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Where there is buying and selling, there is harm.
As is well known, FMCG food products have occupied our lives for many years. When it comes to Master Kong, almost every Chinese person has dealt with it. Some have eaten Master Kong instant noodles, some have drunk Master Kong beverages, and even during disasters, Master Kong is often the first to appear in relief efforts.
But what many people don't know is that Master Kong is not entirely Chinese; for instance, its beverage subsidiary has one-fifth of its shares held by Japanese interests. However, this situation may be about to change. Let's see what's happening:
On June 30, 2017, Master Kong Holdings issued an announcement, as shown below:
In simple terms, Master Kong sold a put option to AIB (a joint venture 80% owned by Asahi Breweries under the Asahi Group and 20% by the Japanese general trading company Itochu), while AIB sold a call option to Master Kong.
These options concern 20.4% of the shares of Master Kong Asahi Beverage Holdings Co., Ltd. (TAB). Whichever party chooses to exercise all options, Master Kong will spend 70 billion yen (approximately RMB 4.2 billion).
The options stipulate that half will be executed in 2018 and half in 2019. Given the nature of options, regardless of the future performance of the beverage holding company, if Master Kong wants to buy the shares or AIB wants to sell, the other party cannot refuse. Of course, it is possible that both parties choose not to transact, but this is unlikely.
Perhaps looking at Master Kong's shareholding structure chart can help us better understand. The following chart shows the TAB equity structure as of the announcement date:
The following chart shows the TAB equity structure after the call option or put option (as applicable) is fully exercised:
That is, after the transaction is completed in 2019, TAB will become a wholly-owned subsidiary of Master Kong (77.9%) and its parent company (22.1%).
Master Kong will also formally end its years-long equity cooperation with the Asahi Group.
How did Master Kong develop? What is its story with Japanese companies? Let me sort it out for you.
- The Past and Present of Master Kong
What we commonly call Master Kong is actually Master Kong Holdings in Hong Kong stocks, originally named Tingyi (Cayman Islands) Holdings Co., Ltd. Let's start with its parent company, Ting Hsin International Group.
Ting Hsin Group was founded by the four Wei brothers, initially engaged in oil refining, but development was unsatisfactory. Later, Wei Ying-chou (Group Chairman) discovered that there were no bowl instant noodles sold on trains, and smelled a business opportunity.
In 1992, they decided to start producing instant noodles. By seizing the first-mover advantage and establishing the first brand image, the instant noodles sold well nationwide. In 1996, they successfully listed on the Hong Kong Stock Exchange.
But whenever we talk about boycotting Japanese goods, Master Kong always suffers unjustly. Where does this come from?
In 1998, the ambitious Ting Hsin proposed to acquire Taiwan-listed Wei Chuan Foods. The transaction itself was not favored by the market, and coinciding with the financial crisis, the stock price plummeted while the company fell into a financial crisis, forcing it to consider selling shares to bring in funds.
In 1999, Sanyo Foods proactively contacted them and spent $143 million to buy half of Ting Hsin's stake in Master Kong, with both parties holding 33.14% each. However, Sanyo Foods did not demand management rights.
The cooperation with Sanyo Foods not only helped Ting Hsin overcome its financial crisis but also brought production and quality management technology, enabling Master Kong to quickly dominate the Chinese instant noodle market.
Meanwhile, with the warming of the tea beverage market after 2000, Master Kong's tea beverage business quickly captured a leading position in China's packaged tea beverage market, with a market share of over 50%.
The Japanese saw an opportunity to get a piece of the pie, and Master Kong was eager for funds to continue expanding its market and suppress "Uni-President." So the two sides hit it off. In 2004, Master Kong Holdings sold 50% of its beverage subsidiary's shares to the Asahi Group.
With money, things were easier. That same year, Master Kong launched mineral water, entering the fiercely competitive water market. In 2006, Master Kong's revenue reached $2.332 billion, with instant noodles and tea beverages ranking first in the industry, and fruit juices ranking among the top three.
