Assessment 2 – Business Report

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Southcorp Limited:

Winemaker’s winding road

Based in New South Wales, Australia, Southcorp Limited is the world's largest maker of premium brand wine. The company oversees a number of brand names, including three of Australia's largest wine groups, Lindemans, and Penfolds, as well as Rosemount Estates, acquired in 2001. Other major wine labels include Wynns and Seppelts--the company has been working to reduce its total number of branded wines to under 850 by the end of 2003. In total, Southcorp owns more than 8,000 hectares of vineyards, and is the largest single landholder in the highly prized Coonawarra region. The company's combined volume, excluding bulk volumes, topped 22.2 million cases in 2001. The company's core brands, including Wynns, accounted for nearly 14 million cases. The United States represents a primary market for Southcorp, absorbing more than five million cases, while Europe accounts for nearly 7.5 million cases of Southcorp-produced wine. The company also owns small winery operations in the United States, where it has formed a joint venture partnership with Robert Mondavi, and in France, where it holds the James Herrick brand. Originally a beer brewer turned diversified conglomerate--the company's former holdings included a large water heater business--Southcorp has transformed itself into a focused wine group, completing the divestment of its water heater operations in 2002. Listed on the Australian stock exchange, Southcorp posted total group sales of A$2.82 billion (US$1.59 billion) in 2002. On 13 January 2005, Foster’s Group Limited announced the purchase of an 18.8% interest in Southcorp Limited from Southcorp’s largest shareholder, Reline Investments Pty Ltd, the Oatley family’s investment vehicle, for AU$4.17 per share in cash, valuing the stake at AU$584 million. Further details of the purchase are set out in the Substantial Holder Notice lodged on 14 January 2005. At the time of the announcement of the purchase both Foster’s and Southcorp sought from the ASX and were granted a trading halt pending an announcement. During the course of 14 to 17 January 2005, various discussions were held between representatives of Foster’s and Southcorp. The purpose of those discussions was to enable the Foster’s representatives to present the details of its proposal to the Southcorp Board and to seek Board support for the proposed takeover bid. These discussions proceeded amicably but no agreement was reached. Foster’s today announced that it intends to launch a conditional off-market takeover offer ("Offer") for the shares in Southcorp that it does not already own at a price of A$4.17 per share in cash. The sale price agreed with the Oatley family is extended to all Southcorp shareholders and values 100% of the shares in Southcorp at A$3.1 billion.

Southcorp became to a single business brewer in 1888 in South Australia. For more than 100 years, South Australia Brewing Holdings (SABH), dominated the South Australian beer market, however they changed strategy in the mid-1980s in response to environmental and competitive threats. In 1984,SABH entered into the wine industry through a friendly takeover of one of Australia’s oldest winemaking enterprises B Seppelt & Sons Limited, who were on the edge of bankruptcy. It is not regarded as a serious entry into wine industry but rather reflected a corporate trend to own a winery. In 1987, a former special projects officer who named Ross Wilson, became SABH’s managing director. He transformed the conservative company in next 7 years during his duty. He divested the share portfolios which make SABH cashed up for further development. He also adopted a strategy that was to set up three core business in food and beverages, packaging, and household appliances, business that could achieve sustained market leadership in all products and services( being number 1 or 2 or leaving the industry). Consistent the strategy, SABH made some acquisition during the late 1980s and early 1990s, and turning packaging into major company earning. Ross regarded international exports as the success key to company, this strategy successfully made SABH became the seventeenth- largest company in Australia by the 1990s, with 1.01 billion market capitalization and 40 per cent of annual profit growth. In 1990, Southcorp was entry into the wine industry seriously by the acquisition of Penfolds for $423 million. It was an expensive acquisition however gave SABH the largest share (32 per cent) of the domestic market. In 1992, Ross planed to be part of an international brewing business and put forward a merger proposal to Foster’s. The proposal was rejected by Foster’s and SABH eventually sold its brewing, malting and hotel assets for $225 million. The acquisition of the number two US hot water company Mor-Flo in 1992 futher compounded SABH’s problems. The investment community responded to the acquisition by driving down the share price. Ross also lost a key canning contract with CUB and made some wrong decisions on packaging investments. Finally, Ross Wilson left the company in early 1994 confronted by strong opposition. However, Under Ross's leadership SABH made several acquisitions including packaging and white goods manufacturer Rheem Australia Limited. SA Brewing took over Australia 's most prestigious wine company, Penfolds Wines Pty Ltd and the company changed its name to Southcorp Holdings Limited by which time it had grown to become Australia 's largest wine company and diversified manufacturer employing over 13,500 people with a market capitalisation of $4 billion. The graph below shows the financial statement of Southcorp from 1987 to 1994, which was under Ross Wilson’s managing.

