Drink brand powering share float

By BRIAN GAYNOR

The first impression of Frucor Beverages share offer, which closes on June 8, is extremely positive.

The company has a very strong position in the domestic beverage market, it has exciting export potential and a highly regarded management team.

On closer examination, the float has several negative features. These include a share pricing mechanism that is unfriendly to individual investors, a highly geared balance sheet and a growth profile that is largely dependent on one brand.

On balance, the positive features outweigh the negatives but investors should be aware of the risks before investing in Frucor.

The Apple and Pear Board started the original Frucor business in 1961 with the introduction of Fresh-Up.

In subsequent years the Just Juice, McCoy, Citrus Tree, Stefans and NZ Natural brands were developed or acquired. "V" was introduced in 1997 and the board stated in its annual report that the launch had been a success.

In June 1998, Frucor Beverages was sold to a consortium of investors for $50.4 million. The main investors were the Australian arm of United States private equity investment firm Bain Capital and Sydney-based Pacific Equity Partners.

In a complex capital reconstruction similar to the Wisconsin Central/Fay Richwhite purchase of Tranz Rail, the consortium contributed equity of $18.7 million and borrowed the remaining purchase cost against the assets of Frucor.

In 1999 Frucor bought the Pepsi, Pepsi Max, 7Up and H2GO brands in New Zealand from Lion Nathan and the high-flying "V" brand was launched in Australia and South Africa.

Following a complex pre-float capital restructuring, Frucor now has 125 million ordinary shares on issue. The net cost of these shares to existing shareholders is $12.1 million (the original equity contribution of $18.7 million plus $5.4 million to exercise management options minus a pre-float dividend of $12 million).

The existing shareholders are selling 62,625,000 shares or 50.1 per cent of the company to the public. No new shares are being issued by the company. At an indicative price range between $1.95 and $2.25 a share, the 50.1 per cent holding will realise between $122 million and $141 million.

The total value of the company at the indicative price range is between $244 million and $281 million compared with a net cost to existing shareholders of only $12.1 million.

This is not a bad little profit in less than two years. The directors of the old Apple and Pear Board, and their growers, must turn a bright crimson when they look at these figures.

The existing shareholders have the facility to sell an additional 12,375,000 shares into the float and they have agreed not to sell any of their remaining shares until June 30, 2001 at the earliest.

The issue is being aggressively marketed here and in Australia. The vendors are paying most of the issue costs and the company will be listed on both countries' stock exchanges.

Frucor has a very strong position in the New Zealand market with a 57 per cent share of the fruit juice market (Fresh-Up, Just Juice, Citrus Tree and McCoy) and 60 per cent of the energy drink sector (mainly "V"). It also has 10 per cent of the carbonated soft drinks sector (Pepsi, Pepsi Max, 7Up and Mountain Dew) and 30 per cent of bottled water (NZ Natural and H2GO).

Its export drive is almost totally based on the "V" brand energy drink. "V" was launched in Australia in February 1999 and its market share exceeds 60 per cent. Frucor believes that "V" has excellent prospects as the Australian per capita consumption of energy drinks is only 0.5 litres compared with 2.3 litres in New Zealand.

"V" was introduced to South Africa in October 1999 and is being launched in Britain now.

The rapid growth of "V" is the main factor behind the bullish revenue and profit forecasts. Operating revenue is expected to increase 64 per cent to $184 million in the June 2000 year and adjusted net profit by 166 per cent to $13.3 million. This forecast should be achieved because 10 months of the year had already been completed when the prospectus was issued.

Directors are forecasting further substantial growth in revenue - from $184 million to $264 million this year and an increase in net profit from $13.3 million to $20.4 million.

The 2001 forecast is based on strong volume growth in Australia with no contribution from Britain. The projections are extremely aggressive, but Mark Cowsill and his management team have rarely missed a target. There is widespread confidence among shareholders and advisers that the prospectus forecasts will be met.

The most disconcerting aspect of the issue - for individual investors - is the pricing mechanism. Individuals have to send in their money by June 8 and an institutional tender will determine the issue price the next day. The shares will be listed on June 13 and institutions will pay for their shares on June 16.

This system has two clear disadvantages for individual shareholders. These are:

Individuals do not know the issue price when they write out their cheque (the price has been capped at $2.25 a share).

Institutions set the price and pay for their shares three days after listing. This allows them to sell their shares before they have paid for them. The issue is being heavily promoted across the Tasman and Australian institutions were heavy sellers of Contact Energy shares in the first few days after listing.

Individual shareholders are normally treated more favourably across the Tasman. Retail investors in Australia have been offered shares at a discount in public offerings and all shareholders participate equally in a takeover offer because of the country's takeover code.

In New Zealand, individual investors go into the Frucor issue wearing a blindfold and if an offer is made for 60 per cent of the company they will probably be excluded.

For an unknown reason the organisers of public floats and legislators in Wellington seem determined to make the sharemarket less attractive to individual investors.

The two other negative features of the company are its heavy reliance on "V" and a highly geared balance sheet. The existing shareholders have cut the balance sheet to the bone and shareholder funds are forecast to represent only 26.5 per cent of total assets at June 30, 2000. In view of this, the $12 million pre-float dividend payment has to be questioned.

The balance sheet structure will not be a concern if Frucor achieves its profit forecasts. But if increased competition or the failure to meet its forecast sales in South Africa or Britain harms "V" the company's financial structure will be a concern.

Nonetheless, Frucor is a very attractive share offer. The company has a highly respected management team with a track record of successful and profitable product innovation. If Frucor achieves its profit forecasts, participants in the float will be well rewarded.

* Disclosure: Brian Gaynor has applied for Frucor shares.