AVCJ Awards Operational Value Add & Exit of the Year - Large Cap: Oriental Brewery

Affinity Equity Partners and KKR made Oriental Brewery the market leader in Korea’s beer industry, then exited via Asia’s largest-ever trade sale. For this and other activities, Affinity was also named Firm of the Year

Wednesday 10th December 2014

By Asian Venture Capital Journal

The first time I.S. Chang was offered the head of sales job at Oriental Brewery (OB), he turned it down. Chang was a 30-year veteran of Jinro - a soju producer that had been acquired by Hite, OB's direct competitor - having joined the company as a high school graduate. He was not inclined to move but Affinity Equity Partners and KKR, the new owners of OB, were determined to get their man.

"When we asked customers who were the best sales people in the industry, the unanimous response was Jinro. And I.S. Chang was highly recommended, not just as a sales person but as a leader," says an Affinity investment professional closely involved in the deal. "We went to see him three times in order to reassure him that we are value creators, not cost-cutters. It took 3-4 months, but eventually we convinced him to join the team."

That was January 2010, about six months after the private equity firms acquired OB from Anheuser-Busch InBev (ABI) for $1.8 billion, including around $1 billion in debt. They turned the longstanding number two player in South Korea's beer market into the number one, and sold the business back to ABI for $5.8 billion earlier this year for an estimated money multiple of more than 5x.

Chang, who was named CEO of OB towards the end of the Affinity-KKR ownership period, is seen as integral to this achievement. First, appreciating the sensitivities tied to his joining OB from Hite - it is a very clubby industry with little cross-pollination between the two superpowers - Chang was patient in implementing change, ensuring people bought into his approach. Second, supported by a handful of experienced executives handpicked from Jinro, he succeeded in altering the mindset of the sales force.

"Would we have been able to find an I.S. equivalent? The alcoholic beverage industry in Korea has a long history and a strong talent base because many of these businesses were once part of larger chaebol groups," says Chung Ho Park, a director at KKR. "But for what we needed to achieve, I.S. had the right specifications - experience in leading a large sales organization at Jinro and a network in the southern region where we felt the opportunity for growth existed - to push our strategy forward."

In many respects OB bears the hallmarks of a standard corporate carve-out, with the private equity investors leveraging the advantages of running a business unencumbered by the baggage that sometimes comes from being part of a multinational. But by Asian standards, the size and scale of the turnaround is noteworthy. OB is by some distance the region's largest-ever private equity trade sale exit.

Slumbering giant

Affinity and KKR acquired the business through a competitive process but there were fewer participants than might have been expected. A number of strategic investors, still grappling the fallout from the global financial crisis and keener on brewers in developing markets than the relatively mature South Korea, declined to participate.

ABI was also a highly-motivated seller. Eight months earlier InBev acquired Anheuser-Busch for an aggregate $52 billion, creating the world's largest brewer but also a debt burden that proved difficult to manage. A period of divestments and de-leveraging ensued. OB was deemed surplus to requirements, perhaps in part because the company had failed to make inroads into Hite's lead.

Established in 1933, up until the late 1980s OB was the clear leader, its eponymous brand holding a 70% market share nationwide. By the time InBev bought the business in 1998, this brand's share was on a downward spiral that would take it into the low single digits.

Even though the Cass brand was on the rise, OB's overall share was stuck on 41%. The Cass brand retained a strong following in metropolitan Seoul and the surrounding areas, but in the south of the country OB's market share was in the teens and low 20s. Under InBev, the company launched a number of forays into the southern region, but to no avail. This was Hite's home territory.

Stephen Ko, a director at KKR, offers a US analogy, comparing the situation to St Louis-based Anheuser-Busch trying to expand into the Miller stronghold of Milwaukee. However, this did not make OB an unappealing proposition. KKR sees beer as the one of the most attractive sub-categories in packaged consumer goods globally with great margins and market dynamics.

And both Affinity and KKR recognized in OB the potential to make some real headway. Cass already had momentum, winning favor with younger drinkers; the production facilities could use additional capacity; the OB brand had strong equity and was ripe for rejuvenation. Above all, the company was the junior partner in a duopoly and had one, gaping weakness - the south. Find ways to address the market positioning and shore up the distribution network, and the balance might be redressed.

"ABI is a skilled operator of businesses and is renowned for driving operational efficiency," says Ko. "But given that Korea is a mature, lower-growth market and OB already had a strong share ABI was more focused on generating cash flow than on driving growth. The management team wanted to pursue growth opportunities, and under our ownership, we built on the strong foundation put in place by ABI, brought in new investments to areas like sales and marketing and helped OB launch its first new products in several years."

Changing the mindset

The sales team was one of the first areas the new owners focused on, with Chang's appointment a key part. The vast majority of beer sales to bars, restaurants, mom-and-pop stores and even large-format retailers in Korea are channeled through approximately 1,400 wholesalers. They wield considerable influence not just over which beers a shop stocks but also how promotions are targeted at customers.