[pic] As the financial statement, the total sales of Southcorp was increased from 571,073 thousands dollars in 1987 to 2,254,288 thousands dollars in 1994, it’s nearly four times increasing. And total assets of SABH’s business, was increasing from 501,938 thousands dollars to 2,071,505 thousands dollars during this seven years. Also all the other values had dramatically increasing. Therefore, there is no doubt Ross Wilson lead SABH to a different level. And strategies were absolutely successful under his leadership. SABH was been added nearly three times value in this seven years.

Graham Kraehe, with a formidable reputation of turning companies around, came to head Southcorp Holdings in December 1994. He continued the strategy of growth through acquisitions also divested noncore businesses. To some extent, he continued Ross Wilson’s approach to gain a number one or two position in each of the businesses or leave the industry. In 1996-97, Graham regained the equity market confidence with remarkable rapidity, reflecting Southcorp’s consolidation and refocusing its core business, with acquisitions designed to improve existing synergies. Graham also worked hard at redefining the incentive system for senior managers, so that their performance was measured against the performance of each division and business within each division. In addition, divisions held operational board meetings monthly and company’s senior management met twice a year to share ideas, network and communicate organizational objectives. Graduate recruitment program was running both in corporate and division levels, which included a two- year rotation throughout the company. Those strategies gave an improvement to the staffs and managing levels. It used labor as a company’s asset effectively. During 1997-98, The EVA analysis was introduced by Graham, which could indicated that while the wine and water heating divisions were value creators, and the other units destroyed economic value. So Graham made decision to sell some business, and only kept businesses which was number one or two in the Australian market, which provided strong cash flow for international growth, particularly in wine. Under Graham's leadership, Southcorp developed as a diversified company serving global markets and generated a significant proportion of its revenue outside of its Australian home market. During his time as CEO, the Southcorp share price, market capitalisation and profit all more than doubled. Both Ross Wilson and Graham Kraehe had been instrumental in moving the wine business from being a very strong national player to becoming a global business. The divestiture strategy was continued after Graham Kraehe retired in 2000. After Southcorp merged with Rosemount Wine Estates, new leader Keith Lambert sold Southcorp’s very profitable water heating business, and eventually Southcorp became a single- purpose wine business. When Keith Lambert took over the leadership of Southcorp, he also faced some problems. First, he introduced a market – driven approach and implementing a materials requirement plan in Southcorp Wines, cutting staff numbers and finalizing a joint venture agreement with Robert Mondavi, a premium wine producer, which some observers viewed as a prelude to a future merger between the two wine giants. However his action proved more controversial, and the inability to hold on to key Southcorp staff were causing brands squeezing in U.S by shelf space lacked. Southcorp business model had a particularly disastrous effect under Rosemount marketing approach. Large supermarket chains became major beneficiaries of this volume- driven approach. They pushed Lambert for bigger discounts. However the rest of industry was follow. And the situation was exacerbated by record domestic vintages in Australia and U.S, which led to grape oversupply. In September 2003, Southcorp announced more than $900 million in trading losses and write- downs. On 13 January 2005, Foster’s group announced the purchase of an 18.8 per cent interest in Southcorp Limited from Reline Investments Pty Ltd, the Oatley family’s investment vehicle. The Combination of Foster’s and Southcorp is Strategically and Financially Compelling
The Offer Is a unique opportunity to create a pre-eminent global wine company, with an unrivalled collection of premium wine brands furthering Foster’s global wine leadership strategy; Positions the combined company as the owner of "Brand Australia" in the beverage category, with a portfolio of leading beer and wine brands complemented by a range of RTDs, spirits, cider and non-alcohol brands that together provide a total beverage offering to customers and consumers; Represents an outstanding price for all Southcorp shareholders, which is evidenced by the sale of the Oatley family’s strategic stake at the same price; Is financially attractive for Foster’s shareholders on all key acquisition metrics; Will also benefit employees, customers and consumers of both companies by providing a stronger and more competitive business model with enhanced global growth prospects; and Retains Australian ownership and control of Southcorp’s icon wine brands in the hands of the logical acquirer, and protects and strengthens Australia’s position in the global wine industry.
An Outstanding Offer for Southcorp Shareholders
The Directors of Foster’s consider this to be an outstanding Offer for Southcorp shareholders as it represents: • A 51% premium to the average of Southcorp broker valuations of A$2.76 per share; • At 14.9 times, one of the highest one year forward EV/EBITDA multiples ever paid for a major listed wine company; • A 48% premium to the average one year forward EV/EBITDA multiple for comparable companies; • A significant premium to the share price prior to the recent consolidation wave which reignited speculation about a takeover of Southcorp; and • The same price as that accepted by Southcorp’s strategic shareholder, the Oatley family.

