Takeover to Makeover

Published on Saturday 21 February 2009 12:48

AS THE last of Britain's big brewers passed into foreign ownership, the board of Scottish & Newcastle met at Edinburgh's Royal College of Physicians for a valedictory dinner to mark the company's drawn-out takeover battle with Heineken and Carlsberg.

That night, as they reflected on achieving the best possible price from their pursuers, the conversation was dominated by talk about prospects for the business which would be carved up by its new owners.

In Amsterdam, Heineken chief executive Jean-Franois van Boxmeer was also in reflective mood as he contemplated a "transformational" deal that gave the firm almost 30% of the UK beer market.

But a year is a long time in brewing. Fast-forward to February 2009 and the mood could not be more different. Unveiling full year profits on Wednesday morning, van Boxmeer spoke of a "perfect storm" ripping through the UK market, where beer volumes have slumped 5.1% on the back of unprecedented pub closures, a fall in the pound, a rise in excise duty, a growing trend for the public to buy ever cheaper lager in supermarkets and one of the worst recessions in a generation.

On top of that, in India, where Heineken inherited S&N's 37.5% stake in Vijay Mallya's United Breweries, it is being sued by the Indian tycoon, who is claiming the rights have lapsed as a result of the takeover. Back in Scotland 650 jobs have already gone from S&N, and more are to follow.

"At the time it was the right strategy and it was the right price," said van Boxmeer on Wednesday. "It is still the right strategy." In private few would blame him if he agreed with S&N's former chief executive John Dunsmore's assessment that the timing of the deal was extremely fortunate.

But the outlook is distinctly uncertain. "The industry is crying out for a leader," says John Wakely, a former managing director of investment bank Lehman Brothers, who has been analysing the drinks market for more than 20 years and is now a strategic consultant. "For too long the breweries have been fighting each other when they should have been fighting the coalition of politicians and forces who are destroying the British pub. We need a fresh initiative to re-instate the British pub as a national institution that has to be cherished. What the industry needs is a new beer-and-pub initiative."

With beer sales at their lowest levels in almost 40 years, an average of 36 pubs closing every week and tens of thousands of jobs already lost in the brewing industry, analysts are now asking: where does S&N go from here?

Striding through the firm's glitzy canteen, which could be mistaken for a City centre style bar, in Edinburgh's South Gyle business park, Jeremy Blood, S&N's UK managing director, is unfazed by the challenge. Blood, who joined the company as a graduate trainee from Cambridge University in 1988, has the look of an army corporal. True to form, coffee in hand, he chooses not to indulge in chit chat.

"Frankly, where could I go to find myself a nice easy industry to work in at the moment?" he asks. "Yes, it's tough, but it doesn't really feel that unusual. What has really hit us, apart from the smoking ban that has accelerated the pub closures, is the inflation in commodity prices. If you think about what goes into a can of beer on a shelf, it is made up of three things: aluminium, which has almost gone up tenfold in price. Barley, an agricultural product that has suffered an increase in price, and the energy that is required to malt barley, which has also increased. Last year, our hit on commodity prices was 60m, which came on the back of a depressed pub sector. It was a shock to the system."

From April, when S&N's shares were de-listed from the London Stock Exchange, it took 100 days to integrate the two companies. For the staff the learning curve was steep. As well as running the business and trying to grow market share as normal, a new culture from the Netherlands had to be absorbed that Blood describes as "perhaps a little more structured than before".

There has also been a shift in emphasis. Despite being Britain's last big independent brewer with a rich 250-year history, S&N had become a deeply unpopular company among mainstream beer drinkers. In Scotland it was perceived as a lager factory routinely stripping beers and pubs of their personality and turning them into commodities. There were many who were not sorry to see it go.

"In a sense Heineken has changed all that," says Blood. "There is some truth to say that British plcs chasing the next six months' results are forced into taking shorter-term decisions. We lost some of our reverence for beer, we cut corners. It (the takeover] has reinvigorated our passion for beer. We used to call them manufacturing sites. Now we call them breweries or cider mills. It's a small change, but it is significant."

A cost-cutting period followed in the summer when bottling lines were reduced and the company announced a phased closure of the Reading brewery and a reduction in the sales force in line with a 25% fall in sales from the pub sector. It wasn't pleasant, admits Blood, but necessary. By September, his team was ready to focus on a new strategy.

Central to this is premiumisation. In a market where volumes are declining, a surefire way to increase profits is to get the customer to pay more for your product. Analysts argue that this was the rationale behind van Boxmeer's takeover of S&N in April: to premiumise its core brand, Heineken, in the UK. Historically, the only successful premium lager has been Stella Artois, which saw its price increase under the advertising slogan "reassuringly expensive". In recent years, the price of Stella has fallen and Blood now sees an opportunity with Heineken and its other brand Amstel.

