Expansion or Diversification?

Expansion or Diversification?AbstractOne of the main objectives of any company is to make money for the shareholders. Asign of prosperity is sustained profitability. Hence, pursuing profits is an ongoingeffort by a company?s management and directors. When all avenues for businessexpansion schemes. Carlsberg Brewery Malaysia Bhd. (Carlsberg) is such a company.It has sustained profitability for ever nearly 40 years in the Malaysian beer and stoutmarket. It serves as an excellent model for the study of business expansion schemes,as part of a corporate finance curriculum. The case study of Carlsberg is in itselfinteresting because it is full of irony. On one hand, Carlsberg operates in a sun-setindustry? with no more scope for expansion because of the ever increasing exciseduties, taxes and other costs, restricted market target groups, the sociallyundesirable/unacceptable nature of the products, high advertising costs and theassociated social responsibility that comes with it. On the other hand, Carlsberg andother competitors have succeeded to remain profitable and cash rich, withconsumption on the rise in spite of the ever increasing prices, and contributesubstantially to the Government?s tax revenue. In discussing on the issue of expansionon diversification, such company has to face the business reality behind Malaysia?shalal premise, the understanding behind sin taxes? and other related social andethical issues. DIVERSIFICATION FOR SUSTAINED PROFITDavid Ross returned to his office at 12.00 noon, after a heavy morning of monthlybusiness meetings. On the way back to his office, all he could think of was what hisboss, Robert Stanley, had said to him.David had been working for 3 years as a consultant with ABC Consulting Sdn. Bhd.,after graduating from university. The consulting firm specialized in businessturnarounds and had been successful in reviving a number of distressed businesses inthe past decade. At this month?s meeting, the Mr. Stanley had lamented that, althoughtheir overall business remained profitable, too much time was taken to resolve casesand, because they dealt with business turnarounds, the firm?s cash inflow had becomeirregular. To be sustainable, Mr. Stanley had suggested that the firm ought to startlooking into proposing schemes to cash-rich firms that wanted to expand, diversify orventure into profitable business. David was given the task of pioneering such a move,with full support from the firm.David, anxious to strengthen his mark in the firm, readily took up the challenge. Heremembered he had read somewhere that the beer and stout industry was at crossroadbecause of the high excise duties. He began his research on the industry and come upwith some preliminary findings. A CASH-RICH COMPANYThere were three very profitable beer companies in Malaysia, supported by a nonMuslim population of 8 million, approximately one-third of its total. One of them, amarked leader with more than a 50% share of the beer and stout market, wasCarlsberg Brewery Malaysia Berhad (Carlsberg).Carlsberg had been incorporated in 1969. Two years after that, it began brewingCarlsberg Green Label beer market in innovation, quality and product launches andcampaigns. The Carlsberg brand became a part of everyday life for the beer drinkingcommunity and held no less than 12 products of beer, stout and shandy. Carlsberg was51% owned by the Carlsberg Group of Denmark and listed on the Main Board ofBursa Malaysia. It locally marketed its products via a 100% subsidiary in CarlsbergMalaysia Sdn. Bhd.Since it began its operations, the prudently-managed company was able to enjoysustainable profits. They increased from RM14 million in 1997 to RM138 million in1999. Even when profits started to decline, the company was still able to maintainrespectable RM76 million in 2008. The company?s share price averaged betweenRM5.00-RM6.00 per share over the last ten years in the Malaysian stock market until2007, despite the 2005 stock split (shareholders give 2 shares in exchange for 1) fromRM1.00 To RM0.50 per share. The share price fell in 2008 but it was still able tosecure a reasonable RM3.50 per share.Carlsberg rewarded its shareholders well. Although its profits fluctuated over theyears, the company was able to keep a stable dividend yield policy. For example, itsprofits after tax changed from RM138 million in 1999 to RM76 million in 2008,while its dividend from RM109 million to RM79 million in the same period. Itindicated that, while its retained earnings plummeted from RM29million to a negativeRM3 million in those ten years (it began to report negative retained earnings since2002), its dividend payments had exceeded its net profits over seven straight years.Furthermore, by Carlsberg?s calculations, if an investor had invested RM1,000 in1971 and an additional RM500 in 1972 (at RM1 per share), as at 31 December 2008,the shares would be worth a market value of RM121,500 with accumulative dividendsof RM191,381. Depositing the same amount with a bank that paid an average