Archives: Case Studies

In the fall of 2020, Liberty Latin America (LLA) completed the purchase of AT&T’s wireless business in Puerto Rico at an attractive price, merging LLA’s dominant fixed internet business on the island with AT&T’s dominant wireless business. We expect the convergence of fixed networks with wireless networks to continue for the next decade around the world. These mergers allow significant synergies as more of the wireless traffic can be offloaded at a low cost to the fixed infrastructure, the fixed connectivity deep into neighborhoods greatly reduces the cost of deploying 5G, customer churn is reduced, and customer servicing costs fall with some of the savings shared with the customer improving the offer. LLA is also pursuing this strategy of fixed/wireless convergence in Chile and Costa Rica, so we wanted to study its progress up close in their biggest market.

A couple of weeks ago, we were thrilled to have the opportunity to spend a day with Liberty Puerto Rico’s CEO, Naji Khoury, and his outstanding team. We spent time discussing their strategies for integrating the two systems and merging the customer relationships. We also discussed the business challenges and opportunities for Liberty Puerto Rico specifically and across the telecom industry. We visited one of their stores with Naji to learn how they are adapting to service fixed and mobile customers in a single retail format. We also spent time in the field with Ricardo Portela, the VP of Technical Operations, and a crew that was deploying new fiber optic cable to homes in a neighborhood and converting an existing hybrid fiber-coaxial (HFC) cable block to fiber. Essentially all new builds in Puerto Rico and across LLA are fiber to the home (FTTH). The cost to deploy fiber has declined and the costs to operate a fiber network are lower than HFC making fiber the future of fixed internet connectivity.

Figure 1. Cook & Bynum team and Liberty Puerto Rico team together in San Juan

Serendipity is an important part of on the ground research. While on the island, we made connections with smaller competitors and learned a lot from their perspective on competing with Liberty Puerto Rico. On the wireless side, we visited several stores of our two primary competitors, America Móvil and T-Mobile. Importantly, we also learned how frequent power outages are on the island since Hurricane Maria. The government-owned electric utility has been mismanaged for decades. As a result, most middle-class Puerto Ricans have some backup plan for dealing with these outages including generators, batteries, and solar panels. Management of the transmission and distribution part of the utility was recently privatized, and power outages should improve over the next few years. These outages impact Liberty Puerto Rico’s competitiveness. HFC cable systems require a power source at the junction boxes in a neighborhood to operate. When the power goes out in a neighborhood, the internet connectivity does, too. However, FTTH systems only require power at the modem in your home to operate since the signal is carried via light pulses down the fiber to a node. This difference during power outages is not material in most places in the world, but the high frequency of power outages in Puerto Rico makes it a meaningful competitive differentiator. We could not have learned of this competitive threat without visiting Puerto Rico.

In November of 2020, the FCC announced the results of the Uniendo A Puerto Rico Fund, a fund subsidizing the construction of a fixed broadband network to the entire island. Liberty won 55% of the municipalities and dollars ($71.5m) available in this process, with the remainder going to America Móvil. Each company will expand their network to provide all homes in each municipality with at least 100Mpbs service. We were encouraged that none of the small fiber overbuilders or wireless broadband competitors won any of the FCC money. We see the outcome of this process as creating a big disincentive for further overbuild on the island. In addition to the fixed broadband money, Liberty Puerto Rico has won $100m to improve its wireless infrastructure.

A few conclusions are worth sharing:

• Liberty Puerto Rico’s business is operating at a high level with significant momentum.
• We were impressed by the clarity of the objectives and the depth of the team at Liberty Puerto Rico.
• The financial benefits of fixed/wireless convergence will begin in the fourth quarter of this year and accelerate as we move towards the end of 2023.
• We expect the fixed/wireless convergence to work by increasing profits in Puerto Rico and many other markets around the world. This is significant because LLA is pursuing a similar strategy in Chile and Costa Rica.
• Liberty Puerto Rico’s most important competitor is America Móvil. In Puerto Rico, America Móvil is poorly managed with a bad brand, poor customer service, and spotty mobile and fixed networks.
• T-Mobile is being aggressive in the less desirable pre-paid mobile space and is acquiring customers. Liberty Puerto Rico plans to counter this threat by introducing a better pre-paid mobile program in the fourth quarter.
• Small FTTH internet companies are building networks in the wealthiest neighborhoods with the goal of stealing customers from Liberty Puerto Rico’s fixed HFC cable internet business. These buildouts have accelerated Liberty’s conversion of those neighborhoods from HFC to fiber. One of the competitors we met with has less total subscribers than the number of subscribers that Liberty Puerto Rico added last quarter. We will continue to watch what these small fiber overbuilders are doing closely, but it is not currently a major threat to Liberty Puerto Rico’s profitability.
• Power outages are a major problem in Puerto Rico, and Liberty Puerto Rico is accelerating the conversion of its HFC network to FTTH to address it.
While on the topic of LLA, we would like to highlight and update some of the topics we referenced in our first quarter 2018 letter when we first introduced the investment.

While on the topic of LLA, we would like to highlight and update some of the topics we referenced in our first quarter 2018 letter when we first introduced the investment.

On the subject of mergers & acquisitions, we wrote:

“Thinking beyond the company’s existing Latin American and Caribbean markets, Liberty LatAm is positioned to become a scale player in a region that currently lacks one. Liberty Global CEO and Liberty LatAm Executive Chairman Mike Fries is on record stating, “There is a massive consolidation opportunity in a market that remains highly fragmented.”

