Capital Management: The Case of the Beer Billions

For several years now, CFO Frank Lai has been wrestling with a cash ‘problem’ that many other finance functions in Asia and the rest of the world also face. How can his company, Hong Kong-listed China Resource Enterprise (CRE), earn higher than bank interest rates on more than US$2 billion in cash and cash equivalents – without taking on risk?
The consumer goods company’s main solution has been to use the money to expand via joint ventures and acquisitions. The latest deal involves paying RMB5.4 billion (US$857 million at the current exchange rate) for the shares, shareholder loans and debts of beer maker Kingway Holdings in nine subsidiaries and one plant in China.
But CRE is not blindly expanding for expansion’s sake, Lai is quick to say. Indeed, it dropped out of the bidding for Kingway last year, then got back in again this year after the winner of the first round, Beijing Yanjing Brewery, walked away because of valuation issues.
“M&A should be a highly disciplined game,” explains Lai. “One thing my chairman, Chen Lang, always tell us, every time he comes and reviews our numbers, he always says: ‘Frank, don’t fall in love with the deal. Don’t think you always have to win. It’s not about ego, that China Resources cannot lose [to anyone].’”
At the same time, though, it’s also not about letting cash pile up on the balance sheet to earn next to nothing in interest. Shareholders are not yet suing in droves for companies to unlock the value of their cash, as hedge fund David Einhorn had done with his now withdrawn legal challenge to Apple and its US$137-billion cash hoard.
But what to do with cash that is steadily piling up can be a dilemma for companies bent on expansion while also committed to prudent financial management.  Even though CRE is actively pursuing joint ventures and acquisitions in China for its beer, beverages and retail businesses, Lai, too, has had to think long and hard about capital management. 
Cash Management
“I must have resources in place because I can’t go [and buy assets] with empty pockets,” he says. “But if I park that money in the bank, I get 0.5%.  Yet I can’t do risk and I can’t go and buy bonds.” There is no saying how long the money needs to be kept readily at hand – CRE worked on the Kingway deal for more than two years. Even after an agreement was signed on 4 February, approval is required from China’s anti-trust agency, among other regulators, which can take months.
In Lai’s view, one way of achieving a good return on the cash without increasing risk, at the same time ensuring ready access to capital for expansion, is through intra-group lending. In 2010, CRE narrowly won approval from independent shareholders on a proposal to lend idle cash to selected CRE sister companies, which like CRE are controlled by Chinese state-owned enterprise China Resources.
In 2011, the practice netted CRE HK$15.8 million (US$2 million) in interest, money that would not have been earned if the cash was parked in fixed deposits. Lai says the company charged sister companies such as China Resources Land “1-point-something percent” for three-to-six-month placements, which is lower than the 2% or so in interest they would have paid the banks in Hong Kong – but higher than the 0.5% CRE would have earned on fixed deposits.  
The loans are guaranteed by the mother company in Beijing and can be pre-terminated any time with two weeks’ notice. “It’s a win-win,” says Lai. But it was a controversial initiative. When CRE asked its independent shareholders – the parent company, which owns 51% of CRE, did not vote – to approve the scheme, only 50.8% said yes.
There were concerns that CRE was moving into non-core areas that it had no expertise in, including lending and property. “You can never please everyone,” says Lai philosophically. “But the job of the CFO is not to please; it is to communicate with investors.”
He continues to explain and clarify to stakeholders that the programme is capital management, not a new line of business, that CRE has no intention of entering the financial-services space, and that the loans are virtually risk free because they are guaranteed and lent only to enterprises with strong balance sheets and solid management.
Triangulating Valuation
There were questions as well about the Kingway assets. Hong Kong-listed Kingway Brewery Holdings lost the equivalent of US$13 million in the first half of 2012 and has warned of more losses in the second half.
Last year, CRE put in a bid through China Resources Snow Brewery, its venture with South Africa’s SABMiller that has about 22% of the fragmented national beer market (No. 2 Tsingtao has some 18%). There were two other bidders – Belgium-based Anheuser Busch InBev, the world’s largest beer maker, and local company Beijing Yanjing Brewery.
Yanjing, China’s fourth-largest beer maker, won the right to exclusively negotiate with Kingway’s controlling shareholder, local government enterprise Guangdong Holdings (GDH). But the talks failed reportedly over valuation issues. GDH, which has said it wanted to monetize its beer assets in order to focus on property development, organized another bidding earlier this year.   
China Resources Snow won this time. It agreed to pay the equivalent of US$857 million, which is much higher than the US$700 million Yanjing was reported to have offered in the first round. Lai says GDH had sweetened the second round bidding by adding the remaining brewery assets that it had originally wanted to keep.
How was the offer price determined? Three valuations were generated – one by investment bank JP Morgan, another by the management of China Resources Snow, and a third by CRE and SABMiller as shareholders. “It was a good process,” says Lai.