interestof 5%, would make a pale comparison as the returns, if compounded annually, wouldestimate RM9,281 by end 2008.An article (in 2009) focused on a comparison between Carlsberg and GuinnessAnchor Bhd (GAB), its main competitor, where Maybank Investment Bank analystshad reported GAB?s 2008 fourth quarter net profit?s dramatis increase of 41% toRM27.39million from a year earlier, while Carlsberg?s 2008 second quarter netprofits fell 21.7% to RM12.88 million.Analysts saw GAB?s gradual gain in marketshare to eventually dominate the Malaysian Brewery Industry.However, CarlsbergManager Director, Soren Holm Jasen, had been quoted as saying that their latest resultwere similar to what they had achieved in the previous year and that they were ontrack and confidence of achieving favourable earnings for that coming year. Hefurther added that the newly acquired Carlsberg Singapore would boost thecompany?s earnings by 40% to 50%. Carlsberg?s accumulated funds prior to 2002 had been invested in money markets,overseas investments and share buybacks. In September 1999, Carlsberg hadrepurchased its own shares through KLSE (now Bursa Malaysia) at a cost of RM12million and held in the company as treasury shares. It had been at the company?sApril 2007 Annual General Meeting (AGM) that the shareholders give the mandatefor the company to repurchase up to 10% of its issued and pay-up capital, inclusive of2.33 million shares in it treasury stock. In addition, Carlsberg had also invested inoverseas ventures. In 2006, the company invested RM29 million in CarlsbergDistribution Taiwan Ltd, and in 2008, RM0.9 million in Lion Brewery (Ceylon) Ltd.In September 2009, it acquired 1 million shares, representing 100% equity capital,from Carlberg Singapore Pte Ltd, at a cost of RM370 million. AT CROSSROADSOperationally, a typical beer company in Malaysia would incur excise duties andtaxes that accounted for more than half of the costs. They included excise duties advalorem tax (49.6%), sales distribution and administration (19.1%), raw materials andpacking cost (13.1%), employee cost (5.5%), depreciation (2.2%), and corporation tax(2.6%).As reported in The Star on 29 July 2009, the beer and stout was facing though timesahead, pending on the hike in excise duties and taxes. Malaysia?s excise duties wereon gradual increase, and currently highest in Asia and second highest in the world.Table 1 below provides the illustration on the increasing duties and tax.Table 1 The effect of excise duties on the consumption per capita of beer andstout in Malaysia Per capita consumption 2002 2003 2004 2005 2006 2007 2008 22 22 23 21 20 20 21 4 5 6 7 7 7 7 (in litres)Excise duties(RM/litre) Note: (1) Per capita consumption is based on individuals of the average age of 20+years in the Muslim population. (2) Source: Star on line dated 29 July 2009.It had been estimated that an increase in excise duties and taxes between 5% and 25%would reduce per capita consumption further by 7% to 21%. All points indicated thatthe Malaysian beer and stout market had reached saturated point, the excise duties andtaxes being the limiting factor. The same sentiments were shared by Carlsberg?scompetitor, GAB. FOREIGN BEERThere is an influx of cheap foreign beer in the market and it may be costing thecountry up to RM250mil in lost taxes annually.Industry sources claim that beer with high alcohol content from Thailand, thePhilippines, China and Europe have flooded the market and are being sold at almost half the price of locally-produced beer at coffeeshops, convenience stores, medicalhalls and even some established supermarkets here.The low prices and easy availability have made the brew attractive to all beerconsumers, particularly the lower income group, such as labourers and migrantworkers. It is learnt that consumers are switching from locally-produced beer tocompounded hard liquor because of the high price of local beer due to high exciseduties.The sources cited reports and analysis, which estimated that the uncollected duty fromcheap imported beer to be around RM250mil while the total tax evasion from allalcoholic beverages could be as high as RM1bil.The report noted that while tax losses from beer smuggling in Malaysia are lowercompared to smuggling of other liquors in terms of the amount of duty paid, the sheervolume of illicit beer makes up for its lower profit margins.Another source pointed out that imported beer should logically cost more than locallyproduced beer if legally brought into the country as the import tax alone would beabout RM5 per litre. Moreover, importers should pay a higher excise duty on beerwith higher alcohol content.The sources also questioned how foreign beer, despite having almost twice thealcohol content of locally-brewed beer, could be sold for as low as RM4.29 per 330mlcan or RM7 per 550ml can (in some places, it?s only RM5) compared to premiumimported beer brands that were priced from RM9 per bottle.A Customs Department official, who declined to be named, said beer pricing was notregulated by the