We expected LLA to be active with M&A at attractive prices, and they have exceeded our expectations by deploying more than $3 billion of capital in intelligent deals during the past three years. This amount exceeds LLA’s current market cap. Their deals include acquiring Cabletica in Costa Rica (2018), Searchlight’s minority interest in Liberty Puerto Rico (2018), UTS in Curaçao (2019), AT&T Puerto Rico (2019), Telefónica Costa Rica (2020), America Móvil Panama (2021), and forming a joint venture with America Móvil in Chile (2021). We anticipate reaping the benefits of these deals in upcoming years as meaningful cost and revenue synergies flow through.

We wrote about the opportunities to improve profitability in their Cable & Wireless unit:

“Liberty LatAm is continuing to improve the profitability of C&W, which itself was the result of the merger of C&W Communications and Columbus International in 2015. Since it acquired C&W in 2016, Liberty LatAm’s management has been focused on taming the company’s bloated cost structure, and the team expects to realize $150 million in annual savings by 2020 via headcount reduction, improved equipment procurement, and scale content acquisition.”

You can see in the chart below the progression of margins at Cable & Wireless, despite the headwinds posed by the pandemic in 2020 and so far in 2021.

Chart 1. LLA has significantly improved C&W margins

Source: Company filings.

We, also, wrote about the value offered by pay TV in LLA’s footprint when compared to that offered by U.S. cable operators.

“About 19% of the company’s 2017 revenues came from cable TV. While cable TV will be under both pricing and volume pressure as over-the-top alternatives (e.g., Netflix) continue gathering subscribers, cord-cutting is much more prevalent in the U.S. than other markets due to the historically high prices of cable TV in our country. Outside of the U.S., cable TV is much cheaper, and it provides some of the best value per entertainment dollar spent (expressed in cost per hours of content consumed). In fact, in many of Liberty LatAm’s markets cable TV remains underpenetrated and aspirational. With these cheaper prices, the incentive to cut the cord is greatly decreased, which makes cable TV revenues defensible and stable for some time.”

Note the table below to see how this has worked out so far. On an organic basis, LLA has gained organic pay TV subscribers while U.S. operators have lost them.

Chart 2. Unlike in the U.S., Pay TV is a stable part of LLA’s business

Source: Company filings.

The days of being a sleepy cable monopolist are long gone. Cheap capital, higher broadband penetration rates, and falling deployment costs are encouraging some overbuild nearly everywhere in the world. A great network, customer service, and fixed-mobile convergence are key to preserving profitability in the face of overbuild for cable companies. Liberty Latin America has been proactive on all these fronts and has done the right things to strengthen its competitive position everywhere. Being a converged player with the combination of the best fixed and best mobile network allows you to offer a better product to customers at a lower cost. This powerful combination enables market share gains and profitability as you are at a huge advantage to unconverged or poorly converged players. LLA is now fully converged in all markets, after M&A in Puerto Rico, Chile, and Costa Rica and years of fixed network upgrades in C&W. LLA remains one of the cheapest positions in our portfolio and trades at 8x our estimate of owner earnings. After it integrates recent acquisitions and completes accelerated network upgrades over the next two years, we expect LLA’s free cash flow generation to improve significantly.

Archives: Case Studies

Just prior to quarter-end, we successfully exited the Fund’s investment in Corporación Lindley.  Based in Lima, Lindley bottles, distributes, and markets soft drinks, fruit juices, water, and sports drinks in Peru.  The company has the exclusive rights to produce Coca-Cola products in the country, including Inca Kola, which is the top-selling carbonated drink with a 33% market share (Coca-Cola is a strong #2).

In late 2015, Arca Continental agreed to acquire a controlling interest in the business. This change in control dislodged other shares, and we started building our position in early 2016 and have added to our stake opportunistically on a couple of occasions since. Lindley was a unique opportunity for the Fund – one that we identified and were prepared to take advantage of because of our underwriting history with the company and our familiarity with Arca, the Coca-Cola system, and South American businesses generally. Given its limited float and concentrated ownership by the Lindley family originally and by Arca now, the company neither had nor has any sell-side analyst coverage in the U.S. or in Peru.

Before our initial investment, we had spent time on the ground in the country during a series of research trips, including meeting with Lindley’s management and surveying the bottler’s execution in the market.  Our findings suggested that Lindley was falling short – there were clear opportunities to improve execution and increase investment in certain parts of the business.  Given our history and familiarity with Arca, we understood that the Mexican-based bottler was the perfect partner to help address and solve these operational shortcomings in Peru.  Since taking over in late 2015, Arca has successfully completed a series of initiatives and instilled best practices at Lindley[1] to: (i) overhaul point of sale execution to drive revenue gains, and (ii) materially improve distribution across the Lindley network to enhance customer service and decrease delivery costs.  For example, Arca made long-term investments in coolers to increase sell-through overall and of higher-margin SKUs, expanded and improved Lindley’s returnable offerings to satisfy consumer demand, and enhanced operational efficiencies with capital investments in new production and distribution facilities.  The impact on absolute earnings and margins has been pronounced:

Figure 1. Annual Operating Profits (in Peruvian Sol) and Margins since Arca’s Purchase

The fundamentals of Lindley’s end markets were and are attractive.  According to the World Bank, Peru grew its GDP over 3% on average since 2015, which is a nice tailwind for personal consumption.  The company also benefited from increasing annual per capita consumption of ready-to-drink products.  Arca has been focused on increasing this per capita consumption from the low 200s of eight-ounce servings of Coke products to a level closer to its other markets.  For example, per capita consumption is over 900 in Arca’s Mexican territory, while per capita consumption in Chile and the U.S. is greater than 400.  We expect countries with per capita GDPs like Peru to steadily switch to ready-to-drink beverages over the next 20 years.  Despite some obstacles and with the benefit of these demographic tailwinds, Arca was able to improve the business substantially.

