China Beverage Sector Alert: Takeaways from Food for Thought with Industry Expert

Our Food for Thought luncheon yesterday hosted a former National OperationsDirector of PepsiCo (2008-10) and Kraft (2000-08). He discussed his views on MNCoperations in China as well as the Tingyi-PepsiCo alliance. Below are the keytakeaways. To recall, Tingyi Asahi Beverage (TAB) has acquired 100% of PepsiCo’sbottling business (CBL) in China, with PepsiCo getting a 5% stake in TAB and anoption to increase it to 20%.

    Learning from PepsiCo’s experience — 1) Cooperation with local partners andgovernments is critical. The expert believed that PepsiCo’s JVs with more than 20partners may have not worked out as planned, and frequent increases inconcentrate prices could have resulted in some of its partners selling off their stakes.

    PepsiCo’s execution capability may have suffered and some market opportunitiescould have been lost in the bargain. 2) Products and marketing strategy need to beconsistent. 3) Product strategies should be well thought out. For example, flavorissues were blamed for the perceived failure of Tropicana’s first launch in China,arguably losing the best window to gain market share in juices.

    View on Tingyi-PepsiCo alliance — The expert felt M&As in China work outrelatively well when local companies acquire MNCs rather than the other way round.

    In the Tingyi-PepsiCo alliance, Tingyi could facilitate the operation with its betterrelationships with local governments and stronger distribution system. The alliancecould lead to the majority of the management teams at the bottlers leaving, but theworkforce on the ground should remain stable. It is reasonable to expect Tingyi toconsolidate the bottling business into its own beverage system in one year.

    However, the risk is that Tingyi’s management resources could be stretched.

    Citi’s forecasts for the Tingyi-PepsiCo alliance — We assume 13% sales growthand 1%/1%/3% OPM, US$ -3.8m/7.1m/24m net profits for FY12E/13E/14E, c.3% oftotal net profit of FY14E (Tingyi has a 47.5% stake in CBL, which in turn owns a78% stake in the bottlers; Tingyi shares 37% of PepsiCo’s (China) total bottlingbusiness earnings). In our bull case, the Tingyi-PepsiCo alliance would contributehigh-single-digit percentage contributions to Tingyi’s net profit in five years.