Why the DOJ is Returning to the Bargaining Table

FILED FEBRUARY 21, 2013

Dear Client:

As reported yesterday, ABI, Constellation, and Department of Justice have entered into "discussions" about ABI's new deal to sell the Piedras Negras brewery to Constellation. As a part of those discussions, all parties have agreed to jointly approach the court to request a temporary stay of all litigation proceedings until March 19, 2013.

That gives the DOJ a month to study the deal and ascertain if it's enough to approve the deal, or perhaps get more concessions out of ABI-Constellation, like shortening the three year transition period to prepare the Piedras Negras brewery to supply the entire US.

Prior to this announcement yesterday, a source close to DOJ/antitrust circles told BBD that representatives from ABI met with Department of Justice lawyers last Thursday and the DOJ's response was "not particularly favorable" although they also recognized quickly that litigating against this new deal would be much more difficult.

So why did our source believe the DOJ would still want to go to court and litigate? Becase they may look at the deal to sell the Piedras Negras brewery "as sort of freebie. Why not litigate.... if you lose you will likely still get what they've offered you, which is Constellation owning production."

WHY THE DOJ CASE GOT THE WIND CUT OUT FROM IT. The DOJ filed a lawsuit to stop the merger as it was originally configured. However, ABI and Constellation would most likely ask the court to rule on the newly revised deal if they can't strike a deal with the DOJ in the next 30 days, and legal experts have told BBD that the court would likely oblige. So, the old deal is dead and the court would only rule on the new deal.

Personally, I think the court would favor ABI with this new deal in place, which is why the DOJ has come back to the negotiation table. The DOJ's only remaining antitrust argument is: Regardless of who owns production, Constellation will still be a follower on price increases. The reality is, anybody and everybody would be (and is) a follower on price increases, and if Modelo were still in place, it would likely be a follower as currency exchange rates change and commodity prices rise in Mexico.

GRAHAM SPEAKS ON SABMILLER'S LEGACY, PRICING, BRANDS

In a speech at the CAGNY analysts convention this week, SABMiller chief Graham Mackay spoke on issues ranging from selling local brands locally to pricing in the US. In a private Q&A with analysts, one source told BBD that when asked about whether the DOJ approved SABMiller owning all of MillerCoors when they first merged, he said he thought it did mean that "unless the rules have changed." When asked if he'd like to sell or buy the rest of MillerCoors, Graham said that he would "prefer" to own 100% of it. Interesting.

Here is a smattering of other comments for your perusal:

GRAHAM ON US PRICING. "What I think is happening in U.S. pricing is that the current level of pricing is set to continue at roughly the current rate. There's quite a lot of complexity going on in that pricing, obviously, because the growth, as you know very well, I'm sure, is all at the top end, and so overall prices are rising because of mix as much as anything else, also because of the gap closure at the bottom. And the trends that have driven that, I think, seem set to continue for some time. I don't see a discontinuity in that. There is some action, though - again, as you probably know - with the introduction of more affordable crafts in the above-premium space, below the super-premium space, and that may change the mix dynamics of those if those take off any further."

GRAHAM ON IMPORT VS PREMIUM PRICING. "What Constellation might do with Corona pricing if they went ahead with this particular deal, is a matter of speculation, yes, if they price up, obviously that would relieve some of the pressure on the premium and premium-light sectors. It's not just Corona, of course, though. The premium at which the international brands, Heineken, Corona and the rest, have been set above premium ... has gone down in the time that we've been involved in the U.S. market by probably 30 percentage points, or at least 20 anyway. So there's been a gradual price compression of those international brands coming down towards local domestic brand pricing, steadily, for a long time."

"Now, what exactly that's been due to I don't know. But presumably the owners of those brands have been making decisions on what prices they can get, what prices their brands can command over the mainstream. So, yes, any widening of that gap obviously would be good for premium lights, I think, and MillerCoors is best at premium lights. So, yes, you would argue that to be a positive development. But there is a lot of other stuff going on in the above-premium space as well, so you'd have to take that into account."