Thanks to the strong operational results and improvements in Lindley’s business, we achieved a successful outcome despite (i) a contraction in Lindley’s valuation multiple from 7.5x forward enterprise value-to-EBITDA[2] when we bought shares in early 2016 to 7.1x forward when we sold these shares, and (ii) a ~10% weakening of the Peruvian sol against the U.S. dollar.  Lindley generated these strong operational results in the face of a GDP growth slowdown, a sugar tax increase, and an implementation of nutrition labeling laws, which many analysts cite as enormous risks for Coca-Cola bottlers, but which we believe are readily manageable.  We remain constructive about Lindley’s future.  It may take until late 2021 or early 2022 for Lindley to fully bounce back from the pandemic, but the company is well-positioned to continue growing revenues and improving margins over the long term.  Lindley had also recently completed a major capital expenditure program to support this growth, which means that free cash flow will be greater than earnings in upcoming years.  With this cash flow, we expect management to continue paying down debt, and the business could begin distributing meaningful dividends in the intermediate term.

We sold our shares at a significant premium to Lindley’s then-prevailing market price.  While this sales price is below our estimate of per share intrinsic value, the current opportunity cost is high for this capital.  When we invested in Lindley in 2016, publicly listed emerging market Coca-Cola bottlers traded at an average of 10x trailing enterprise value-to-EBITDA, and they now trade at 6.5x trailing enterprise value-to-EBITDA (we bought our Lindley shares at a discount to peers and sold them at a premium).  All investment decisions require a careful weighing of competing alternatives, and it made sense to liquidate our investment in Lindley to take advantage of more attractively-priced assets that were available.  At the time of the exit from Lindley, Arca Continental and Coca-Cola Icecek were trading at 7x and 6x forward enterprise value-to-EBITDA.  As a result, we are actively redeploying Lindley’s sales proceeds into Arca and Coca-Cola Icecek shares, which both have larger margins of safety and are more liquid than Lindley.

[1] Arca has used the same playbook to improve margins substantially in its U.S. territories it acquired in 2018.  We expect Arca to use this playbook again in future acquisitions.

[2] We prefer multiples of operating earnings (EBIT) or owner earnings, but multiples of EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) are commonly used and often the only datapoints available for bottlers.

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Embonor produces and distributes Coca-Cola products.  Approximately half of the business serves parts of Chile outside of metro Santiago.  As previously highlighted, Embonor’s business in Chile grew strongly through the double shock of protests and COVID-19 shutdowns in the fourth quarter of last year and in the first quarter of this year.  Second quarter results will be weaker as the loss of jobs affects consumers’ purchasing power in Chile and Bolivia, but Embonor will still produce positive free cash flow in 2020.

Embonor sells for ten times the net income it earned over the last twelve months, which has been a challenging period economically.  Embonor will almost certainly be a bigger business in ten years through an increase in per capita consumption of its current portfolio with the growth of the middle class in Chile and (particularly) Bolivia, product innovations such as its Guallarauco fruit juice joint venture that grew 400% in the first quarter, and alcohol distribution deals like the recent contracts with Diageo and Capel.  The Vicuña Family, which owns a controlling stake in Embonor, seems to agree; family members bought additional shares in March above the current share price.

As further potential upside in the investment, we believe a merger between Embonor and the larger bottler Coca-Cola Andina will be compelling at some point for the controlling shareholders of both companies.  The companies already work closely on joint ventures, and a combined business would benefit from substantial costs savings, particularly in their adjacent regions in central Chile.  If such a combination were to happen around the historic valuations of similar mergers, Embonor shareholders would enjoy a 60%+ premium to its current price at the current earnings level.

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The first half of 2020 is a tale of two continents for Arca.  Mexico represents almost 50% of Arca’s profits.  Before COVID-19, Mexico was enduring anemic economic growth due to the business-deterring policies of President Andrés Manuel López Obrador, commonly known as “AMLO.”  Uncertainties about the seeming capriciousness of some of AMLO’s decisions have retarded foreign direct investment at the very time Mexico should be one of the primary beneficiaries of America’s trade war with China.  Mexico was slower to implement COVID-19 regulations, and Arca grew volumes slightly, revenues by 6%, and EBITDA by 9% during the first quarter.  The regulations in Mexico are not having a major impact on Arca’s ability to do business, and there is some evidence of pantry stocking.  Arca will likely benefit modestly from forced brewery closures in the country as consumers shift some consumption from beer to soft drinks.

