100,000 100,000 20,000 80,000 10,000 70,000 21,000 49,000 2

Fujian Sedrin 100,000 50,000 50,000 40,000 10,000 20,000 (10,000) (10,000) (1)

Cash Acquisition 330,000 120,000 210,000 60,000 150,000 35,000 115,000 34,500 80,500 4 41,500 415000

Stock Acquisition 330,000 120,000 210,000 60,000 150,000 30,000 120,000 36,000 84,000 2 45,000 450000 300,000 600,000 2 1,400,000 600,000 2,000,000
3,450,000 35,000

Repayment of Debt 330,000 120,000 210,000 60,000 150,000 150,000 45,000 105,000 3 66,000 660000 300,000

200,000 200,000 1 800,000 200,000 1,000,000 2,000,000 20,000 100

100,000 400,000 4 600,000 400,000 1,000,000 1,000,000 20,000 50

200,000 700,000 4

600,000 600,000
2,015,000 20,000

800,000 600,000 1,400,000
3,060,000 35,000

101

99

87

*For the simplicity of calculation, it is assumed that 1€ = $2 Moreover, by targeting only the territories in east and south China, Inbev was foregoing the opportunity to tap the North China market, which accounted for around 47% of the total beer market in China. According to the analysts, ignoring the northern territory may give Inbev’s competitors, Anheuser Busch, SABMiller and Yanjing, a chance to capture the northern Chinese market. However, some felt that as the beer sales in the US and Europe was gradually falling, it was imperative for the foreign players to tap the developing markets, where the cost of large scale operation and expansion was cheaper. It thus remained to be seen, whether or not, Inbev would be successful in implementing its visionary growth strategy of ‘Targeting Clustered Territories’. Answer the following questions: A. Multiple Choice Questions 20 x 1 = 20 1. Chinese beer market opens up premium opportunities for the investors, because A. With a low per capita consumption, there remains a huge potential. B. A changing consumption style points out that rural consumers are moving ahead of their urban counterparts C. The urban beer market in China grew by around 6% D. The market was about to be saturated. E. Explosive growth experienced around late 1990s had slowed. 96% of beer consumed was of domestic brands, especially in the rural areas. 2. The global beer brands had the highest potential in China, because A. The foreign brewers were yet to tap the potential of the rural Chinese beer market. B. While the retail sales value increased from 53.36% to 55.63% between 2000 and 2006, the consumption has grown by 33.56% during the same period. C. The population is projected to grow at 0.7 - 0.8%, from 1.32 billion in 2004 to 1.38 billion by 2010. D. Per capita beer consumption is projected to rise by a further 27%, to 28 L by 2010. E. All of the above

3. A rapidly developing Chinese beer market is also cradling competition, because A. More and more MNCs are flocking to get a share of the most promising beer market B. Competition was fierce between the local brands and the imported ones. C. The foreign brewers are striking up partnership with profitable local brewers to integrate less competitive medium or small enterprises into superior ones D. Foreign investments and an increasing number of mergers are becoming a routine affair. E. All of the above 4. Which is not an underlying problem for the Chinese beer manufacturers? A. Breweries that faced losses wrapped up their business and looked forward to global partnerships in order to sustain B. The state promoted the idea of ‘protectionism’, where provinces were protected from competition from other provinces. C. Local brands often did not venture out of their own provincial domains. D. Taxation by the state E. Competition from the producers of hard liquor, which had joined the brewing business after the government, had started to control consumption of hard liquor. 5. Initially, attempting to reap the profits from the premium segment of the Chinese beer market, the global brewers had to bow out and were more or less unsuccessful. The prime reason was A. They entered the Chinese beer market with vigor and the popular strategy of building partnerships. B. They went for major Greenfield investments C. Fragmented nature of the market, where local preferences reigned supreme D. All of the above E. None of these 6. Which one of the following is not an acquisition or joint venture? A. Inbev-Fujian Sedrin B. Carlsberg-Kunming Huashi Brewery, C. Carlsberg-Huizhou brewery D. Anheuser-Busch-Harbin brewery E. SABMiller-Zhejiang Yinyan Brewery 7. InBev forgone the opportunity in Northern China and was attempting to build a stronghold in South-Eastern China, because A. The South Eastern provinces of China were economically prosperous and densely populated in China. B. South Eastern provinces the possibilities for rising future sales C. The per capita beer consumption in China was lower than that of the US or the European market. D. The alliance brought to InBev a 60% market share of China’s south eastern beer market apart from a complete hold on the eighth largest brewer of the country. E. Anheuser-Bushch, SABMiller, Yanjing had already established a presence in the Northern Region. 8. The Chinese beer market had high growth potential, mainly because of its A. high population B. rising disposable income C. betterment of living standard D. Higher foreign investments. E. All of the above 9. The further Inbev operates above its operating break-even point, the closer its degree of operating leverage (DOL) measure approaches A. Minus one B. Zero C. One D. Infinity

