A takeover in a brewery?

A week rarely goes by without Scottish & Newcastle (S&N) emerging as a takeover target for one of its rivals and speculation is once again driving up the share price of Britain’s biggest brewer.

But any deal still seems to be a long way off, with most rival brewers admitting only a lukewarm interest in the company. SABMiller, Carlsberg, Diageo and Heineken have all reportedly distanced themselves from the idea of making a formal bid.

Analysts say the bid speculation is symptomatic of the current market, which is rife with rumours about several unrelated blue-chip stocks, including Sainsbury’s, Boots and Imperial Tobacco.

They remain doubtful about a bid for S&N, although the brewer of John Smith’s bitter and Newcastle Brown Ale has a healthy business in Western Europe. It recently reported a 13.9% rise in pre-tax profits to £452m last year, and a 7% increase in turnover to £4.15bn. The company also claimed to have increased its share of the UK beer market to 26.5%, up from 25.3%, winning drinkers in a declining market with the launch of new lines such as Foster’s Twist.

But it is S&N’s position in Western markets that is putting off interested parties, say analysts. "The lack of any serious bid is because of the unattractive nature of the mature Western Europe brewing market," believes Sam Hart, an analyst at Charles Stanley.

Dresdner Kleinwort analyst Andrew Holland adds/ "Two-thirds of S&N’s profits come from the UK and France, both of which are horribly competitive markets. The UK market suffers from price deflation and brewers in France have little pricing power."

But it is the "reasonable size" of S&N that makes it an attractive target, according to Hart, who says it will be "an easy business to digest for any rival". Both Hart and Holland also point out that S&N is in the unique position of being the only brewer with an "open share register", when compared to family-owned rivals such as Heineken, Inbev and Carlsberg, making it more vulnerable to a takeover.

A source at a rival brewer says that with most companies now focusing on new and emerging markets, there will be no need to "buy into mediocre markets". The source says that the UK has been suffering steady declines in the beer market and the French market is "going back" in terms of growth.

Shadow of the smoking ban
S&N chairman and managing director John Dunsmore has already warned that it will be a tough year in the UK and is forecasting that the smoking ban that comes into force in England and Wales in July could reduce its operating profits by £10m.

In the UK, S&N is working hard to attract more drinkers to its main portfolio, while getting rid of its non-core brands. In 2005, it invested millions in new "super chilled" technology that was designed to keep pints of Foster’s, Kronenbourg and John Smith’s colder for longer but passed the marketing of Miller Genuine Draft and Peroni back to SABMiller (MW September 15, 2005). Earlier this year, it sold its once-famous Courage bitter brands to Wells & Young’s Brewing Company (MW January 18). The Courage brands will be 83% owned by W&YBC and 17% owned by S&N. The company also increased its marketing investment in its cider portfolio by 50%, aiming to further boost its share in the category (MW March 15).

But it is Baltic Beverages Holding (BBH) – Russia’s largest brewery that is a joint venture with Carlsberg – which is viewed as the jewel in S&N’s crown. BBH operates in the emerging markets of Russia, the Baltic States and Kazakhstan and is now moving into Uzbekistan and Belarus. It posted operating profits of £160m last year, a 39% increase on 2005, and last week S&N announced a 14-year licensing agreement with BBH to produce the Russian beer Baltika in the UK.

Attractive though it might be, the source at the rival brewer sees the joint venture as the "impediment" to any potential bid. "The agreement is bound by the complex Texas auction clause, making it very difficult for a third party to buy into that complication," he says.

Under the agreement, Carlsberg would have first refusal on S&N’s stake if it decided to sell. If one party wanted to buy the other out, a sealed bid system would be put into operation and the party which made the highest bid would be entitled to buy out the other’s interest in the joint venture.

It has been suggested this could lead to a merger of S&N and Carlsberg – both of which need to bolster their global positions – but analysts aren’t convinced. Hart points out that Carlsberg is controlled by a charitable trust and for any merger the charter would need to be changed.

"The merger would also lead to competition issues, because it would mean an unacceptably large market in the UK, Portugal and France," adds Holland, who also believes that the Foundation that owns the majority stake in Carlsberg is not keen to sell.

Diageo, already struggling in the Western European markets, is seen as the least likely rival to consider a takeover of S&N. Heineken has been ruled out because any acquisition would be a huge financial stretch, according to one insider.

No global appeal
Another barrier to a possible sale remains S&N’s lack of a global brand portfolio. Although Kronenbourg is a potential global player, rivals do not see it as a premium brand like Stella. Another rival adds/ "What S&N lacks is a top-tier brand to attract any serious bids." One City analyst unsentimentally calls the brand portfolio a "big pile of crap". Interbrand director of brand strategy Max Raison says that, although Kronenbourg remains a very strong international brand "S&N is missing a UK hero brand".

A former retailer agrees that the company lacks a strong British brand and adds: "Foster’s lager is one of the biggest brands in its portfolio, but it is deeply entrenched in its Australian roots; San Miguel has a Spanish heritage; and Kronenbourg is French." Other brands in its portfolio include Miller beer and Beamish Irish stout.

Holland says with the UK business being cash generative, he sees a break-up bid as a more realistic option, with BBH sold off separately: "I think a private equity company, which is in the business of getting rich and not building global beer business, will be a more likely bidder than a trade buyer."