"What is dramatically different in the UK from almost any beer market in the world is that the prices are low. Just really, really low. Stripping out tax and duty, the price the brewers charge for beer is roughly about half of the level in western European markets."

Blood argues that the success of S&N's brands, such as Foster's and John Smith's, has been diminished by the way they are sold in supermarkets as a commodity to be discounted. It is a situation he likens to the baked beans wars of the mid-1990s when some chains started selling their own brand of beans for as little as 3p.

"What is also peculiar to the UK is our tradition of drinking beer in pints. This has led to a situation where the price between the most and least expensive pint is very, very close. If you look at the Scotch whisky market they have been very successful in creating value, mainstream and super premium products.

"I'm not saying I am a genius businessman by taking out costs and raising prices. It is about decommoditising beer over the next 10 years, investing long term in our premium brands in such a way that people will pay more. It is only by creating that sort of value that the beer industry will be sustainable in the UK. We are not going to get there by volume growth."

Another option is to introduce in the UK different draught sizes and smaller, more elaborate glasses. One size being considered is the third of a pint, allowing lager to be served with a large, frothy head. At the other end of the scale, Blood also has his work cut out with Foster's, a brand that has seen its volumes fall by 10%. A new advertising campaign is being considered that will reinvigorate more of an irreverent and jocular personality around the brand.

"If you are in Scotland you can't help but look at what the whisky guys have done," he says. "They have had a long-term commitment to their product, its provenance and its roots. They have added value by investing in their brands over the long term. That is how you build value in branded goods in mature economies."

But it's not all about beer. In Strongbow and Bulmers Orginal, S&N has a large swathe of the cider market. Last year Blood launched Bulmers pear, which is served over ice. Next month Irish cider maker Magners will launch its own pear variant. The irony is not lost on Blood. In December, former S&N board members John Dunsmore, Stephen Glancey and Kenny Neison took over at Magners cider maker C&C.

"In that sense we know our enemy very well," he smiles. Let the battle commence.

Mallya 'close to selling stake' to Diageo

SPECULATION was growing last night that Vijay Mallya, right, the Indian drinks tycoon, was flying to London to sign a deal with Diageo for the acquisition of up to 14.9% of his United Spirits Group, writes William Lyons.

Sources close to the negotiations say a deal is imminent as both sides look to conclude months of wrangling. Diageo, which markets brands such as Johnnie Walker, J&B Rare and Smirnoff vodka in India, is understood to want improved access to the Indian spirits market.

After a spate of acquisitions over the past three years, including Whyte & Mackay, and his decision to open Kingfisher Airlines in 2005, analysts suggest Mallya is desperate for a cash injection.

Before global stock markets collapsed last year, Forbes estimated Mallya's fortune at $1.2bn, ranking him at number 962 in its 2008 list of the world's billionaires. But his United Spirits, India's largest drinks firm, with a 40% share of the market, has seen its share price plummet 46% this year amid investor concerns over its financing of the Whyte & Mackay acquisition. It reported a 65% fall in net profit for the three months to December.

Mallya, who used to socialise with top brass at UK brewer Scottish & Newcastle before it was acquired last year by Carlsberg and Heineken, has been forming closer links with Diageo. One of his children recently joined the company temporarily in the UK as an assistant brand manager for Guinness.

United Spirits lays claim to a 55% share of India's spirits market, but analysts say Mallya is keen to take on a non-Indian partner as the sector expands. Mallya has already pledged 30 million of his own shares in United Spirits as collateral against loans for the company's 595m acquisition of Whyte & Mackay and has pledged to deleverage United Spirits completely within six months.

He recently told an Indian television news channel: "There is not the slightest risk that these shares will be sold or that banks will call upon these shares to realise their outstandings because the underlying company performance, and the assets that these companies have, are strong enough to repay all the loans when they come due." So far Mallya has launched nine brands in India, including The Dalmore, Isle of Jura and Whyte & Mackay blended Scotch.

Meanwhile Mallya is embroiled in a legal battle with Heineken amid claims by Mallya that the rights attached to the minority stake lapsed as a result of the takeover of S&N.

As part of the takeover, Heineken inherited S&N's partnership in United Breweries, India's biggest brewer. Mallya, UB's co-owner, insists that Heineken may not be a shareholder in both UB, famous for Kingfisher, and its rival, the Singapore-based Asia Pacific Breweries, whose Tiger brand launches in India this summer. Mallya argues that the partnership was rendered void by the S&N takeover and refuses even to give Heineken financial details on UB.