Did Labatt Guzzle Too Much Too Fast?William C. Symonds
George S. Taylor, the dour CEO of John Labatt Ltd., was almost giddy when he announced plans last July to pay $510 million for a 22% stake in Mexican brewer Femsa Cerveza. After years of seeking growth beyond the flat Canadian beer market, Canada's second-largest brewer had cracked one of the world's most promising markets. "We have clearly positioned ourselves for growth," Taylor crowed. Paul A. Volcker, former Federal Reserve chairman, now of James D. Wolfensohn Inc., Labatt's investment banker, shared his exuberance. Volcker called the deal "a landmark transaction in the post-NAFTA environment."
Barely 10 months later, that landmark looks more like a land mine. With the collapse of the peso at the end of last year, Labatt says it will have to take a $219 million writedown on its Mexican investment in the fiscal year ended Apr. 30. And with the Mexican economy reeling, Taylor concedes the Femsa deal is likely to hurt Labatt's earnings for the next two years. Analyst Jacques Kavafian of Levesque Beaubien Geoffrion Inc. estimates that Labatt's net earnings will climb only 3% in the fiscal year that's just ended, to $118 million, as its revenues rise 35%, to $2.3 billion. And the financial fallout continues. The Canadian Bond Rating Service on Mar. 16 issued a "negative" outlook for the company's debt, after pointing out that the Mexican writedown would raise Labatt's debt-to-equity ratio to 58%, from 44%.
The Femsa fiasco is the latest of several setbacks that have infuriated shareholders and set off speculation among analysts that the company may be ripe for a takeover. Already, Onex Corp., Canada's leading leveraged-buyout firm, disclosed on Apr. 14 that it was evaluating Labatt as a possible "acquisition opportunity." It's clear that many investors are unhappy with Taylor's strategy to expand into global beermaking, sports, and entertainment. From its 1992 peak of around 22, Labatt stock has tumbled 30%, to about 16. "Most of their thrusts have failed," grouses Ian Joseph, vice-president of Altamira Management Ltd., one of Labatt's institutional investors.
For the time being, Taylor, 54 and a 35-year Labatt veteran, is holding firm. Although he concedes the Femsa deal has put Labatt "in a potentially vulnerable position," he insists the company isn't for sale and vows to defend it against any hostile bids. "I share some of the frustration with the time it's taken" to execute the strategy, he confesses. To assuage restive shareholders he is trying to sell some of Labatt's sports and entertainment assets, including half of its 90% stake in the Toronto Blue Jays, to pay off some debt.
STEADY PROGRESS. Labatt's chief executive certainly has gone a long way toward remaking the 148-year-old brewery. After taking charge in 1992, Taylor sold off the company's low-margin food and dairy units, while improving the profitability of Labatt's core $1.3 billion Canadian brewery business. Aggressive marketing has helped Labatt capture 45% of the Canadian market, up from 41%. The net result: Operating profits at the Canadian brewery nearly doubled last year, to $192 million. Moreover, Labatt's net profit came in at $115 million in fiscal 1994, up 17%, on less than half the revenue it had in 1991. Even an executive at archrival Molson Breweries calls Labatt's "a very credible performance in a market where there's no significant growth at all."
Elsewhere, Labatt has made steady progress building market share for its beer operations outside Canada. Analyst Michael Palmer of Equity Research Associates figures Labatt has invested more than $275 million in Birra Moretti, Italy's third-largest brewer, and a network of 500 pubs in Britain. Labatt's Latrobe Brewing Co. has also made impressive gains. Since Labatt acquired full control of the Pennsylvania company in 1988, sales of its key brand, Rolling Rock, have doubled. It's now the eighth-largest brewer in the U.S.
Still, the foreign ventures haven't produced the bottom-line results that cheer shareholders. In expanding its European beer operation, Labatt lost $2 million last year. Meanwhile, Labatt earned just $3 million on U.S. sales of $169 million. Taylor blames marketing costs for sapping profits. "It takes a long time to build a beer franchise," he says, adding that fiscal 1995 results, to be released shortly, will show sharply improved earnings in the U.S. and Europe.
