More on ABInBevSABMillerGrupoModelo

FILED FEBRUARY 8, 2011

Dear Client:

Credit Suisse issued a follow-up report to their much-cited theses last week that SABMiller and AB InBev may be headed for a tie-up (although several press reports inaccurately are reporting that the two are already in talks). Citing feedback from "senior industry participants", CS said that "nobody in our diverse pool of responders indicated that we are off the mark." Credit Suisse reiterates that "SABMiller is smaller and does not have a control group" and "management of SABMiller recognizes that ABI could come knocking," perhaps as soon as later this year. Credit Suisse's Tony Bucalo "likes SABMiller for its ability to drive double digit organic earnings growth and sees nearly a 40% takeout premium.

More reasons the deal works, according to CS: "Altria owns 27% of SABMiller and the Santo Domingo Family another 14% and both may need equity. Less than 59% could be funded with cash and from asset sales. A $10 billion sale of the US and a $4 billion sale of the China could drop ABI's debt need for financing toward $30 billion."

Want more? One exec even suggested that "ABI might not want to hang on to ABI's 50% stake in Mexico's Grupo Modelo. This could cut the cash needed for an ABI+SABMiller deal to below $20 billion."

But some execs took issue with Credit Suisse's contention that there's a "need for cultural evolution at SABMiller," suggesting those comments were "unfair." "Even a very senior former SABMiller competitor argued that SABMiller is a better organic growth management team than ABI. If fair, then it would advance our case that the US venture is the anomaly that should be sold."

What about distributors? We'll have our own take on that later, but CS says "the read-through for US Beer distributors is bleak. An ABI+SAB tie up would not be funded from great synergies since few countries overlap and these are two of the most efficient brewers in the world. All the low hanging fruit has already been taken out of MillerCoors and the old Anheuser-Busch. We think that TAP and the new megabrewer would want to look at the nearly 1,000 US distributors and finally drive the massive consolidation consultants Joe Thompson and Mike Mazzoni have been calling for over the years. Coke and Pepsi seek to displace more liquid volume and more SKU's with only 2 distributors."

GOOSE ISLAND HIRES BANKER FOR EXPANSION

Chicago's Goose Island Beer Co. has reportedly hired an investment banker to raise funds to expand their brewing capacity, according to a report in Crain's Chicago Business by Kate MacArthur. Goose brewed 130k barrels last year and is growing. It has hired Chicago-based Livingstone Partners LLC to find investors to fund the expansion. Goose chief John Hall told Crains that he hopes to find investors willing to take a stake, but leave the Hall family in control of the brewery. Goose had already cut a three year deal with Craft Brewers Alliance to brew some beer for them, but they are looking to keep their options open.

RECORD-BREAKING JANUARY FOR CRAFTS

Despite miserable weather in already (usually) slow January and the slipping numbers the overall industry cited for it, many craft brewers have posted record-setting highs for the month. Jim Caruso told BBD Flying Dog was up 47% in January. "If it weren't for a winter storm that halted shipping for a couple of days, January sales would have set a new record for the highest volume month ever," he said.

Contributing to the banner month for that brewery: a 93% sales jump in the Mid-Atlantic region, even "going up against strong numbers for that region last January." The overall increase was also a payoff from momentum two years in-the-building, as well as increased velocity and new accounts.

FD IS NOT THE ONLY GROWER. New Glarus' Deb Carey said this Jan. was up 40-plus % over last year. Deb summed up the phenom succinctly: "Economy is turning, Super Bowl and holiday media [have] promoted craft beer."

Industry consultant Bump Williams said Blockbuster January is something he's only seen from craft this year, though from a "myriad" of them. He attributes it to five things: continued consumer trending toward craft, spillover craft holiday sales, expanded footprint payoffs, 2010 momentum leverage and, of course, strong seasonal releases (with out-of-state titles doing very well at retailers). Says Deb: "In short craft beer industry matures into dependable quality just as major domestics stumble." Ouch. Numbers back her up.

COURT HANDS DOWN FAVORABLE DISTRIBUTOR RULING IN NY CASE

In the case of Amtec International of NY Corp v Beverage Alliance, importer Beverage Alliance terminated Amtec International of NY Corp and asserted that it was not a successor brewer under New York law because it did not purchase the import rights from the prior importer, but rather from the overseas brewery, Carlsberg Okocim, SA, itself. The Court, however, disagreed, and ruled in favor of the beer distributor, that an importer qualified as a "successor brewer" under the statute, and thus could not terminate its wholesaler without "good cause" even though the successor importer did not acquire its import rights from the prior importer.

In its decision, the Court stated that "[i]mposing the brewer's obligations on the intermediary shields the wholesaler from arbitrary termination." In doing so the Court indicated it was upholding the intent of New York's legislature to "level the playing field between brewers and distributors."