Arca’s second biggest division, Coca-Cola Southwest Beverages, serves almost all of Texas and parts of Oklahoma, Arkansas, and New Mexico.  Governments in these areas have generally imposed less stringent COVID-19 regulations, and Arca grew volumes by 4%, sales by 10%, and EBITDA by 21% in the first quarter.  We expect second quarter volumes to be somewhat weaker, and there will be some pressure on profitability from consumers switching from single serve packaging to multipacks as they stay home more.  In the U.S., the difference in profitability between the two categories is much wider than other markets around the world.  Mitigating this switch to less profitable presentations is a sharp reduction in discounts and promotions.  Frequently Coca-Cola 12 packs (12-ounce cans) are discounted to “3 for $11” or “4 for $12”.  These promotions are rarer now.  Arca is selling 12 packs for $4.98-$5.49 each with a greatly reduced advertising budget.  Please let us know what prices you see in your local stores for fridge packs.  The U.S. represents 25% of Arca’s profitability.

While COVID-19 is having only a modest impact on Arca’s North American business, the situation is tougher in South America, where Arca serves customers in Peru[1], Ecuador, and northern Argentina.  Beginning in late March, Peru and Ecuador imposed some of the tightest restrictions on their populations in the free world.  While Coca-Cola sales are deemed an essential service, many outlets are unable to open, and curfews restrict the ability of Arca to supply these outlets.  For the first quarter, South American volumes were down 5%, sales fell 2%, and EBITDA shrank by 9%.  April and the beginning of May were worse.  However, restrictions eased beginning in mid-May, and selling conditions will improve as Arca is able to meet consumer demand.  South America represents 25% of Arca’s profitability.

Despite these short-term headwinds from COVID-19 in South America, Arca’s and Lindley’s businesses are well positioned for the economic downturn we are seeing across the world. The combination of their strong brands, extensive distribution networks, and income inelastic products suggest the performance of these businesses will be much better than the average company regardless of the severity of the economic downturn. Both companies will continue meeting the varied demands of millions of consumers and will grow volumes, revenues, and earnings as expanding middle classes in Mexico, Ecuador, and Peru increase consumption on the other side of this recession. Arca and Lindley currently trade at trailing price to owner earnings multiples of fifteen times and twelve times, respectively, which provide a margin of safety to their intrinsic value.  Both companies have recently finished large capital expenditure programs to increase capacity and extract operational efficiencies, which will increase near-term cash generation and allow for share repurchases, dividends, and value accretive M&A. It is worth noting that although Arca trades at a modest premium to other public Latin American Coca-Cola bottlers (Coca-Cola FEMSA, Coca-Cola Andina, and Coca-Cola Embonor), its peers trade at valuation multiples not seen since the bottom of the 08/09 Great Financial Crisis.  We think this reflects large short-term equity flows out of Latin America.  We continue to believe that Arca is the best Coke bottler in the world.

[1] Corporación Lindley, Arca’s majority-owned subsidiary in Peru, is also one of the Fund’s holdings.

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Backus is responsible for nearly 99% of the beer produced and sold in Peru.  From this dominant market position, Backus earns extremely high margins and returns on capital.  On March 16th, the Peruvian government deemed the production and distribution of alcohol as “non-essential,” which effectively prevented Backus from doing business.  Retailers could continue to sell the beer they had on hand, but stores ran out sometime in April.

Under the government’s return to normalcy plan, Backus will be able to restart its production in June.  Recently, Backus was able to resume distribution of its existing inventory, but that only bridged about nine days of typical consumption until production recommences.  Because of fermentation times, it takes about fourteen days for bottles to start rolling off productions lines after the brewery is restarted.  Management already has a plan in place to begin this production immediately under tight compliance with global work safety guidelines.   As would be expected given the severe government restrictions, second quarter revenues and profits will be down sharply.  Fortunately, we do expect beer sales will bounce back quickly given pent-up consumer demand and the relative strength of the Peruvian economy.  From a balance sheet perspective, Backus could not have been better positioned to weather this type of shutdown, even if it ends up being extended or even recurs.  The company has no debt, and, as result, has no liquidity issues.  Additionally, and perhaps most importantly, this lost quarter and any ramp it takes during the rest of 2020 to get back to full steam has little bearing on Backus’ long-term earnings power and, by extension, its intrinsic value.  Backus is a resilient, non-cyclical business whose moat is a function of its dominant brands/customer loyalty and superior distribution; its balance sheet gives the company tremendous staying power.  The business also benefits from Peru’s status as one of the healthiest economies in global emerging markets.  On the other side of this crisis, Backus should grow owner earnings at 5-10% annually for the foreseeable future.

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ABI’s manifesto is, “Bringing People Together for a Better World.”  Obviously, social distancing conflicts with this sentiment.  The beer industry has been the most affected of our industries due to social distancing habits and regulations.  In some markets, the ability to do business has been temporarily suspended through varying restrictions on production, distribution, and/or sales of alcohol.  In most places, beer sales have been displaced as on-premise options (e.g., bars and restaurants) have been closed or changed, but off-premise options like supermarkets have remained open.  This slide from ABI’s first quarter earnings presentation outlines this situation in various markets:

ABI is the world’s largest and most profitable brewer.  Most of ABI’s sales are made using its superior distribution network, an advantage that is particularly strong in emerging markets.  To understand both ABI’s long-run plans and the nearer-term impact of COVID-19, an investor should look at each market as a separate business.  In some markets, like Brazil and the United States, ABI is the market leader facing competitors seeking to steal some of its share of profits.  In other markets, ABI is the market leader but still gaining share from a strong number two, such as in Mexico.  In markets like Chile and Nigeria, ABI is stealing share and profitability from the current market leader.  While in places like China, ABI is growing fast as part of a rapidly expanding market.  The net result of these has been organic beer volume growth of 0.6%, 0.8%, and 0.8% in 2017, 2018, and 2019, respectively, despite a protracted recession in Brazil, ABI’s second biggest market.  After the impact of COVID-19, we expect volume growth to accelerate modestly, and profitability per hectoliter to expand through both premiumization and consumer acceptance of high-margin value offerings brewed from local grains.