Certain elements of the wholesaler community are partisan in nature. Former executives from OB or Hite might get into the wholesale business and remain loyal to their former employers. Others are more open-minded. OB's sales force simply wasn't getting out on the road and building relationships with wholesalers and as a result the company was losing a lot of goodwill.

"OB sales people were seen as number crunchers and not wholesaler-friendly. When new pubs were opening up, the owner would ask which beer they should bring in and the wholesalers would recommend Hite," says the Affinity professional. "The Jinro executives we brought in had a very different style - they were meeting people, emphasizing the personal touch, and going the extra mile. Gradually the existing sales people's mentality changed and this helped transform the sales force and the company into what it has become."

The transformation was supported by efforts to ensure data were being used properly. KKR's Park describes the process as follows: A sales rep was visiting a hypothetical, longstanding OB wholesale client that bought 700 bottles of beer each month; the challenge was how to get the order to 710 bottles.

The revised approach saw the entire wholesale market divided into clients that should be maintained, potential growth clients, and those whose business was no longer a priority. In this context, a second hypothetical wholesaler came into consideration. A Hite loyalist, he bought 10,000 bottles of beer a month, of which only 10% were OB. But doubling that share to 20% would have a far greater impact on the bottom line than persuading the first wholesaler to stretch to 710 bottles.

Another initiative targeted the incentive structure. Sales executives used to receive a bonus for hitting their monthly targets, based on how they beat those targets by.

If an executive was having a poor month and unlikely to qualify for a bonus, sales used to get held over to the following month - essentially giving up the current month's target in order to improve the chances of collecting an incentive the next month. In order to encourage consistency, OB gave its people the chance to win back monthly bonuses if they met their sales targets on a cumulative basis.

"We got them to think about it in 12-month increments rather than one-month increments," says Park. "This gave the sales people more time to build relationships with potential clients."

Capstone, KKR's operations unit, was also heavily involved in the re-launch of two brands alongside a newly-appointed head of marketing. The first was Cass Light, which had previously been trialed but failed to catch on, despite the popularity of light beers in other markets. A considerable amount was invested into the segment, including signing up several local celebrities with youth appeal to act as brand ambassadors, and the market responded positively.

The OB brand was arguably a trickier proposition given the extent of its fall. The company's previous launches had been unoriginal, with products rushed out in response to moves by Hite. With the OB brand, there was a conscious effort to reconfigure the beer in a relevant way. Cass appealed to the younger demographic so OB was positioned for the more sophisticated beer drinker in his early to mid-30s.

"We changed the taste profile and it went from being a lighter tasting beer to a fuller-bodied darker beer," says KKR's Ko. "An existing product, OB Blue, emphasized the use of rice as an ingredient so we got rid of that and started using hops, stressing the lager element. It went through about 25 tests with consumers before launch."

Into the south

The brand renewal efforts helped lift customer perceptions of OB as well as internal morale. Further confidence was drawn from a push into the southern region. In consultation with management, the private equity investors devised a three-year, multi-phase strategy for a "south attack." It was based on establishing a beachhead in sales, building a distribution network and accumulating brand momentum.

With Chang and the other former Jinro sales executives on board, OB had a means of reaching out to southern wholesalers, but it was not an easy process. There remained a high level of distrust of OB in the wholesale community, and Hite was threatening to pull its products from wholesalers that decided to do business with OB as well.

"In the first year we made a 1% market share gain but we saw more distribution. In the second year it was 3% but distribution went up quite substantially with wholesalers quietly starting to reach out to us as they began to trust OB once again," the Affinity professional says. "In the third year we started guerilla attacks - going after pockets of strength where we thought our younger brand profile would work in the southern region. That is when OB's market share began to explode in the region."

By the time Affinity and KKR exited OB, the company's market share in the south was above 40%. In August 2011, OB's overall share of Korean beer sales crossed the 50% threshold for the first time in 15 years. The lead over Hite continued to widen, reaching 67-68% in 2014.

However, it was a costly endeavor to begin with. Engaged in a battle over market share, OB wasn't in a position to increase pricing, while committing substantial resources to sales, marketing and other parts of the commercial infrastructure necessary to support long-term growth. The private equity firms put $250 million towards capital expenditure. OB also had to shed excess inventory left by ABI.

As a result, EBITDA margins went down for the first couple of years before rebounding. During the ownership period, revenue grew by 80% reaching KRW1.48 trillion ($1.3 billion) in 2013, while EBITDA rose 109% to KRW529 billion. There was also a 63% increase in total volumes, a 141% gain in export volumes, and the number of full-time staff went up by 6% to 1,700.

ABI had an option to buy back OB five years after the sale, although a number of rival strategic investors began making inquiries as the deadline approached. The two companies maintained a close relationship while OB was under PE ownership because OB continued to distribute many of its former parent's international products. In part because of this ongoing dialogue, ABI agreed to a deal ahead of the date on which the call option could have been activated.

There were, however, plenty of questions as to how Affinity and KKR had managed to drive a turnaround that had for so long eluded ABI. "Our approach in our discussions with them was to share everything we had and make it clear that it wasn't momentary, it wasn't financial engineering, it was fundamental and sustainable improvements in performance," says Ko.