According to Amtec representation Ettelman & Hochheiser P.C., the Court also strengthened New York's franchise law in three ways: by ruling that the law "clearly covers non-written agreements"; that it "may not be superseded by contract"; and that "beer distributors tend to become associated with the brands they distribute and that a distributor's investment in the brand generates 'good will.'"

WSJ DOES PRIVATE LABEL BEER

Walgreens, 7-Eleven, Supervalu, Trader Joe's -- they all sell private label beer. Should the industry be concerned? Well, some do it better than others. Trader Joe's and Costco are selling private label craft beers, which makes sense, since there isn't much brand loyalty (it's more akin to wine). Walgreen's and Supervalu are selling low end budget beers, which in our opinion doesn't make sense, since the big brewers have protected their flank on the low end with nationally advertised budget beers (Busch, Natty, and Keystone being the trifecta).

So Walgreens comes out with a private label cheap beer called Big Flats, and the big media is covering it from various angles. My friend David Kesmodel at the Wall Street Journal writes this morning of "Buck Range Light, a low-priced domestic brew" owned by the Supervalu chain which came out in December. And of course Walgreens is fronting Big Flats for $2.99 a six pack. The common denominator is that both chains have turned to Winery Exchange to source the brews from various breweries with capacity. I met the chief of Winery Exchange a few years ago in New York, but back then it was primarily sourcing private label wine. Now it's getting much more into sourcing beer for retailers. The price increases that the big brewers have taken, coupled with some excess brewing capacity, have created an opportunity for private label beer.

Says the Journal:

"Part of the attraction for retailers is that sales of other store-branded goods--from soap to pasta--have been robust. Revenue for private-label products rose 2% last year in food, drug and mass-merchandise outlets, according to market-research firm Nielsen Co., compared with a 1% decline for branded items.... But store-branded beers have struggled to gain traction for years in the U.S., in part because beer is typically consumed in social settings and brand image is important. Private-label alcoholic beverages made up less than 1% of alcohol sales in the retail outlets tracked by Nielsen last year, while store brands accounted for 17% of all items sold."

Note that this market share figure of "less than 1%" is for all alcohol. From what we've been told by those who know, retailers have had much more success with private label wine and spirits than beer, so store-branded beer market share is likely much less than that.

WHAT THE CHAINS ARE SAYING. "Based on the economy, we saw an opportunity to offer our customers a high-quality, low-priced beer in a can," said Michael Siemienas, a spokesman for Supervalu to the WSJ. Consumers are demanding value "now more than ever," said Bryan Pugh, vice president of merchandising for Walgreens. What about 7-Eleven's Game Day beer, a budget beer that we've heard has been a dog. "Admittedly, Game Day has had some challenges, particularly in the 12-pack," said 7-Eleven. But 24 ounce cans have sold well, they said.

WHAT THE BREWERS ARE SAYING. Given the scant market share of private label, the big brewers aren't exactly shaking in their boots, yet. "Retailers should be cautious about over-proliferating their beer shelf with private label, unsupported brands that can commoditize the category," said MillerCoors. A-B chief Dave Peacock told the Journal "the industry is defined by players who invest heavily behind brands."

MASS FILES NEW SMALL BREWER PROTECTION BILL

A new bill that would allow small brewers (6 million barrels or less) to switch distributors without dealing with pertinent laws has been filed in Massachusetts, according to MassLive.com.

From the story: "Under the current laws, breweries must show 'good cause' to switch wholesale distributors, reasons that could include disparagement of a brand by wholesalers or proof that the distributor failed to put its best efforts into promoting a specific brand. ... The new law would provide for a 90-day binding arbitration process if both sides cannot agree to a fair-market price for the license." The bill had 38 co-sponsors by mid-day Friday.

BEER BRIEFS:

DESCHUTES' GRAND EXPERIMENT. Responding to complaints that some of its iconic 2009 Abyss and Mirror Mirror special release beers were inappropriately sour, Deschutes blogged last week that they will use a flash pasteurizer to kill the brett from their barrel-aged beers, which will then be blended with unpasteurized beer from tanks so the final product will still be bottled conditioned. According to sources, it's unlikely any other U.S. brewers are treating their brett barrel-aged beers in this way.

THE LION BREWERY, the second biggest Penn. Brewery behind Yuengling, is getting into the cans business with a $15 million expansion that includes a new can production line and automated racking system, according to Citizensvoice.com. The new can line "produces about 800 16-ounce cans a minute and about 1,100 12-ounce cans a minute and packages them." CEO Cliff Risell and investors purchased the company in 2007; their investments in equipment and workforce have since grown business by about 20 percent.

BREWPIC OF THE DAY. One of the White House chefs has brewed White House Honey Ale, a White House aide told the Obama Foodorama blog. "It uses one pound of honey from this year's 160-pound harvest of honey from the White House Bee Hive, which sits beside Mrs. Obama's South Lawn Kitchen Garden." The beer was served during the White House Super Bowl party on Sunday.



Until tomorrow, Harry

"I base my fashion taste on what doesn't itch."
-Gilda Radner


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