China currently delivers about 9% and rising of ABI’s revenues.  In fact, more Budweiser is sold in China than in the United States.  The country’s hard lockdown in the first quarter had a severe impact on ABI’s business and offers some example of what the near future might hold for the overall business.  Volumes in China were down about 45% in the first quarter as the nightlife channel was closed for much of the time and consumer mobility was severely restricted.  Fortunately, the business is recovering.  By the end of April, 95% of stores, 85% of restaurants, and 25% of the nightlife channel had reopened.  April volumes were down 17% versus 2019 with business improving each week.

Since 2014, the Federal Reserve’s Trade Weighted U.S. Dollar Index (a measure of the strength of the U.S. dollar) has appreciated by more than 30%, including 7% appreciation so far in 2020.  Despite its diversified operations in more than 50 countries, ABI’s intrinsic value has been adversely impacted by the strength of the U.S. dollar relative to almost all other world currencies for three primary reasons:

  • While ABI currently earns 65% of its profits in emerging market currencies, the company reports results in S. dollars. In recent years ABI has grown its business in local currency largely in line with our expectations, but adverse currency movements against the U.S. dollar have exceeded organic growth.
  • About 40% of ABI’s cost of sales are denominated in U.S. dollars, even in markets that earn revenues in other currencies. As a result, a strengthening U.S. dollar shrinks gross margins, as these costs represent a higher percentage of revenues on a translational basis.
  • Approximately 60% of ABI’s debt is denominated in U.S. dollars. As foreign market results are translated into fewer U.S. dollars, dollar-denominated interest payments eat up a larger portion of operating earnings.  The result is lower net income margins.

In total and adjusted for acquisitions, ABI has reported cumulative revenue and operating earnings declines of 2% and 3%, respectively, from 2017 to 2019 due to cumulative negative FX headwinds of 7% and 9%. The global panic surrounding COVID-19 and the ensuing flight to safety has further strengthened the U.S. dollar, especially against currencies in large ABI profit-centers like Mexico, Colombia, Brazil, and South Africa.  If current FX rates persist for the remainder of the year, currency movements will be a 9% headwind to ABI’s 2020 reported revenues and a larger headwind to owner earnings.  While these headwinds are negative for ABI’s intrinsic value, two mitigants are worth mentioning.  First, ABI hedges its U.S. dollar-denominated costs on a rolling twelve-month basis, which eliminates operational risk to a strengthening dollar over this period. Second, a large portion of ABI’s cost structure is commodity-based (like diesel fuel and aluminum) which tends to be inversely correlated with the U.S. dollar. We have a general expectation (backed by market observations of inflation differentials) that over long periods of time the U.S. dollar will appreciate against a basket of currencies that match ABI’s markets.  The movement in the last few years, however, has been materially faster than the fundamentals imply and is well ahead of the long-term trend.  It is hard to know in real time how much of the currency move is an overshoot based on sentiment and how much is fundamental.  We do not expect the dollar to appreciate at the current rate in perpetuity.  Coca-Cola CEO James Quincey provided some interesting context during a July 2019 earnings call, “when you take a step back and you look at dollar cycles over the last 20 or 30 years, the current cycle is the longest one, it’s the longest one we’ve had […] and when you look at […] both the macro indicators over the next 12 to 24 months plus some […] of the political commentary that that has been in play around the world, it does point to us being at […] the high end of dollar strength.”

The U.S. dollar’s strength has a more noticeable effect on ABI’s results because ABI reports in dollars and do not hedge revenues (like Coca-Cola does, for example).  Except for our Peruvian businesses where the Peruvian sol has remained strong, all of our companies would benefit meaningfully if the U.S. dollar slowed its upward march.  The U.S. dollar’s purchasing power is very high in many of our countries, and market forces should begin to bring that to equilibrium.

We have stress-tested ABI’s balance sheet extensively against persistent volume drops larger than April’s decline of 32%, and ABI will survive even our most pessimistic forecasts.  ABI’s cash balance will exceed $20 billion when the sale of its Australia business is completed in June.  Its debt has an average interest rate of 4%, is termed out to an average of 15 years, and has no financial covenants.  In fact, ABI successfully accessed the debt markets in early April by issuing $11 billion in euro and U.S. dollar-denominated bonds that have maturities as long as 40 years.

Many of ABI’s costs are variable (barley, hops, labor, electricity, diesel, etc.) and fall with volume declines.  As a result, ABI will generate cash in 2020 even with the current large revenue declines.  While ABI should surpass 2019 levels of profitability in the next several years, the market currently values the business at eleven times the free cash flow it earned last year, eight times the free cash flow it earned in 2017, and nine times the dividends it paid in 2017.  We believe that is a wide discount to its intrinsic value.  We sold some shares in January at $80 per share and bought back a similar amount in March at $36 per share.  The Brazilian investors who founded 3G Capital and built ABI bought 1.1 million more shares last week at $42 per share.  Prospective returns are compelling from current price and valuation levels.  A broadly weakening U.S. dollar could create a lollapalooza result.


