A Toast to a Pared Down Foster's Group - Barron's

by: Rachael Granby

Australia's Foster's Group (OTC:FBRWY) hasn't been as successful with wine as it has been with beer. Barron's Eric Ellis says if Foster's can only pare down its product line, investors will have reason to raise a toast to the company once again.

Foster's holds nearly 52% of Australia's local beer market but a decade ago executives worried there wasn't much room to grow. They believed expanding into Asia would be difficult and, seeing Australians grow wealthier, decided instead to go on a $5B wine-focused buying binge. Foster's product line now ranges from six-packs of beers to highly-prized $5,000/bottle wines.

Foster's wine business, however, has never managed to reach the success its beer business has sustained over the years. In its most recent fiscal year wine made up 48% of revenues but only 33% of operating profits, and net profit dropped 88% on $A730M of write-downs on expensively acquired vineyards. Even CEO Ian Johnston admitted "our performance in the last 12 months has not been up to what we would expect ourselves."

One of the main problem has been sales. Foster's tried to sell wine to chic restaurants and specialty liquor stores using the same sales force trained to mass-market beer to large so-called beer barns. Johnston says in "hindsight, some of our marketing assumptions were flawed" and the company is trying to correct those assumptions now. Investors have also been turned off by Foster's "very poor acquisition strategy," says Matt Williams of Sydney's Perpetual Investment, as the company has paid too much and has bought at the wrong times.

The poor returns have prompted speculation that several companies (including INBVF.PK, OTCPK:SBMRY, DEO, among others) may be looking to buy Foster's. Trading around $A5.05, some analysts expect 20% or more upside if a bid materializes or the company significantly reorganizes. With a market value of $A9.7B, Foster's is a large local player but not too big for major global players to make a bid. And with beer assets alone valued near $A11B, a buyer would get Foster's wine portfolio virtually free. Johnston declined to comment on who might be considering a bid, though the company recently appointed Goldman Sachs to advise on a possible bid defense.

Meanwhile, Johnston has begun reviewing the company's wine operations and disappointing volume growth, which some investors take to mean he's assessing which vineyards to sell. A sale, even at a marked discount, could be tough because of an oversupply of vintners on the Australian market. Its beer business has continued to do well and sector outlook remains positive, leading Williams to think the company may be preparing for a split, separating the beer division from a stand-alone wine division. Or, perhaps Foster's best bet is to get back to basics, selling wine labels to cancel debt and then re-focusing on its strong beer business.