As the board of Coca-Cola Amatil jets into midtown Atlanta for a three-day visit with its major shareholder, Indonesia has been flagged as a key topic of discussion – and heated debate.
Talks have been under way for weeks to create a new structure for CCA's Indonesian bottling business, to help fund a likely big capital expenditure program over the next few years.
Discussions revolve around The Coca-Cola Company (TCCC), which owns 29 per cent of CCA, taking direct ownership in the Indonesian venture via an injection of equity into a new entity. The funds would then be reinvested into Indonesia to help fund the roll out of new plants across the region. Any future capital expenditure would be split between TCCC and CCA according to the equity split.
The program, which kicks off on Tuesday, is the first time in more than five years that the CCA board has been invited en masse to spend time with senior executives at Coca-Cola's global headquarters, something that won't be lost on chairman David Gonski or the rest of the board.
According to CCA, the meeting was organised before a new boss was appointed.
The stakes are high for the new boss Alison Watkins, who has been in the top job for seven months. Besides the visit being her first real introduction to the Coca-Cola system, it will be a test of how she will navigate her way through the anchor bottler's complicated – and at times tense – relationship with its major shareholder.
She will have the company's other shareholders watching intensely.
With an investor day scheduled for the end of the month in Sydney, the clock is ticking for some results. It comes against a backdrop of a falling share price, sliding group earnings and an announced strategic review, which has resulted in numerous consultants crawling over the bottler. The strategic review is designed to improve its Australian and New Zealand businesses, review its Indonesian franchise, revise its alcohol strategy and confirm the future of its food business SPC Ardmona, of which CCA recently had to write off hundreds of millions of dollars and seek government assistance.
Up and down
Under CCA's previous boss, Terry Davis, relations with TCCC had its ups and downs, particularly as the business started to come off the rails. With a new chief executive, the TCCC undoubtedly sees it as an opportunity to renew relations and start afresh. The board will visit sites and supermarkets in Atlanta, socialise and listen to presentations about how TCCC sees the world.
Besides improving relations, the purpose of the trip will have a broad-based agenda but also a focus on Indonesia and trying to resolve what has become a Mexican stand-off in recent weeks over how each values the Indonesian assets.
The gap is believed to be hundreds of millions of dollars, with TCCC's valuation at the lower end of the scale. Whether this gap can be closed will determine the next step in the Indonesian story.
CCA is understood to have hired UBS to help it come to a valuation, believed to range as high as $2 billion. The talk is that TCCC wants CCA to invest between $600 million and $1 billion in Indonesia over the next few years to take on the Latin American family-owned AJE Group, which owns Big Cola, a business that has wreaked havoc on the soft drink giant and snared market share due to its lower costs and cheaper prices.
Some investors would not be happy to see CCA sink big money into Indonesia given the poor historical returns and the challenges facing its Australian business, which represents the lion's share of its earnings.
In the past 22 years CCA has invested more than $1.3 billion in Indonesia and according to Credit Suisse its earnings have been about the same, raising questions of whether Indonesia has been a sucker's bet.
Not surprisingly some of its other shareholders don't have the same appetite as TCCC to invest more capital in Indonesia.
For TCCC, Indonesia is part of TCCC's ambitious 2020 Vision to double its business by the turn of the decade.
Lagging Pepsico
TCCC is trading at a record high but is lagging the performance of arch rival PepsiCo; it wants to turn this around.
To this end it has identified a number of countries that will help it get there and Indonesia is one of them.
It wants CCA to expand its foothold in Indonesia to capitalise on population and GDP projections and take on competitors such as Big Cola with lower cost bases.
The valuation of the Indonesian business is important as it will dictate the size of TCCC's stake in the new economic entity or joint venture, or whether other options need to be considered.
For example, if the Indonesian business is valued at $1.5 billion and TCCC takes 10 per cent it would result in an equity injection of $150 million. If it is valued at $2 billion, the equity stake might be far less, or might include debt. This stake would be on top of the stake it has in the main entity. However, given the relationship between CCA and TCCC, any deal to sell down equity in Indonesia would need to be independently assessed by an independent expert such as Grant Samuel to ensure it is fair and reasonable.
How the discussions play out will be watched carefully by shareholders who will want to see that the new chief executive is working with TCCC but not to the point where the rest of the share register is at a disadvantage.
CCA is an anchor bottler for TCCC, which holds equity and two board seats.
CCA might try to argue differently but the relationship means there is a natural tension within the relationship, where TCCC wants volume to be the endgame, while CCA is more focused on profit margins.
Tough decisions
It puts Watkins in a tough position. If she plays too hard and an agreement on Indonesia can't be reached and TCCC doesn't increase its stake in Indonesia through a joint venture, some tough decisions will need to be made. This could include introducing a new equity player into the mix. Or TCCC could wield its power and take back the Indonesian licence and give it to another bottler such as Mexican bottler Coca-Cola FEMSA. Back in 2001 CCA sold its Philippines business back to TCCC and San Miguel after it suffered deteriorating earnings. Interestingly, in December TCCC sold 51 per cent of its Philippines bottler to Mexican bottler Coca-Cola FEMSA, which marks its first expansion beyond Latin America.
But at the end of the day, Indonesia is a sideshow to the bigger problem for CCA: Australia and New Zealand, which represents more than 80 per cent of its earnings, and which has gone off the rails.
One of the country's leading analysts, David Errington at Merrill Lynch attributed some of CCA's current predicament to a flawed pricing strategy under the previous regime: "Over the past two to three years, Amatil has driven prices for its products too high, or allowed its prices relative to competitors to be at too high a premium."
This strategy cost it volumes, with volumes at the same levels in Australia as they were five years ago. A combination of increased competitive pricing by Coke's competition, a lack of new product innovation within the Coke system (the last big brand innovation was Coke Zero in March 2006), the rising power of the supermarkets and a switch by consumers from sugary soft-drink products to healthier products, have also taken their toll on the group's profits.
Despite TCCC owning almost a third of CCA, it is not as concerned with the traditional investment measures of return on equity, dividend yields and margins. Historically it has been more interested in the per capita consumption of the sticky brown liquid – and that makes Indonesia one of the company's most exciting markets on a volume basis. The growth of the Coca-Cola company is tied to the amount of concentrate it sells to its bottlers around the world. More sales means more concentrate; more concentrate means more profits. In essence, anchor bottlers are distribution companies. They mix flavour concentrate, sweetener and water, carbonate the mixture, fill the bottles and cans then distribute to retail outlets. Bottling plants are constructed to plans approved by head office. Atlanta also takes charge of all product development, and controls the brand building and marketing of products.
Tooth and nail
Watkins is well aware of the relationship with TCCC and wants it to change. She is committed to Indonesia and will fight tooth and nail to keep its deal with TCCC.She told investors in August that she was working closely with TCCC "to ensure we have the right plan to deliver growth in both volume and returns over the next five years."
She flagged different arrangement types with TCCC going forward.
When she took the top job she quickly discovered she had inherited a mess, including an uncompetitive product portfolio, an alcohol business in need of a clear strategy and a struggling food manufacturing business. To put it into perspective, the share price is trading at $8.42, which is down sharply from $12.41 a year ago.
Watkins is well regarded and highly credentialed, but fixing CCA will be challenging, as the board well knows.
The market will await CCA's next move, but there is no doubt TCCC will be watching even more closely to make sure CCA's plans fit in with its own.