During the 2008 global financial crisis, Ting Hsin Group wanted to introduce outside corporate directors to improve corporate governance. Considering that partners should have Eastern cultural characteristics, Itochu, which had previous cooperation experience and an "Eastern bloodline," surfaced. It paid $710 million to acquire 20% of Ting Hsin Group's shares.
In 2011, because Pepsi (PEP.US) was being comprehensively suppressed by Coca-Cola in the Chinese market, it chose to cooperate with Master Kong. Master Kong obtained Pepsi's equity in 24 bottling plants in China, while Pepsi obtained 5% of TAB's shares. For Master Kong, this achieved resource optimization and expanded brand advantages.
- Reasons for the Breakup
The Chinese market is so vast; how could the shrewd Japanese be willing to let go of this big cake?
The reasons for being willing to sell can be summarized as two helplessness:
First, the Asahi Group urgently needs money to develop overseas business;
Second, China's beverage market is declining.
(1) Actively Expanding into the European Market
In fact, China can be considered a place of disappointment for the Asahi Group. Besides the unfavorable cooperation with Master Kong, its investment in Tsingtao Brewery shares has also been unsatisfactory.
The Asahi Group stated this year that it hopes to have business cooperation with Tsingtao Brewery, using its channels to sell Asahi beer brands. It also pointed out that its stake in Tsingtao Brewery remains purely a financial investment. The Asahi Group invested in Tsingtao Brewery in 2009, but it seems the group has failed to find a development path in China over the years.
According to Euromonitor data, the Japanese beer market is approximately $21 billion and is currently in a state of stagnant growth, with growth not expected until 2019. Meanwhile, the global beer market will grow by 8.2% over the same period.
It should be noted that the Asahi Group's main business is beer. Although it is a top brand in Japan, its global market share is only 1.2%. A stagnant Japanese market, coupled with unfavorable development in China, forced the Asahi Group to make overseas acquisitions to reverse its disadvantage. Before turning to Europe, it naturally needed to sell Chinese assets to free up funds.
In 2016, the Asahi Group spent RMB 19.7 billion to acquire three European beer brands from SABMiller. Subsequently, the Asahi Group spent RMB 56.4 billion to acquire five Eastern European beer brands from Anheuser-Busch InBev, setting a record for the largest cross-border M&A deal in Japan's beer industry history.
(2) Declining Beverage Market
In the decade after Master Kong's cooperation with the Asahi Group, from 2004 to 2013, the compound annual growth rate of beverage revenue was close to 30%. After 2013, Master Kong's beverage revenue and profits continued to decline.
The Asahi Group originally cooperated with Master Kong for profit. From 2013 to now, beverage sales have recorded four consecutive years of decline, and profits have fallen from a peak of $250 million to $50 million.
The market has attributed Master Kong's sharp profit decline to intense competition in China's beverage market and Master Kong's failure to keep up with changing consumer tastes. The reasons seem reasonable, but the Asahi Group, in urgent need of money, would still choose to leave faster.
But is the inside story really that simple? I think not.
- Where There Is Buying and Selling, There Is Harm
Master Kong's overall business is indeed declining, as can be seen from the drop in revenue. This cannot be faked.
But what I want to argue is that there are degrees of decline. Is the competition in the beverage industry really so intense that even a giant like Master Kong has profits only one-fifth of its peak?
Let's look at operating cash flow, which is more realistic than profit, as shown in the table below:
Due to drastic changes in Master Kong's accounts payable in 2014, cash generated from operating activities decreased significantly.
But in the following two years, operating cash flow steadily recovered. In 2016, the company's operating cash flow had returned to the levels of 2012 and 2013, which were the company's peak profit years.
Therefore, from the perspective of operating cash flow, the actual operating situation last year had already begun to stabilize.
(1) Why Is There No Sign of Profit Rebound?
Because the depreciation rate, which affects profit but not operating cash flow, has been rising significantly each year!