The numbers were understandably different (though they did not diverge too wildly) because not only land, buildings, production facilities and other tangibles were being acquired. There were intangibles as well – for example, the Kingway brand and the distribution agreements, which Lai describes as “semi-secure” since the distributors can choose to walk away.
Then there are the different assumptions about the value Kingway will bring to Snow’s business. “The management [of China Resources Snow] tended to be aggressive, because they think they can do better,” says Lai. “They use their own data and Snow has a faster rate of growth [than Kingway].” CRE and SABMiller, as shareholders, had more conservative views, while JPMorgan’s valuation drew on macro developments, such as the beer market’s rate of growth.  
“We challenged each other’s assumptions,” recounts Lai. Reference points were also provided by peer valuations, such as how much Anheuser Busch paid for its stake in Chongqing Brewery three years ago. After much discussion, China Resources Snow tendered an offer price that triangulated all the differing views.
The key to the final valuation was Kingway’s unutilised production capacity in its newly built plants, which Lai says will require only marginal expense to turn into production lines for Snow beer as well as Kingway beer. Kingway also has significant market share in southern China, where Snow’s footprint much smaller – Snow became China’s No. 1 beer brand largely on its market share in the north, where Kingway does not have much of a presence.
The two brands complement each other’s strengths and weaknesses, but not to the point, Lai says, that they dominate the still fractured China beer market. Even combined, Snow and Kingway’s market shares in southern China will still be smaller than that of Tsingtao beer. That’s one reason why Lai is reasonably confident that the anti-trust and other regulators will approve the Kingway deal.
Other Lessons Learned
Since becoming CFO in 2009, Lai has been helping fine-tune CRE’s strategy, optimising capital and cash management, and honing the capabilities and remit of the finance function. The other insights and lessons learned that may spark ideas among other CFOs include:
Know your business and shed assets not aligned with it. When CRE decided to focus on China’s consumer goods sector in 2009, it swapped its textile and container shipping interests for a supermarket chain and a brewery plant owned by its parent. CRE also sold its fashion apparel Esprit China business for an exceptional gain of HK$3 billion (US$387 million) and monetized other non-core assets.
The asset sales helped make CRE a net-cash company, along with the cash flow from the swapped supermarket chain and other multi-format retail outlets CRE subsequently acquired – in 2011, Chinese consumers spent RMB5 billion (US$769 million) on pre-paid cards to give as Chinese New Year gifts. The beer business, which accounts for a quarter of CRE’s sales, has also been a contributor of free cash.
Invest methodically and build the business step-by-step. CRE could have moved very fast to acquire supermarket and breweries at almost any price. “The biggest danger is that, when you think it’s strategically important, then no more discipline needs to be applied, especially if you have deep pockets,” warns Lai. “For us, because we are so cash-rich, I can justify [almost any valuation].”
Don’t give in to the temptation, he advises. Make sure the valuation is right, determined by due diligence, analysis by external and internal parties, peer market pricing and other objective measurements.  
Don’t be afraid of partnerships. The SABMiller joint venture has been going strong for nearly two decades now, as evidenced by Snow “continuing to be the world’s bset-selling single beer brand,” says Lai. Particularly in China, partnerships not only help accelerate business expansion, but also extend the company’s networks to include the partners’ own stakeholders. Once a company has proved a reliable partner with one enterprise, as CRE has done with SABMiller, teaming up with others becomes easier as CRE applies lessons learned.
In 2011, CRE and Japanese beer giant Kirin agreed to inject their non-alcoholic beverage brands into a joint venture company in China. The partnership gives CRE access to Kirin’s hundreds of beverage brands and new teas, coffees and other drinks constantly developed by Kirin R&D. CRE has also teamed up with Chevalier Pacific Holdings to operate the Pacific Coffee chain, which has stores in China, Hong Kong, Macau, Malaysia and Singapore.
Enhance transparency and governance. CRE has been voluntarily producing quarterly financial and operational reviews even before the Hong Kong stock exchange recommended them as best practice. Lai also stresses the important of regular communications with investors, media and other stakeholders. Asset managers are often immured in their glass offices in Central’s office towers, he says. They need to know – and appreciate – what’s going on in China’s supermarket aisles, restaurants and karaoke bars, coffee shops and the business world where CRE operates.  
About the Author

Cesar Bacani is Editor-in-Chief of CFO Innovation. 



Suggested Articles

Some of you might have already been aware of the news that Questex—with the aim to focus on event business—will shut down permanently all media brands in Asia…

Some advice for transitioning into an advisory role

Global risks are intensifying but the collective will to tackle them appears to be lacking. Check out this report for areas of concern