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Liberty Latin America (“Liberty LatAm”) connects and entertains people through broadband internet access, premium TV, mobile services, and undersea fiber.  Liberty LatAm provides these services in Chile, Panama, Puerto Rico, Costa Rica, and across the Caribbean.  Demand for its offerings has never been higher as customers are working from home, seeking ways to connect to friends and family digitally, and consuming more digital entertainment than ever.  Liberty LatAm’s fixed broadband network has seen a 40% increase in demand, for example.  Broadband access sales have risen with this increased demand.  Across its markets, first quarter revenues and operating cash flow were up 2% and 4%, respectively.

About 12% of Liberty LatAm’s business is selling access to its mobile network to customers via prepaid cards (i.e., prepaid mobile).  This part of the business is the most economically sensitive as wealthier customers typically pay for mobile access by the month under traditional plans (i.e., postpaid mobile).  Additionally, since many customers are at home, they are consuming data more through their broadband connections rather than over mobile towers, which further depresses prepaid mobile demand.  Liberty LatAm’s mobile business is primarily in the Caribbean where lost tourism will impact the consumer more than other Liberty LatAm regions where fixed connections are the primary offering.  Even though the biggest COVID-19 pinch for mobile is happening during the seasonally low summer period for Caribbean tourism (high season runs from mid-December to mid-April), we expect prepaid mobile revenues to decline substantially in 2020.

Liberty LatAm’s biggest competitor is financially troubled.  Digicel recently reorganized its debt again, as it converted some of its existing bonds to convertible notes to give the company breathing room on its interest payments.  Even with this restructuring, Digicel remains on life support and falling prepaid mobile revenues will add to its business challenges.  The company cannot afford to be aggressive in its pricing, nor can it fund capital expenditures to enhance its network.  We view Digicel’s distressed financial position as an advantage for Liberty LatAm.

Reflecting Liberty LatAm’s utility-like fixed network offering, we expect revenues and profitability to be only modestly affected by COVID-19.  Management has reacted prudently to the environment by reducing fixed operating costs and capital expenditures by $150 million this year to help ensure financial health and flexibility, and the company expects to generate free cash flow in 2020.  Appreciating the opportunity offered by the current stock price, Liberty LatAm’s board of directors initiated the company’s first share buyback program in late March.   With the stock price cut in half despite only a modest impact to the underlying business, the directors believed that allocating capital to buybacks at prevailing stock prices promised strong long-term returns for shareholders.  Demonstrating personal confidence in this corporate decision, insiders have purchased shares in the open market throughout the COVID-19 market selloff, with CEO Balan Nair buying shares as recently as May 13th.  Additionally, pending regulatory approval, Liberty LatAm will complete its purchase of AT&T’s Puerto Rico wireless business later this year, which will combine its dominant broadband offering on the island with AT&T’s dominant wireless business.  Liberty LatAm will be able to cross-sell a complete bundled solution to customers, reduce costs, and shrink customer churn in a deal that will be immediately cash flow accretive to Liberty LatAm’s shareholders.  This strategic combination is an important step in management’s plan to build a scale telecom provider in the region.  Given the strength of Liberty LatAm’s core business and the organic and M&A/consolidation growth opportunities potentially on the horizon, we believe the business is undervalued at seven times its owner earnings.  We bought additional shares in mid-March at even lower prices.

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In October 2019, two weeks after we met with Embonor senior management team in both Santiago, Chile, and Santa Cruz, Bolivia, political and social turmoil broke out in both countries.  The protests in Chile had a particularly large impact on the Chilean stock market and currency in the fourth quarter, which combined to materially impact the U.S. dollar value of the Fund stake in Embonor.  Subsequently, we have talked with Embonor management team and extensively with our other contacts in Chile to assess the impact on near-term operational results, although Embonor territory does not include Santiago where protests have been most disruptive.  Our current information indicates the impact might be smaller than the market is expecting.  Coca-Cola Andina, the other Chilean bottler whose territory does include Santiago, recently reported that the protests have had only a minimal effect on its business so far.  In fact, Andina Chilean volume grew 1.9% in the fourth quarter.  We do expect GDP growth in Chile to be modest next year, which will dampen Embonor growth in 2020.

The protests in Bolivia were a bit different in nature, as they were focused on the future of a politician, rather than broader Chilean concerns about income inequality.  In fact, contrary to many countries around the world, Bolivia middle class is expanding rapidly.  From 2013 to 2018, the number of Bolivian households with annual incomes over US$20,000 has grown 17% annually, helped by “pragmatic socialist” policies of Bolivia ex-President Evo Morales.  However, many feared his re-election might lead to a more autocratic administration as the election results were perceived to be a result of voter fraud.  Ultimately, Bolivian protesters successfully removed Morales from power, although there were counter-protests in his favor.  His resignation has led to some volatility but also a more business-friendly, capitalist environment.  The short-term risk of a devaluation of the Bolivian currency has probably risen, but the opening up of the Bolivian economy should be a positive in the long run.

In October 2019, we met with CEO Cristian Hohlberg and CFO Anton Szafronov in Santiago for nearly four hours.  Cristian only meets with a handful of outside investors each year.  Like Backus and Lindley, the company publishes results only in Spanish.  In companies like these, we have observed that macroeconomic factors and investment flows often have a bigger influence on the short-term stock price than underlying fundamentals.  This reality produces a result like this year, where the stock fell 29% in the face of positive operational results for 2019, expected stable earnings through the end of 2020, and anticipated healthier growth thereafter.

