Why Grupo Modelo Wants to Stay Single

While some global brewers are aggregations of local beers that are each strong in their home markets, Mexico's Grupo Modelo is the owner of a true cross-border success story: Corona. The pale lager's foreign appeal has helped shift more than 40 percent of Modelo's sales to markets outside Mexico. And Modelo managers believe there's more growth ahead if they can continue expanding their brews internationally. "What the controlling families—the Mexican families—want today is to keep working to consolidate and strengthen our company," says Chairman and Chief Executive Officer Carlos Fernandez Gonzalez, whose uncle married the sister of one of the founders.

Executing that go-it-alone strategy will be tough. Acquisitive Belgian brewer Anheuser-Busch InBev (BUD), the world's largest, inherited a 50 percent stake in Modelo plus 9 of its 19 board seats through its $52 billion acquisition of the former Anheuser-Busch in 2008. In July, Modelo lost an arbitration bid to deny board seats to some AB InBev directors. Moreover, the beer industry's global consolidation has left Goliaths such as AB InBev, SABMiller, and Heineken so big that it's increasingly difficult for independents such as Modelo to develop the distribution and marketing muscle to compete.

In gaining the Modelo stake held by the U.S. brewer, AB InBev also inherited long-running tensions between the partners. Anheuser-Busch in 1993 agreed to buy 10 percent of the Mexican brewer, with options for more; the stake has since grown fivefold. After the 1994 peso devaluation, however, Modelo and Anheuser-Busch sparred over how to value options to buy more of the Mexican company. Modelo continued its expansion in the U.S. without using Anheuser's distribution network. Competition from Corona later led Anheuser to create Bud Lime as a counterpart to its ambitious partner's flagship.

Since Anheuser-Busch's change in ownership, the frosty relations continue. Modelo greeted the AB InBev takeover with a $2.5 billion legal challenge, claiming it violated the original option agreement with Anheuser-Busch, and the Mexican brewer attempted to block the transfer of its shares to the Belgian beer giant. Two months ago, Modelo chose an AB InBev rival, Molson Coors Brewing (TAP), as a distributor of its brands in Britain. Modelo has been "very protective" of its independence, notes David Belaunde, a Barclays Bank (BCS) analyst in New York.

Fernandez says Modelo isn't looking for acquisitions and won't add other beverages to diversify beyond beer. Further expansion in Mexico is limited by Modelo's 58 percent local market share as well as inroads there by Heineken, which last year paid $7.6 billion for the beer business of Fomento Económico Mexicano (FMX). Given that environment, exports will remain Modelo's lifeblood, Fernandez says. "This is the unique business model that we have," he explains.

Although Modelo's legal challenge has been turned back, management still isn't making nice. As Fernandez last month toured a new $650 million brewery in the northern city of Piedras Negras with reporters in tow, he noted that Modelo is starting a relationship with "partners that we don't know." The plant is part of an effort to boost exports to the U.S., where Modelo has been No. 1 by volume among imports since dethroning Heineken in 1997. AB InBev so far has had nothing but accolades for its new beer buddy. It has "great respect" for Modelo, its brands, and senior management and looks forward to continuing the partnership, says Karen Couck, a spokeswoman for the Leuven (Belgium)-based company.

When InBev's Anheuser-Busch takeover formed AB InBev, Modelo became the focus of speculation that it would be gobbled up next. That still may be inevitable, says Lauren Torres, an HSBC Securities (HBC) analyst in New York. Modelo can't match larger rivals' cost savings and faces a struggle to maintain its export growth pace, so the families, with 56 percent of the voting shares of the world's eighth-biggest brewer, eventually may be persuaded to sell, says Torres. "The environment is getting tougher because things are consolidating," she says.

Modelo's sales outside Mexico rose 50 percent over the past five years. They accounted for 42 percent of 2010 revenue through September. Annual sales may reach 85 billion pesos ($6.8 billion) in 2011, according to a Bloomberg tally of analysts' estimates, more than twice the level of a decade earlier.

As its flagship Corona brand slides toward a fourth annual decline in the U.S. and the entire import market shrinks in America, partly due to the recession, Modelo is counting on lesser-known beers such as Modelo Especial and Victoria to spur sales north of the border. So far the plan is working. U.S. volumes for all Modelo brands rose 1 percent last month, compared with a 3 percent drop among all top-selling brands, says Alan Alanis, a JPMorgan Chase (JPM) analyst, citing Nielsen data. That ranked it No. 4 among all beer producers in the U.S., with 5.4 percent of the market.

That's a drop in the beer stein compared with the 50.9 percent U.S. share for AB InBev's U.S. brands, including Budweiser. Yet among imports, Modelo beers held 43 percent of the U.S. market in the 12 months that ended in October, according to researcher SymphonyIRI Group. "We are growing in the U.S. faster than the market segment as a whole," says Jose Pares, Modelo's sales and marketing chief. "We have a complete and disciplined portfolio of export brands." It's that export success that boosts Modelo's profit margins—and allows it to keep would-be acquirers like AB InBev at arm's length, says Alanis. In fact, Modelo's operating margin of 26.5 percent last year was second only to AB InBev among major brewers.

Nonetheless, HSBC's Torres says Modelo's reliance on a network of local distributors around the world that's also shrinking through mergers is as much an obstacle to its future as waning sales of the maturing Corona. "Wanting to stay independent and be a Mexican beer company and still work through partners is what they believe should be their current business model," Torres says. "But times are changing."

The bottom line: Grupo Modelo has prospered thanks to strong export demand for Corona beer. Industry consolidation could put its independence at risk.

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