• Phronimos

paying up for cheap beer in Hanoi

About fifteen years ago my wife-to-be and I enjoyed a street-side beer in Hanoi that cost us 20 cents. A minor scooter mishap might have followed. When we say we like to ‘kick the tires’ on our investments, this was one of our most thorough operations!

Thai Bev is Thailand’s largest maker of spirits and second largest producer of beer, founded and controlled by reclusive Thai billionaire Charoen Sirivadhanabhakdi. I’ve been practicing but still can’t manage to say it in one go.

We managed to acquire some shares in Thai Bev on a valuation of around 15 times earnings, a similar multiple of free cash flow and under 13 times enterprise value to EBITDA (a measure of operating earnings excluding depreciation, interest and tax). These are levels we consider to be quite reasonable for this type of business, and certainly a substantial discount to global and regional peers. These types of businesses tend to experience fairly stable volumes and pricing regardless of the economic cycle, they generate healthy profit margins and good free cash flow. The nature of these businesses makes for a very stable and defensive earnings streams with modest, but reliable long-term growth.

Without going into a huge amount of detail, we think the company’s spirits business alone was worth more than the price we paid for the shares. This means we acquired an interest in the domestic and Vietnamese beer assets, food and beverage assets, and listed associates for nothing.

Thai Bev’s spirits business is the goose that lays the golden eggs. It commands an 80% market share in Thailand with its ‘white spirits’ brands including SangSom and Ruang Khao, and cheaper ‘brown spirits’ labels including Mekhong and Hong Thong. This dominant share is partly attributable to government restrictions on foreign ownership, partly environmental regulations and also a quirk of history. Thailand’s unique excise tax system also makes white

spirits by far the most affordable alcoholic beverage relative to other spirits and relative to beer in particular.

This combination of market dominance and favorable excise taxes goes a long way to explaining why margins in Thai Bev’s spirits segment are so attractive. Gross margins have averaged 33.6% over the past four years and operating margins averaged 22%. The spirits business alone produced free cash flows of around US$700 million in 2020 financial year. This is also a business that is much more local and rural, meaning it survived the pandemic without much impact. Spirits volumes were unchanged at 668 million liters over the year to September.

Thai Bev’s domestic beer business is substantial but not nearly as profitable as spirits. Thai Bev’s Chang brand holds between 35-40% of the market, second to the Leo and Singha labels of the local Boon Rawd Brewery with a 55-60% share. The beer business generates mid-single-digit EBIT margins, partly as a result of unfavorable excise duties (a combination of ad valorem and specific excise taxes adds 30 Baht to a 75 Baht 600ml 5% alcohol beer pre-excise price beer), but also because of higher marketing and distribution costs versus global beers—something we are still trying to understand. Beer volumes also declined substantially in the year to September owing to a drop in tourism and a temporary ban on alcohol sales during the pandemic.

While Thai Bev’s domestic beer business is challenged Thai Bev now holds a 53.6% interest in Vietnam’s Saigon Beer Company (‘SABECO’), Vietnam’s largest brewer with a national market share of around 40%. Vietnam is one of the most attractive beer markets in Asia. In terms of per capita consumption Vietnam stands at around the same level as South Korea and Japan but Vietnam’s demographics and per capita income growth outlook are far superior. It was the world’s fastest growing beer market in 2018 with volumes rising by 7% and it is one of only two countries that produce over 10% of Heineken’s group profit (the other being Mexico). SABECO has a large share of of the mainstream beer segment and is starting to introduce premium labels to move up market. Moving the brand up-market can be challenging, but very rewarding if it can be achieved. But there are also simpler steps Thai Bev can take to improve efficiency at SABECO including reducing the number of breweries.

In short, SABECO is a very nice business, with good top-line growth averaging 7.7% over the three years to 2019 and an EBIT margin of around 14-15%. In 2019 SABECO generated US$1.6 billion in revenue, US$265 million in EBITDA and US$218 million in net income and had net debt of US$640 million. SABECO is listed locally in Vietnam with a market cap of around US$5.4 billion or a trailing price-to-earnings multiple of 25 times. Similar beer businesses in fast-growing emerging markets including Tsingtao, China Resources Beer and Budweiser Brewing Asia trade on significantly higher multiples.

What makes this interesting is that Thai Bev management has signaled it is looking to list its beer segment assets separately, which would probably allow the beer business to attract a higher valuation. At the price we paid the market was imputing virtually no value for the Thai beer assets, but as part of a regional South East Asian beer group they would certainly be worth more.

Another objective for carving out the beer business, however, might be enticing Budweiser Brewing Asia into making an acquisition. Budweiser Asia is the Asian arm of beer giant Ab Inbev and was listed separately in Hong Kong in 2019. Its key asset is a 16% market share of the Chinese beer market and the company is valued at US$43 billion with no net debt. Management of Budweiser Asia are on record saying they want exposure to faster growing markets, calling out India and Vietnam specifically, and an opportunity like SABECO doesn’t come up every day, especially with the government also looking to sell their remaining 36% stake in SABECO. An acquirer of both stakes could end up with 90% of the largest brewery in Vietnam.

One stumbling block to any deal might be price. Budweiser could pay a substantial premium, using either cash, stock or a combination of both, and still have the deal be accretive given its stock trades on a multiple of around 40 times. There would certainly be some synergies and costs savings from being part of a much larger, global company. Whether they could go as high as the US$4.85 billion that Thai Bev paid originally (and almost certainly overpaid) is another question. Anything less than that would result in an embarrassing write down of the purchase price for Thai Bev, even though it would be rational to accept an offer of more than the current market value. Structuring a deal that leaves value for Ab Inbev and is face-saving for Thai Bev is the key.

At the price we paid we think we will achieve a reasonable return on investment based purely on the status quo, but the industry dynamics here could certainly help.

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