GRAHAM ON BEER'S AND SABMILLER'S TRANSFORMATION. "We can choose from a range of flavors and strengths and a broader array of brand imagery. Bottles and labels are more attractive, cleaner, and the perception or the status of beer, particularly in emerging markets, over this period has been transformed.

"Before industry consolidations began, beer's value proposition in emerging markets was unclear, perhaps even paradoxical. On the one hand, relative to most forms of local alcohol, such as vodka in Eastern Europe, sorghum homebrews in Africa, cane spirits in Latin America, or country liquor in India, beer was priced at a high premium, certainly per unit of alcohol, and in many cases in absolute terms as well. This is because beer was and still is intrinsically a higher-cost form of alcohol than the other liquor types, both to produce and to deliver, with higher capital and operating expenses which impact CapEx and margins.

"But on the other hand, the image of beer was scruffy and unsuited to commanding a premium. Old bottles, uninspiring packaging, and rather simplistic marketing campaigns tended to have only one target in the minds of consumers, and that was the working man. And on the screen you can see some emerging market bottle imagery as well as some conventional use of the male psyche.

"In the early 1990s, we saw compelling opportunities to run beer assets better in the breweries as well as out in the marketplace with retailers, and create a better image for consumers. Perhaps unlike many other U.S. or Europe-based brewers, we focused on the potential of the markets, as we saw it, for beer growth rather than being put off by the assets, which were often of extremely poor quality at the time.

"We might even have underestimated the extent to which beer would alter the mix of consumers' alcohol consumption, raise its share of total alcohol. But as we've reported for many years since then, beer's share of alcohol has risen in many markets as a result of our work to upgrade our category. Over time, beer has displaced local spirits and other subsistence alcohol in more and more occasions. As we looked beyond our original operations in South Africa, we saw opportunities in other countries for the capabilities we'd developed at home."

ON SABMILLER'S FOCUS ON LOCAL BRANDS. "Turning now to our brand portfolios, which are local, beer remains different from other FMCG categories. Alcohol is of course a mood-altering substance, and beer in particular has a history as old as civilization, omnipresent across numerous societies. All over our planet, beer is seen as local, expected to be local, with consumers' brand loyalties driven by local associations and heritage.

"And of course this emotional reality is reinforced by the economics of producing and distributing what is a bulky and perishable product. We of course all feel deeply what the sage on the screen expressed. There was a man not troubled by self-doubt. You can tell by looking at his moustache.

"Our approach to local consumer insights drives our segmentation and projections for profit pool segments in each country, to understand the financial landscape of that industry, and ensure our portfolios are well targeted....... However, doing this all at once is of course not easy. We've long recognized the difficulty of trying to run business models which simultaneously cater to high-volume mainstream brands - i.e., local flagships - and low-volume, high-touch, high-growth premium portfolios all within the same local business. In some cases, we tried running these together; in many places, apart. Our current model in the U.S. is one construct which has been successful so far [Tenth and Blake]."

BOSTON BEER HAS STELLAR YEAR; FRESHEST BEER PROGRAM ONGOING

Boston Beer saw fourth quarter depletion (STR) growth of 16% and full year 2012 growth of 12%. That's a big number. Advertising, promotional and selling expense increased $12.0 million, or 8%. Rourth-quarter profit fell 5.1% as margins slid and prior-year results included a tax-settlement gain.

MARTIN ON Q4. Boston chief Martin Roper said that their growth was based on Sam seasonals, Twisted Tea and Angry Orchard, offset by "some slight decline in some of our other Samuel Adams brand styles. The timing of our transition to our Samuel Adams Spring Seasonal was consistent with last year, as we accomplished a conversion from our Winter Seasonal to Alpine Spring by early January in most of our markets. We expect to continue to increase investments in advertising, promotional and selling expenses behind existing brands and also in innovation, commensurate with the opportunities and the increased competition that we see. During the quarter, we may have benefited from our updated Samuel Adams packaging and from our brand messaging, 'For the Love of Beer' that builds on our previous campaigns."

