Heineken: An acquired taste

18 May 2012

The last ten years have seen Heineken’s appetite for acquisitions grow exponentially, with almost 40 new companies now under the global organisation’s control. FDE talks to executive board member and CFO René Hooft Graafland about takeover strategies and integration, keeping a close eye on cashflow, and how well beer travels.

Over the past decade, Heineken has been in keen pursuit of acquisitions - with impressive results. As the third-largest company in the beer industry - AB InBev and SABMiller are number one and two, respectively - its post-2002 tally currently stands at 39. This has tripled the number of employees and doubled revenues, and, more importantly, the overall profile of the company has strengthened from a predominantly European and developed-markets player to a leading global one.

A recent acquisition that has considerably influenced this growth and increased profile occurred in early 2010 when Heineken acquired the beer operations of FEMSA, one of Mexico and Latin America's largest beverage outfits. This positioned the Netherlands-based company in a particularly fertile market, where emerging markets now constitute two thirds of its volume and half of its profitability.

This entry strategy and subsequent performance are key indicators of executive board member and CFO René Hooft Graafland's approach.

"The FEMSA acquisition played an important role, opening up Latin America and giving us a strong position in Mexico and Brazil, so this was one of the biggest of our 39 acquisitions," he explains. "It added skills, geography and many opportunities as it is in a developing part of the world with a growing beer business."

The acquisition process

Prior to the FEMSA deal, however, or before any deal for that matter, any assessment of business integration potential is based on an in-depth due diligence process to help build a business plan around the target. The templates are standardised, but the content is customised from region to region in that when Heineken examines a target, it makes an investment hypothesis asking why it should acquire this particular company and what the main elements of success will be.

"Once you acquire it," Hooft Graafland continues, "you confirm the business plan with an integration team, including the people working for the acquired company itself. After the three to six-month integration phase, you move to full execution mode, which involves the implementation of a new and refined commercial strategy based on market segmentation, pricing and a stronger focus within the acquired company."

"In emerging markets, it is all about growth, getting higher penetration among consumers and pushing per capita consumption up - and there are ample opportunities for that."

With such a rich history, Heineken has a lot of experience from which to draw when looking at acquisition targets and deciding how to integrate them in a seamless fashion.

"There are different areas where we typically find buckets of value in an acquired company," he says. "We can improve the operations from the cost side and a big advantage of any acquisition is usually the costs saved by implementing our operational standards. Operating the breweries in line with our practices can save a lot of money by, for example, bringing the purchasing in our global purchasing contract. That is where you drive a lot of the benefits."

With FEMSA in particular, revenue was a priority. Hooft Graafland and his M&A team clearly saw that, despite the fact FEMSA had a 40% share of the Mexican market, the company was under-leveraging its brand portfolio with a relatively weak regional approach; there wasn't enough price differentiation in the market. Heineken recognised that, with a few tweaks, the potential of the brands could be realised, so a key part of its business plan focused on revenue management.

Another aspect of the FEMSA move was the opportunity to control a list of strong local brands, and leverage their power and expertise in order to become a top player in the market.

"Beer is very local," explains Hooft Graafland. "When people look at Heineken, everyone thinks about the Heineken brand, but the Heineken brand is only 15% of our total volume, while 85% is strong regional and local brands.

"We benefit from combining the premium Heineken brand with a full local portfolio; we're brewing it in the same brewery, packing it in the same lines, trucking it in the same trucks and selling it with the same sales force that sells the whole portfolio. All these costs are shared with the local brands, but we ask for an additional 50% premium for the Heineken brand - as you can imagine, that drives a lot of the profitability."

Hunt for cash

When Heineken had what Hooft Graafland calls "a serious debt level" five years ago, the company saw that it had to focus more closely on the company's cash generation. They now have centralised cash, capital structuring and credit, as well as forex management and robust global banking relationships.

But most central to Heineken's treasury is its focus on cash management in the operating company.

"We started the Hunt for Cash programme to increase the company's cashflow, whereas historically the company has very much been profit focused," recalls Hooft Graafland. "All the incentive schemes and the operating company were very much seen through the lens of profitability - EBIT and operating margins. Since investment in the company reached a much higher level as a result of an aggressive acquisition strategy, we are putting much more focus on free operating cashflow. It is amazing what you can realise if you really focus on that."

Over the past three years, driven by the Hunt for Cash programme, Heineken has increased its cash conversion ratio to over 100%. The company has also slashed €1 billion of its working capital and reduced its capex levels by pooling assets in the supply chain, which has led to a free operating cashflow of €5.8 billion that, in turn, helped to bring the net debt/EBITDA ratio down from 3.3 to 2.2 by the end of 2011.