While conceding that Taylor's U.S. and European bets may eventually pay off, shareholders and analysts complain that his tenure has been marked by poorly thought-out and executed moves. Just one example: Labatt's legal tussle with Anheuser-Busch Cos. Anheuser sued Labatt in 1993 after the Canadian company tried to win U.S. trademark protection for the name "ice beer." Labatt contends it invented the process for making the smooth-tasting beer. On Feb. 11, a St. Louis jury ruled that ice beer was not a trademark and awarded Anheuser $5 million in punitive damages. Labatt is appealing the decision, but industry insiders say an angry Anheuser could cancel Labatt's lucrative licensing contract to brew Budweiser in Canada. Labatt dismisses such speculation as absurd. But a rival beer executive says Anheuser "wants to get out of the contract," since Labatt keeps most of the profits Bud generates in Canada. Anheuser wouldn't comment, except to say that terms of the contract are confidential.
Femsa is another sore point. At the time of the deal, many shareholders complained Labatt paid way too much for it. After all, Femsa has been losing market share since 1988 to Grupo Modelo, Mexico's No.1 brewer, owned 17.7% by Anheuser. And as tariffs fall under NAFTA, analysts suspect Mexico may be swamped with U.S. brands. Philip Morris Cos.' Miller Brewing Co. turned down an opportunity to buy the same stake in Femsa because it felt the price was too high. With the peso's devaluation, Palmer of Equity Research figures Labatt's stake is now worth just $175 million--$335 million less than it paid.
In response, Taylor says no one could have predicted Mexico's financial meltdown. But he insists Labatt's Mexican expansion will eventually generate significant returns. True, beer consumption in Mexico, measured in volume sales, will shrink 6% this year, because of the economic crisis, according to Jose Antonio Fernndez Carbajal, director general of Femsa Cerveza's parent company. But historically, Mexican beer consumption has recovered quickly from downturns.
Taylor claims he is sensitive to the concerns of investors, but he doesn't believe they're doing all that badly. Including special dividends and stock paid to shareholders in recent years--much of it from the company's spin-off of its dairy operations--Labatt reckons its shares have yielded a healthy annual return of 10.8% over the past five years.
BYE-BYE BLUE JAYS. Meanwhile, Taylor is also trying to repair the company's balance sheet, by selling half of Labatt's share in the Toronto Blue Jays to its partners in the Sky-Dome. Within a year, Taylor also hopes to unload Labatt's rock concert promoter, BCL Entertainment. Still, these sales aren't likely to make a big dent in Labatt's $643 million of long-term debt. Analyst Kavakian of Levesque Beaubien Geoffrion estimates that Labatt's interest expense will nearly double in the current fiscal year, to $64 million.
Despite the planned asset sales, Taylor says Labatt's future remains closely tied to sports and entertainment. He's already looking to expand Labatt Communications Inc., which owns English- and French-language cable sports networks. Both are highly profitable, but the household penetration of cable is near its saturation point in Canada. To expand viewership and advertising opportunities outside Canada, Taylor is talking with U.S. networks such as ESPN Inc. and Fox Inc. about taking a 20% stake in LCI. Another possibility: to swap part of LCI with a Canadian broadcaster for another broadcast outlet. In all, Taylor is willing to part with 49% of LCI.
Although Taylor believes his strategy has considerable merit, shareholders seem unwilling to wait for results. Last September, institutional holders voted down a poison-pill plan Taylor proposed that would have allowed Labatt to issue more stock to fend off a hostile bid. It was the first time a management-supported pill had been defeated in Canada, and that sent an open invitation to takeover bidders. Analysts expect that an acquirer, such as Onex, would sell most of Labatt's businesses to repay some of the estimated $1.8 billion purchase cost, keeping just the Canadian brewery or broadcasting arm.
Some analysts suggest that the financial fallout from the Femsa deal makes an imminent takeover unlikely. If that's the case, some shareholders say they may take matters into their own hands by proposing an alternative list of directors at this year's annual meeting. The "most meaningful way to drive value might be to shake up management," says one. The message to George Taylor is clear: Patience may not be the virtue he thinks it is.