10. The acquisition of Fujian Sedrin was an important part in InBev’s China strategy, as A. Fujian Sedrin had been the largest brewer in South Eastern China B. Sedrin operated in Putia and Sanming in the Fujian province and in Nanchang in the Jiangxi province C. Sedrin had a 45% market share in Fujian during 2004 D. InBev would gain a market position in Fujian and Jianxi province E. The production will be increased to 35 million hectoliters 11. Inbevs degree of operating leverage (DOL) will depend primarily upon its A. Sales variability B. Level of fixed operating costs C. Closeness to its operating break-even point D. Debt-to-equity ratio E. None of these 12. An EBIT-EPS indifference analysis chart can be used by Inbev’s management for A. Evaluating the effects of business risk on EPS B. Examining EPS results for alternative financing plans at varying EBIT levels C. Determining the impact of a change in sales on EBIT D. Showing the changes in EPS quality over time E. All of the above 13. Inbev’s EBITDA is usually the same thing as Inbev’s: A. Funds provided by operations. B. Earnings before taxes C. Gross Profit D. Net income E. Operating profit 14. In the context of Inbev’s operating leverage break-even analysis, if selling price per unit rises and all other variables remain constant, the operating break-even point in units will: A. Fall. B. Rise C. Be constant D. Stay the same E. Still be indeterminate until interest and preferred dividends paid are known 15. If Inbev has a DOL of 5 at Q units, this tells us that: A. If sales rise by 5%, EBIT will rise by 5%. B. If sales rise by 1%, EBIT will rise by 1%. C. If sales rise by 5%, EBIT will fall by 25%. D. If sales rise by 1%, EBIT will rise by 5%. E. None of these 16. This statistic can be used as a quantitative measure of relative "financial risk" of Inbev A. Coefficient of variation of earnings per share (CVEPS) B. Coefficient of variation of operating income (CVEBIT) C. (CVEPS - CVEBIT) D. (CVEPS + CVEBIT) 17. Inbev's degree of total leverage (DTL) is equal to its degree of operating leverage____________ its degree of financial leverage (DFL). A. Plus B. Minus C. Divided by D. Multiplied by E. Remains constant

18. The inorganic growth path attempted by InBev comes with its share of doubts. Which one among the following posses the least amount of threat to Inbev? A. The Chinese beer market remains the stronghold of the local breweries B. Per capita consumption remains low as compared to the European and the American markets C. Fragmented nature of the Chinese market D. Poor distribution network E. Low profitability 19. Which of the following add up to the costs of financial distress in Inbev? A. Direct bankruptcy costs, primarily legal and administrative costs. B. Indirect bankruptcy costs, reflecting the difficulty of managing a company when it is in bankruptcy proceedings. C. Costs of the threat of bankruptcy, such as poor investment decisions resulting from conflicts of interest between debt holders and stockholders D. All of the above 20. According to pecking order theory, Inbev’s management will often choose to finance with: A)New equity rather than debt, due to bankruptcy costs B) Debt rather than new equity, to avoid reduced share price C) Debt rather than retained earnings, to lower the WACC D) New equity rather than debt, to strengthen EPS B. Subjective Questions 5X6=30 1. Analyse the beer market in China. How distinct is the Chinese beer market from other global markets? 2. “… foreign breweries found it difficult to penetrate into the Chinese beer market and gain popularity as a national brand.” What do you think were the reasons behind this? 3. How different was Inbev’s strategy from other international brewers? Do you think InBev’s strategy is feasible? Why or why not? 4. What were the major reasons behind acquiring Fujian Sedrin? What synergies did InBev expect through this acquisition? 5. “However, InBev’s $750 million acquisition of Fujian Sedrin raised different views…” What do you think were the reasons behind this?

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