The competitive edge

Despite Heineken's global reach, the most competitive market in the industry is right on its doorstep: Europe. Looking at market shares on a country-by-country basis, Europe is by far the most competitive area.

"In new markets, we follow a premium strategy, not a mainstream strategy. In our industry, 'mainstream' success can only be achieved by acquiring local players."

"If you look at a continent such as Africa," suggests Hooft Graafland, "the positions you have in those individual countries are much stronger, so your share in these markets is typically higher than you would see in European countries."

In emerging areas of the world, the approach is much more to build and lead the beer market, and the environment is fertile for this due to population and economic growth, and increasing political stability - all of which benefit the beer industry.

Naturally, there is a lot of competition from existing players, but the long-term beer market can be built by increasing availability, achieving deeper distribution lines and strengthening brand attraction among consumers.

"In Europe, the market is not volume driven but value driven, the key words being segmentation, innovation and premiumisation," says Hooft Graafland. "In the emerging markets, however, it is all about growth, getting higher penetration among consumers and pushing per capita consumption up - and there are ample opportunities for that."

Penetrating new regions

Take India, for example: together with its joint venture partner United Breweries, the Kingfisher brand is the leader in this huge market. Although per capita consumption is only one and a half litres per head at the moment, and in spite of stringent regulations, the Indian beer market has on average experienced double-digit growth over the last ten years.

"In a market like this," explains Hooft Graafland, "we entered by acquisition and obtained a joint control stake in the leading Indian brewery, which we manage on a 50:50 basis in collaboration with a successful native entrepreneur."

Looking ahead, there are upward of three million young adults with an urban lifestyle entering the market. So the two-part question for Heineken is, firstly, how do you make this ever-increasing population ready for beer consumption and, secondly, how do you tempt them away from their parents' traditional habit of drinking whisky?

In short: how do you make beer an aspirational product?

"India is a fledgling beer market and it's great that we are in such a solid position with a very strong local brand," says Hooft Graafland. "In the coming ten years, we will primarily focus on the Kingfisher brand while also building the Heineken brand. We will create brand equity for the Heineken brand with a view to achieving long-term benefits."

In other countries in Asia, such as Vietnam, Thailand and Cambodia, Heineken started with green field breweries rather than acquisitions.

"If you arrive early in the market as an international player, you have a head start in building these positions," he says. "When we start from scratch in a region, the Heineken brand plays an enormously important role because the brand is recognised by consumers and it is an affordable luxury.

"In these countries, we follow a premium strategy, not a mainstream strategy. In our industry, 'mainstream' success can only be achieved by acquiring local players."

Africa, on the other hand, where Heineken has been for over 70 years, involves fewer acquisitions, although it does happen; for example, Heineken recently entered Ethiopia by acquiring two local breweries. However, in principle, the game in Africa is about ramping up investment ahead of the curve to ensure you can drive and supply the market, getting distribution systems up to speed, and choosing strong local brands that are favourites among the country's consumers.

"If you look at a brand like Star in Nigeria," says Hooft Graafland, "it's an extremely strong brand - a national champion - and consumers love it."

What's at stake

Heineken's strategies in burgeoning markets such as these are based on field-tested business plans that subsequently elicit a collective nod from within the company. Ultimately, however, they have to make sense to investors outside the company and meet their requirements.

When it comes to increased emerging markets resource allocation, Heineken aims to manage investor expectations with transparency, but that intention doesn't always make things 100% crystal clear.

"Obviously investors always want more information," says Hooft Graafland. "As a company, we aim to be as transparent as possible when it comes to investors. In principle, our business is easy to read in that it's all beer, and beer is not very complicated, but what makes our company more difficult to understand than some of our competitors is our geographic spread.

"AB InBev is the leader in the beer industry and it gets over two thirds of its profitability from two markets. SABMiller gets the majority of its profitability from just three markets. So these companies are very easy to read by investors.

"No individual market of ours achieves more than 12% of our profitability, so the build-up of our company's total profit is much more widely spread. Of course, that is also the case for the market risk, so there is a positive flip side to this."

Heineken is a truly global brand with operations in no less than 71 countries, making things more complex for investors to get to grips with. A large part of the company's emerging-market exposure is also in partnerships and joint ventures, which the company doesn't consolidate according to International Financial Reporting Standards.

"We take our share of net profit and this makes it more challenging for investors to see what is behind that line," Hooft Graafland continues. "You don't see it on the revenue line; you don't see it in your growth profile. So to give them this information, we invite investors to seminars. For example, in December 2011, we held a big conference with local management in Singapore, where we shared insight and clarified what is behind the joint ventures we have over there."

Heineken has acquired 39 companies in a decade.
Heineken's worldwide acquisitions, 2008–present.
René Hooft Graafland is chief financial officer.