MARTIN UPDATES US ON FRESHEST BEER PROGRAM. "We believe that as a result of our Freshest Beer Program we are delivering better, fresher Samuel Adams beer to our drinkers while lowering wholesaler inventories, reducing costs and improving efficiency throughout the supply chain. While we did not achieve our goals in 2012, we currently have 89 wholesalers in the program and at various stages of inventory reduction and we remain committed to the program. We have over 59% of our volume on our Freshest Beer Program and believe this could reach between 65% and 75% by the end of 2013. We continue to evaluate whether we can reduce these inventory levels further and to invest in the breweries to improve their service and support the Program."

JIM ON WHY CONSOLIDATION HASN'T HAPPENED IN CRAFT. "Well, it's hard to speculate on the future, but when you look at the patterns of the past there really hasn't been very much. Everybody keeps looking for a rollup and it doesn't happen. I think for a bunch of reasons. One of them is, this is a fun business to be in. It's growing, so it's very exciting, so don't have a lot of people who are willing sellers.

"Second, people want to protect the spirit of their own brewery and its brand. And that doesn't lend itself to consolidation. And third, there are often negative synergies in the consolidation, because the franchise laws, which for us a consolidator into incompatible footprints, that you have a certain wholesaler footprint, you buy somebody else, they're in different wholesalers, franchise laws prevent in many cases you are putting them into a common wholesaler, so you have negative synergies because you are now competing with your primary wholesaler."

MARTIN ON PRICING: "We're not all that excited about being able to raise pricing as much as we would like and certainly don't believe we will be able to raise pricing to fully cover cost increases this year."

JIM ON CANS. "What you saw announced this week was culmination of several years of work around trying to redesign the standard beverage can for something that would improve the Sam Adams drinking experience. We are putting a can line into our Pennsylvania brewery, and we believe that we will have the capability with that can line to fill this can.

"Now, the announcement came out because we are pretty confident that sooner or later this is all going to work. But bear in mind, no one has ever mass produced this can in significant quantities, and nobody has ever filled it in significant quantities. So it is part of our sort of ongoing innovation.

"The timing on it we don't know for sure yet. We are hoping some time in early summer. But again, that's subject to being able to do several things that have not yet been done. And in terms of reaction I think our distributors welcome it, retailers welcome it. What its affect our volume will be, it's way too early to tell....

"We'll be looking for incremental shelf space for the can. We would not anticipate very many retailers taking the bottles off-the-shelf and replacing it with the cans. So our anticipation is that bottles will continue to outsell cans as we have seen with other craft breweries will offer both."

BEER BRIEFS:

CORRECTION: In yesterday's letter, several readers pointed out that I put the decimal in the wrong place on a couple of market share numbers from IRI. The correct shares are: Bud Light Lime in the last 52wk share is 0.94 points (not 0.094), Bud Light Chelada is 0.14 points, and in the most recent week, Budweiser Black Crown share 0.85 points. The full corrected issue is here: http://beernet.com/publications_daily.php?id=2872

THE AMERICAN BEVERAGE INSTITUTE (representing bars and restaurants) has released a new video depicting the latest threat to social drinking -- alcohol detectors installed in every new vehicle as original equipment. This video emphasizes that efforts to restrict social drinking remain a constant threat, even as today marks 80 years since Congress voted to repeal Prohibition. Check it here: https://www.youtube.com/watch?v=fll873k4RME

Until tomorrow, Harry

"I find nothing more depressing than optimism."
-Paul Fussell

--------- Sell Day Calendar ----------
Today's Sell Day: 15
Sell days this month: 20
Sell days this month last year: 21
This month ends on a: Thurs
This month last year ended on a: Wed
YTD sell days Over/Under: 0

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