Through the third quarter of 2019, Embonor revenues were up 11%, and operating income rose 16%.  Chilean results have been strong across product categories this year, and operations in the country are just starting to benefit from a recent Embonor agreement to distribute Diageo products and Capel pisco (Capel has 45% market share in pisco, and pisco accounts for one-third of all spirits consumption in the country).  This alcoholic category tailwind should last for another 2 years or so.  Embonor might soon start distributing for Diageo in Bolivia, as well.  Bolivian results have not been as positive in 2019, even as Embonor has invested in growing production capacity in the country.  Embonor continues to enjoy significant competitive advantages from dominant brands and superior distribution, but the company’s pricing power has been limited because local B-brand competitors have not raised prices in three years.  Management has made the rational decision to keep raising prices, albeit at a slower pace, which has resulted in a loss of around two percent of market share over this period.  The fundamentals in Bolivia remain interesting and consumption will grow over time as annual incomes rise in the country, especially as Embonor introduces a broader array of ready-to-drink products such as premium bottled water and fruit juices.  Additionally, and in accordance with growing per capita incomes, management is focused on increasing single-serve consumption in the country through more cooler investments (the #1 factor in ready-to-drink consumption is cooler penetration).  This focus should yield growth, although those gains will be muted as long as competitors hold down pricing.

We did decrease the position by about 20% in the middle of the year based on our moderated growth expectations (we sold at around US$2.25 per share, and the stock traded at US$1.73 at year-end).  Embonor cash flows will remain resilient and predictable, but we felt the position size at the time was too large for the future returns we expected given our revised projections for Bolivia.

Archives: Case Studies

Lindley is a business largely unknown to and overlooked by the broader market; like Backus, no sell-side analysts publish reports on the company.  On the other hand, we have been following the business closely for about a decade, including meeting with the company in Lima on several different occasions and as recently as September 2019.  We have long recognized that Lindley Peruvian markets and brand portfolio, including its top-selling Inca Kola, were and are compelling assets, but we were underwhelmed by the company’s operational effectiveness a decade ago.  While we never saw the hoped-for improvement from the legacy management team, we were prepared to act when Arca Continental purchased a controlling stake in the company in 2015.  Thanks to our long history and familiarity with Arca, we trusted that this new controlling shareholder would institute operational best practices that were missing at Lindley and would unlock full potential of the business.

Improvements began immediately under Arca.  Management’s long-term investments in point-of-sale improvements (like coolers) and operational efficiencies (new facilities and more returnable bottles) are paying off so far in 2019.  Through the first nine months of the year, revenues grew 6% and operating income rose 23%.  Operating income margins have expanded nearly 50% since Arca took control of Lindley.  The most significant Lindley capital expenditures, such as the plant in Pucusana that we visited in September, are now complete.  In combination, these dynamics have sharply grown the company’s free cash flows, and we expect increasing dividends to follow.

Peru is experiencing some political machinations and gridlock at the national level, which is hampering GDP growth and, by extension, ready-to-drink volume growth.  The country’s carbonated beverages excise tax changed in mid-2019 benefiting low calorie/reformulated beverages with lower levels of sugar, which will help Lindley on a relative basis as the company has intelligently increased its offerings in these categories over the years.  Low/no-calorie beverages now constitute more than one-third of total revenues, which is one of the highest levels in the world.

Lindley currently trades at a 35% discount to the price Arca paid in 2018 for The Coca-Cola Company remaining ownership stake.  This large gap between the prices of voting and non-voting shares is irrational, and this discount will inevitably shrink.  Most importantly, the price we would require to sell our stake continues to increase as the intrinsic value of the business grows.  Our biggest lament is that we have not been able to buy a larger stake in the business due to Lindley’s closely-held ownership and limited liquidity.

Archives: Case Studies

Thanks to Backus’ lack of an investor relations team, its absence from passive index funds, and its Spanish-only reporting, no sell-side analysts publish research on the company.  Backus is a hidden gem that has the deepest moat of any business we own — as reflected in its 99% market share in Peru.  When we met with a potential competitor in South America in October, its investor relations team told us that they considered it “impossible” to compete with Backus in Peru.  Our October in-market site visits in Lima reinforced our understanding of the company’s competitive position and the dominance of Backus offerings at the point-of-sale.  Both revenue and profit grew in excess of 10% during the first half of the year, with a mid-year excise tax increase drying up this growth in the third quarter (Backus excise taxes paid per unit volume increased by around 33%).  This incremental tax will probably limit Backus revenue growth to the low-single digits for a few quarters.  Over the longer term, we do expect the company to grow revenues at mid- to high-single digits thanks to premiumization opportunities (price-mix improvements) and consumers who have increasing amounts of disposable income (volume growth).

The stock is more expensive than when we first built our stake in 2018 at a compelling mid-teen price-to-earnings multiple, but we remain comfortable with the position’s size.  Our downside is well-protected by the company’s entrenched competitive position, the recession-resistant nature of beer, Backus’ net cash balance sheet, and the company’s capital allocation policy of paying out a majority of its free cash flow in dividends to help its parent company service debt.  We hope to be long-term owners of this wonderful business.