As shown in the chart, the red line represents instant noodle depreciation expenses, which have basically stabilized over the past three years. In contrast, the blue line represents beverage depreciation expenses, which have been rising sharply over the past three years.
Think about it: from a profit perspective, beverage revenue has been continuously declining, while depreciation expenses have been increasing year by year. It would be surprising if profits didn't deteriorate significantly!
Those familiar with accounting know that depreciation can be amortized over ten or twenty years, leaving significant room for adjustment. Based on Master Kong's operating cash flow, the overall business has actually stabilized long ago. The sharp decline in profits is just a smokescreen affected by depreciation expenses.
(2) What Is Master Kong's Motivation for Doing This?
Here I propose a bold conjecture: to accelerate the expulsion of the Asahi Group.
The Asahi Group's intention to withdraw from the non-alcoholic market is not new. In 2008 and 2013, it sold a total of 18% of Master Kong's beverage shares to Ting Hsin, and then in September 2016, it sold another 10%.
It can be seen that the three sales were spaced 3 to 5 years apart, reflecting the Asahi Group's wait-and-see attitude toward the Chinese market.
Where there is buying and selling, there is harm. The seller wants to sell high, and the buyer naturally wants to buy low.
Master Kong, with absolute control, used compliant accounting methods to lower the subsidiary's profits, ultimately accelerating the Asahi Group's decision to withdraw. Less than a year after the third sale in September 2016, the Asahi Group chose to sell all its remaining shares.
I can only say: In business, there are no eternal enemies or eternal friends, only precise calculations.
- Next Year, Master Kong's Beverage Profits Have a Chance to Rebound Strongly
Besides the news of Master Kong and the Asahi Group transferring the subsidiary, there is another piece of news that may have been overlooked.
In June 2017, Master Kong announced the sale of equity in five of its subsidiaries to Zhangzhou Yilaifu Food Co., Ltd. These five production companies mainly produce and sell ready-to-drink tea, fruit juices, carbonated beverages, and also some bottled water products.
If the transaction is completed smoothly, Yilaifu will become the sole shareholder of the five production and sales companies, with a 100% stake in each. In other words, Master Kong will completely divest these factories.
The market's understanding of Master Kong selling its five factories is that Master Kong is learning from Coca-Cola, divesting heavy assets and transitioning to an asset-light model.
In fact, outsourcing production has never been a new business model. If it were to save declining profits, why didn't Master Kong transition earlier, and why implement it precisely at the time of buying back the Asahi Group's shares?
It's simple: because the Japanese "foreign devils" have left, there is no longer a need to suppress profits.
But you might ask, what if profits aren't suppressed?
If sales continue to decline, profits will eventually reflect the downward trend in revenue. Okay, let's look at the sales trend of Master Kong beverages.
Benefiting from the hot season, demand for packaged beverages increases, making the second and third quarters of each year the peak sales season for the beverage business. Therefore, when comparing performance growth, we can only compare year-on-year to eliminate seasonal effects.
As can be seen from the chart below, in the first and second quarters of 2016, Master Kong's beverage sales were still declining year-on-year. But starting from the third quarter of last year, the year-on-year comparison began to recover, with sales achieving the first positive year-on-year growth in recent years, and this has continued for three consecutive quarters.
- Summary
So we see a clear picture.
Since the beverage industry's sales weakened in 2012, Master Kong's sales have also declined, inevitably affecting profits.
But based on operating cash flow, Master Kong's business has actually gradually stabilized over the past two years, and last year's figures even returned to the levels of 2012 and 2013.
However, the company's beverage depreciation expenses have, intentionally or unintentionally, risen sharply in these two years, causing profits not only to fail to rebound with operating cash flow but also to continue declining, with the beverage segment's profits falling to one-fifth of their peak.
In 2016, the Asahi Group finally couldn't bear it anymore and sold shares in Master Kong's beverage company again, and this year it decided to completely sell the remaining shares.
Master Kong achieved its goal. In June, it sold the water plants, lowered depreciation, and combined with the industry recovery, I foresee a perfect rebound in beverage company profits over the next two years.
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