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Posted June 2013

 

And the winner is … Constellation

Modelo takeover │ That’s it, then. And what a saga it has been. It’s taken Anheuser-Busch and its successor, AB-InBev, a total of twenty years to acquire the Mexican brewer Grupo Modelo. However, it’s not been so much a case of “patience pays off” (the Brazilians) as of “patience worn thin” (the Mexicans). Ever since the Brazilian-Belgian brewer InBev bought its U.S. competitor Anheuser-Busch in 2008, a full takeover of Modelo was merely a matter of time. The final three-way transaction between AB-InBev, Modelo and Constellation Brands had some surprising twists and turns, especially when Constellation Brands became the white knight that saved AB-InBev from the fangs of the U.S. antitrust watchdogs. How could this happen? Indeed, the question is: how did U.S. wine company Constellation manage to turn itself from twice-saviour of Modelo into Modelo’s ultimate gravedigger?

“Who the heck, is Constellation?” many of my readers outside the U.S. will have asked themselves, when in June 2012 AB-InBev announced that they would spend about USD 20 billion to buy the half of Mexican brewer Grupo Modelo they did not own yet, while at the same time offloading Modelo’s 50 percent stake in the U.S. importer Crown Imports to their long-term partner Constellation for USD 1.85 billion.

My readers can be forgiven their oversight. Not many analysts had Constellation on their radar screens either. Constellation is a wine company with a turnover of USD 2.8 billion (for the year ending February 2013). These days it likes to call itself “the world’s leading premium wine producer” which is not quite the same as saying “the world’s leading wine company”. This title probably went to its privately-owned rival E&J Gallo in 2012, after Constellation had to pull the plug on its distressed Australian wine company Hardy and offload it in a rush for USD 290 million in 2011 – notwithstanding the fact that Constellation had paid a hefty USD 1.1 billion for it in 2003

But irrespective who actually tops the list in wine, being “world leading” is a fairly presumptuous claim anyway, as the top five wine companies E&J Gallo, The Wine Group, Constellation, Accolade Wines and Treasury Wine Estates (the former Foster’s unit) controlled only 8 percent of global wine volumes in 2012.

According to U.S. media, Constellation had humble beginnings as a purveyor of bulk wine. One of its biggest sellers remains Richard's Wild Irish Rose, which is often derided as "bum wine". CEO Robert Sands and his brother Richard Sands, the company's Chairman, are the sons of the late founder, Marvin Sands, who began the company in Canandaigua, New York, in 1945 in a former sauerkraut factory. Then named Canandaigua, it went public in 1973 and twenty years later embarked on a shopping spree which lasted well in into the Noughties when it snapped up more than 15 companies. Fortunately, Canandaigua changed its name to Constellation Brands in 2000 – they said this served “to better reflect the broad range of brands” – or investors would have given the company a wide berth as they struggled to make its cumbersome name drip from their lips.

Actually, they should have given the company a wide berth for altogether more prudent reasons. Investing in an agribusiness, like wine, is highly risky and requires a deeper understanding of the nature of the game, than say, beer, in that it's subject to uncontrollable variables like the weather. From that point of view, for an investor, wine is a flawed business model as there is no clear line graph showing an increase in profits every year. No wonder, that with relying on wine sales for about 45 percent of its revenues, Constellation has struggled to generate good operating margins (18.3 percent in fiscal 2013, compared to AB-InBev’s 32 percent) in its global wine platform and for years has tried to prove to Wall Street that it can drive long-term profit growth without relying heavily on dealmaking.

Besides, Constellation has never paid any dividends in its 40 years as a stock market-listed company, nor have investors had much say in the company. The Sands family still controls the voting stock. Investors have shown quite some faith in Constellation, given that they could only earn money on their investments if they sold shares that had appreciated. This faith was sorely tested between 2010 and 2012 when Constellation’s stock hovered around the USD 20 mark. Luckily, the spoils investors have reaped since the announcement of the AB-InBev-Modelo transaction must have more than compensated them for their suffering. Constellation’s share price was USD 51 at the end of May 2013.

As I see it, Constellation’s one and only saving grace in the past 20 years has been its beer unit Barton Brands, whose profits funded Constellation’s forays into wine. Here the story becomes really fascinating because Barton was one of the two U.S. importers of Modelo’s beers, the other one being the Gambrinus Company from Texas. Each looked after half of the U.S. territory: Barton had the West and Gambrinus the East. Together with Gambrinus Barton took Modelo’s Corona Extra brand from zero to greatness and en passant wrote the greatest success story in the beer industry to date. Barton, whose portfolio included a large number of imported beers and spirits, was itself the result of a management buy-out by British CEO Ellis Goodman in 1987. When Mr Goodman sold Barton to Canandaigua in 1993 for USD 140 million, it was probably out of desperation. After enjoying significant growth during the early 1980s, Modelo’s U.S. sales dropped from 23 million cases in 1987 to 13 million cases in 1993.

One could cite a number of reasons for this, one being August Busch III who in 1987 decided to change the packaging of his beers from boring stubbies to non-returnable longneck bottles at great speed and even greater cost, which eliminated one of Corona’s USPs in no time. As history shows, Corona’s decline was halted when Gambrinus absorbed the doubling of the Federal Excise Tax. In 1993 it began its phenomenal rise which lasted until 2006. Ironically, Mr Goodman was not to profit from this. Having seemingly lost faith in Corona’s turnaround, he decided to cash out while he could.

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