Frank Swan, Chairman of Foster’s, commented:
"The acquisition of Southcorp is an excellent strategic fit. It will enhance Foster’s long-term global growth prospects and deliver significant benefits to shareholders of both companies.
The Acquisition Will Deliver Significant Value.That will provide greater scale in key geographies and price segments for wine particularly in the US, the UK and Australia. • It will result in a more diversified and balanced earnings stream for the Group, with the Group’s earnings more evenly distributed between Foster’s Australian multi-beverage business, Carlton & United Beverages and its global wine business, Beringer Blass Wine Estates. • Synergy benefits are expected to result from reducing cost structures and maximising revenue benefits. In combining its activities with those of Southcorp, Foster’s is well placed to achieve synergy benefits given that the majority of the cost benefits are likely to be generated in Australia, where Beringer Blass Wine Estates has a proven track record in optimising production arrangements, capturing cost reductions and in turn enhancing the capital efficiency of its business. • The acquisition is expected to be earnings per share accretive in year two and thereafter against scenarios based on either of the two alternative uses of surplus cash (that is, debt paydown or a share buyback program that would have included an off-market transaction in FY2005). In year one, the transaction is earnings per share neutral against a debt paydown alternative and mildly dilutive against the share buyback alternative. • The acquisition is not expected to dilute Wine Trade cash flow generation capabilities. • The acquisition is expected to generate double digit returns by year three. • The Group is committed to retaining investment grade credit ratings. Moody’s Rating • Assessment Services has indicated that Foster’s credit rating will be Baa2 with a stable outlook, down one notch from Baa1, with its short term rating of Foster’s of Prime-2 unchanged. Foster’s has reiterated to Standard & Poor’s and Moody’s its commitment to return to pre acquisition credit metrics within three years. In my opinion, Foster’s Group will be a good corporate parent for Southcorp’s future development. Foster’s got strong cash flow for running and supporting Southcorp. Also Foster’s Group was a big company which had biggest market share in Australia wine industry Foster’s was yet to make a convincing case about the expected synergies between the two companies but some analysts and institutional shareholders had an uneasy feeling that the acquisition was a somewhat desperate attempt to make Foster’s struggling wine business work. They also wondered whether Southcorp’s wine business would be better off under Foster’s than it had ever been before. In conclusion, Southcorp is a major Australian wine producer with a strong international presence. Southcorp sells approximately 20 million cases of wine per annum generating net sales revenue of approximately A$1.1 billion in the Americas, Australia and the UK. The company produces the great majority of its wines in Australia and owns viticulture assets of over 8,000 hectares (20,000 acres) in some of Australia’s finest wine producing regions. Southcorp owns around 25 key brands in total, with leading brand rankings in Australia, and strong rankings internationally. Its four core premium brands are Penfolds, Rosemount Estate, Lindemans and Wynns Coonawarra Estate. In aggregate these core brands account for around 80% of Southcorp’s total sales revenue and around 65% of total sales volume. Southcorp employs around 2,500 people. To look forward to Southcorp could have a better movement after acquisition by Foster’s.

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Reference:
Tatiana Zalan, “Southcorp Limited: winemaker’s winding road”, The University of Mel.

Foster’s Group, Melbourne, ‘Foster’s announces take over offer for Southcorp’. 17 January 2005

"Australia's Southcorp, Robert Mondavi May Merge in 2 Yrs.," AsiaPulse News, March 28, 2002.
Davenport, Rosie, "Southcorp Puts Monkey on Australian Wynns," Grocer, September 7, 2002, p. 61.
"The Wine Wizard of Oz; Australia's Southcorp Aims to Be the World's Biggest Wine Producer in Five Years, Business Week Online, September 7, 2001.

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