department. (Source: Star on line dated 17 October 2013) BEER IN SOUTHEAST ASIASoutheast Asia is currently experiencing one of the fastest growth rates in beerconsumption in the world, according to a study by market researcher Euromonitor(Source: Asean Lifestyle dated 6 March 2015). Why? Mainly because it?s so hot, saythose who enjoy a cold beer to wash down spicy food at stalls and open-air restaurantsbetween Bangkok and Manila.The main reason why Southeast Asia?s citizen are gulping more booze is the growthin the number of young people with higher disposable income in recent years. Thereis a clear correlation between the consumption of beer and economic dynamics, letalone Western influence through the growing influx of tourists, Western-stylerestaurants and international beer brands. All this lets Southeast Asian people turn away from their traditional distillates, be it rice whiskey in Thailand, arrack inIndonesia or various sugar cane or coconut brews elsewhere.The survey also found that beer is increasingly being consumed in times of prosperity,while people were seeking solace in cheap domestic liquor during harder times in thepast.Asia overtook Europe and the Americas in beer consumption already in 2007. In2011, the continent drank 67 billion liters of beer, against 57 billion in the Americasand 51 billion in Europe, according to the latest available figures by Euromonitor. Thesurvey predicts that beer consumption is expected to grow 4.8 per cent in the AsiaPacific region each year up to 2016.The top beer-drinking nation in ASEAN is Vietnam. Vietnamese drinkers downed 2.6billion liters of beer in 2011, followed by Thailand with 1.8 billion liters and thePhilippines with 1.6 billion liters, nearly double the total amount of beer consumed inIndonesia (236.4 million liters), Malaysia (171.4 million), Cambodia (136.3 million),Laos (134.3 million), Singapore (108.2 million) and Myanmar (30.4 million). Nofigures were available for Brunei where no alcohol is officially sold, but certainrestaurants in the small Chinese quarter in Bandar Seri Begawan would serve booze intea cups upon request at unknown volumes.San Miguel Corporation, which produces San Miguel beer, the most popular beer inthe Philippines, has a business history of 125 years (Source: Inquirer.net dated 23September 2015). It is the country?s largest conglomerate in terms of asset size. Thegroup now has interests in several industries, locally and overseas, from energy totelecommunications with consolidated revenues of $20 billion annually. AN OPPORTUNITYDavid reckoned that the major beer industry players were worried about the industry?sfuture direction, having recognized that there was not much of prospect for expansionin the market itself. Diversification appeared to be a promising alternative for suchcompanies like Carlsberg & GAB. David considered the types of products he felt heshould purpose for Carlsberg to diversify into. The strength of Carlsberg laid in itbrewery operations and it bottling and marketing forces. An alternative was seen inthe bottling and marketing the non-alcoholic beverages where the company could tapinto a much larger market in Malaysia.After looking at the Carlsberg?s and GAB?s 2014 annual reports, David felt confidentthat he could sell the idea of manufacturing sparkling grape juice under a halalbrand to Carlsberg. David was equally aware that Guinness had successfully launchedthe non-alcoholic Guinness Maltase? many years ago. He also considered a routemap to list the new company in Bursa Malaysia within the shortest time frame. Armed with research, David estimated that a carbonated beverage operation, under awholly owned subsidiary, would require an investment of RM200 million, where theinternal rate of return would be a likely 12%.Required:a. From your analysis of the case, identify and elaborate THREE (3) pertinentissues.(15 marks) b. Identify and thoroughly discuss THREE (3) business strategies shouldCarlsberg adopt when entering new markets.(15 marks) c. Assess and contrast the strength and weakness, opportunity and threat of abeverage company similar to Carlsberg doing business in Malaysia.(20 marks) d. To expand in new markets, funding is a critical factor for its success. Discussthe company?s funding ability. If not internally available sufficiently, analyseand propose other sources can the company tap into.(15 marks) e. Assuming you are David, what would you recommend to Carlsberg in termsof dealing with increasing competition, country risk and new productreception?(20 marks) f. The challenge for David is convincing Carlsberg whether it is viable and themarket is receptive for marketing a halal? soft drink owned by a beercompany. What are the alternative businesses that David can proposeassuming that Carlsberg is willing to go for expansion strategy? What internaland external changes do you think need to be considered? What businessmodel needs to be used to make it viable? You need to quote examples ofother sinful? companies that have followed this path.(15 marks)