In a development that has convulsed the Japanese food and beverage sector, Japan's largest beer company Kirin Holdings on Tuesday confirmed a media report that it is in merger talks with Suntory Holdings to create the fifth-largest food and beverage company in the world. However, Nobutada Saji, Suntory's president and a member of the founding family, insisted that the two companies had taken "only half a step".
Nevertheless, it's an exciting development. For decades the Japanese beer industry has been frozen, with Asahi, Kirin, Suntory and Sapporo (in that order) carving up the market between them. As is traditional with Japanese companies, the idea that a merger or an acquisition could be a way for two firms to radically draw away from the rest of the pack was not countenanced -- until now. (A classic example was the rational but firmly resisted effort by Oji Paper to take over Hokuetsu Paper in 2006.)
"One of the reasons the deal has met with such a euphoric response is that it is extremely unusual in Japan for two bitter rivals in the same industry to merge for economically rational reasons," Mikihiko Yamato, food and beverage analyst at Japaninvest in Tokyo, told FinanceAsia.
Indeed, following the Nikkei report on Monday, shares in Kirin went up by 10% at one point, before closing almost 8% higher. Suntory is unlisted and has been owned and managed by the same family since it was founded in 1899.
The share prices of Sapporo and Asahi also rose -- although the outlook for them is much grimmer. "Above all, the move is terrible for these two companies. An important industry dislocation has taken place and it puts a lot of pressure on these two firms," said Yamato.
"Although Asahi has managed to acquire Cadbury's soft drinks business in Australia, as well as a minority stake in the Chinese brewer Tsingtao (for a substantial 14x Ebitda multiple), it looks immobile compared to Kirin's numerous corporate initiatives," agreed Frederic Gits, senior director at Fitch Asia-Pacific in Tokyo. Sapporo's beer activities are taken even less seriously, since most of the group's profits (but not its revenues) come from real estate. Based on 2008 numbers, the sales of a combined Kirin-Suntory entity would be more than twice as large as Asahi's.
It may be old school ties that brought this unusual deal to fruition. The presidents of Suntory and Kirin are both graduates of Keio University, and are therefore both members of that university's influential (at least for a certain generation of Japanese businessmen) alumni club. One analyst, and a Keio university graduate himself, told FinanceAsia that it was through this alumni network that the presidents got to know and trust each other.
A key aspect of the deal will be its structure. Fitch's Gits is concerned that Kirin should not over-extend itself financially, given its recent bout of acquisition activity. Last year it purchased Australian dairy company National Foods, and earlier this year it made Australian alcoholic beverage producer Lion Nathan a 100% subsidiary and raised its stake in Philippine brewer San Miguel Brewery to 48%. Kirin Holdings has spent around $10 billion since it started its overseas acquisition binge.
"The credit impact (from a merger with Suntory) would depend on whether there is a substantial cash outlay involved or not, and what Suntory's debt and cash flow generation are. We have already announced that Kirin could be downgraded by one notch to A flat after the Lion Nathan deal goes through, since that will bring their net debt to Ebitda ratio to about three times -- too high for an A+ rating," Gits said.
Kirin is predicting a 13% increase in pre-tax profit for the first half of this year over the same period last year, thanks to strong sales in down-market pseudo-beers, which are drinks that taste like beer, but are made differently.
Bankers close to Kirin estimate that the deal will be a genuine stock merger, rather than a cash take-over. The maths is basic, given the lack of information on Suntory, but one foreign banker said that the theoretical value of Suntory excluding debt, could be around $6 billion, based on 10 times operating earnings. Assuming an equity value for Kirin of around $12 billion (before the recent surge in the share price) you have a combined entity of $18 billion, with Suntory owning around one-third, or less depending on the amount of debt on its books.
"A single shareholder owning up to one-third of the merged entity is an extremely powerful position to be in. It could be used as a blocking stake, for example, making it very difficult for anybody to take over the new company. Of course, it could also be used in the opposite manner. So a great deal will depend on the relationship between the founding family of Suntory and the Kirin management," said the foreign banker.
One analyst noted that Suntory's Saji has stated publicly that he is not wedded to the idea that Suntory should always be run by a member of the founding family -- rather, he believes it should be run by the right team.
The foreign banker added that the sharp increase in Kirin's share price on Monday was 'bizarre' since nobody yet knows the terms of the deal. If the merger ratio is not favourable to Kirin's shareholders, there could be a transfer of value from Kirin to Suntory. In other words, a situation might arise where the bulk of the benefits from the deal accrue to Suntory shareholders, rather than to Kirin shareholders. This could be the case if Kirin is so desperate to execute the deal that it offers Suntory too generous a stock merger ratio.
He is not alone in pondering the issue. Credit Suisse analyst Yoshiyaku Okihira points out that if Kirin is the initiator (although it is not clear if it is), then it might have to pay quite a steep premium. "Premiums are often steep when acquiring a consumer business, often 10-12 times Ebitda, even if the acquirer is trading at half that level. The shortfall has to be made up from synergies or revenue enhancements," he said.
An intriguing angle to this deal is the way Kirin has switched from overseas expansion to the domestic market. The rationale for overseas expansion is one part of the Holy Grail of M&A, namely revenue enhancements in the growing markets of Australia and New Zealand and other parts of Asia. One can argue that the deal with Suntory ensures progress is made towards the second part of the Holy Grail, namely cost cutting, or synergies. "Possible savings could be the closure of duplicate regional production facilities and better marketing efficiency, notably through concentration on the best brands and products in the merged entity," said Gits.
But while there is overlap, the two companies also complement each other. For instance, Suntory has by far the the biggest market share in soft drinks of any of the Japanese brewers. The new entity would be strong in both sectors. In addition, analysts point out that the deal will enable food and beverage manufacturers to wrestle back bargaining power from the retailers, which have been going through a consolidation of their own and are forcing ever-lower prices on their suppliers (thus pleasing the ever-poorer Japanese consumers).
Japaninvest's Yamato believes the deal, although domestic, will strengthen foreign expansion possibilities. "Increased size will enable the merged entity to make much larger acquisitions abroad, thus becoming a global player," he said.
A final issue is whether Japan's regulators will permit the creation of such a powerful company. The bet is that it is quite likely, given the relatively toothless nature of Japan's Fair Trade Commission, at least compared to US trust-busters.
"The issue is how you measure the market. For example, the brewers will say that the regulator needs to look at the global market, not the domestic market. Or the brewers could do a similar trick as carried out by Nisshin Food after they acquired instant noodle maker Myojo in 2006. They argued that although they had more than 50% of the instant noodle market, they had a tiny share of the overall noodle market. The argument was accepted," said one analyst.
The foreign banker quoted above sounded a word of caution about the completion of the deal, however. "This leak was six months too early, and will lead to a lot of disruption for the two parties. There is still a lot of work to be done," he said.