Archives: Case Studies

We traveled all over the world in 2019 visiting Anheuser-Busch InBev (ABI) markets, including various stops in Africa, Europe, North America, and South America.  These visits build our understanding of ABI’s overall point-of-sale execution and positioning relative to key competitors in each market.  While not perfect, we observed that ABI’s go-to-market approach was working well, which was reflected in its operating results.  In the first half of 2019, ABI enjoyed its best volume performance in the past 5 years.  The business is experiencing healthy volume, revenue, and market share growth in Mexico, Western Europe, Colombia, South Africa, and several other African countries.  Budweiser sponsorship deals with the English Premier League and Spanish La Liga underscore the company’s focus on premiumization to drive revenue and profit growth well in excess of volume growth.  3Q19 results were not as positive, with volumes and revenue coming in below expectations (although revenue still grew).  The most pronounced third quarter weakness was in China, which was attributable to the Chinese government’s crackdown on night clubs/KTVs and the phasing of summer activation shipments into 2Q19.  While this pressure in ABI’s Asian business likely continued through the end of the year, we believe both issues are passing phenomena and that the long-term growth picture remains intact in China.  Budweiser is the number one premium beer in China, and premium penetration in the country is only about one-third of developed market levels.

The U.S. business is stable.  The craft market is increasingly saturated, and the threat of continued market share losses for ABI is fading.  We spent a couple of days at the craft beer convention in Denver, which improved our understanding of the category and the pressures facing these sub-scale brewers.  We also met with Molson Coors while in Denver.  This competitor to ABI is struggling with falling market share, revenues, and profits.  We expect its business to decline further in the near to medium term.  On the other hand, Michelob Ultra, with its attractive gross margin profile, continues to grow quickly for ABI.  In fact, Michelob Ultra has surpassed Budweiser and Miller Lite in volume.  The hard seltzer category has eaten into beer, wine, and spirits consumption, and ABI is mounting challenges to White Claw and Truly with Bud Light and Natural Light Seltzer launches.  We are closely watching share gains and competitive responses in this exploding category, and ABI still needs to demonstrate it can stem volume market share losses.  However, revenues and margins remain steady, and we continue to expect the U.S. to be a source of re-investable profits for ABI’s emerging market businesses.  We are also interested in opportunities for ABI and the Coke bottling system to introduce the hard seltzer category outside of the U.S.

We remain pleased with management’s capital allocation decisions.  The combination of the pending sale of the Australian business and the successful IPO of Budweiser APAC (ABI’s Asia business) at rich valuations relative to ABI’s share price was a good result for shareholders.  Management is using the proceeds to retire debt, bringing ABI’s net debt-to-EBITDA ratio below 4x, about a year ahead of previous guidance.  We expect this ratio to fall below 3x by the end of 2021, absent any major acquisitions.  We believed at the time that the market’s punishment of ABI stock price in 4Q18 over leverage concerns was unfounded, which has proven true.

After the sale of its Australian franchise, ABI will be a 70% emerging market consumer business by volume.  This profile is attractive for long-term growth, although the nature of these end-markets will create some bumpiness in quarterly results.  ABI currently offers a 7% owner earnings yield, and we continue to expect these owner earnings to grow in the mid- to high-single digits annually over the next decade thanks to secular volume expansion (led by emerging markets), premiumization, pricing power, cost rationalization, and investments in breweries and route-to-market assets that promise returns on invested capital above 20%.  With less leverage at ABI and APAC equity currency, management will also be able to selectively pursue M&A opportunities.  Trading at a wide discount to its intrinsic value, ABI is a high-quality, well-run business that will be substantially bigger and more profitable in a decade.

Archives: Case Studies

We spent significant time on the ground in Liberty Latin America (“Liberty LatAm”) markets in 2019 and met with several local management teams, including in Chile (Liberty LatAm’s #1 market) and Panama (#2 market).  We have a visit to Puerto Rico (#3 market) planned for March, when we will have an opportunity to evaluate the company’s recently announced acquisition of the largest and most advanced mobile network on the island.  Because AT&T was pressured to sell this network by an activist shareholder, Liberty LatAm was able to purchase the business at an attractive valuation that should be accretive to free cash flow.  During the year, we also spoke with a series of competitors, suppliers, and global peers.  These calls allow us both to verify what we learned on the ground from Liberty LatAm’s managers and to better understand the competitive ambitions of these other players.

We assess potential competitive threats across Liberty LatAm’s markets in several important ways.  First, we look closely for any changes in network overbuild and overlap from one or multiple competitors.  Second, we independently track the quality of Liberty LatAm’s and competitors’ networks in each market through speed test aggregation.  We want to know if Liberty LatAm is improving the quality of its offerings on an absolute and relative basis from the consumer’s perspective.  Third, we independently record the offerings and packages in Liberty LatAm’s larger markets for both Liberty LatAm and its competitors.  This effort helps us follow price and service changes in real-time to consider who has the best value proposition and where margin pressures may be lessening or increasing.  In parallel, we try to look forward to competitive considerations that are developing elsewhere.  To that end, we follow Liberty LatAm’s developed market peers to assess business trends before they potentially migrate into Liberty LatAm’s markets.  And we follow the changes in technology that could be either threats or boosts to the industry.  All of these factors are important to reliably projecting Liberty LatAm’s long-term cash flows.

We spoke with management on multiple occasions during the year on timely corporate finance topics, and we had an extended meeting with Liberty LatAm’s CEO Balan Nair and CFO Chris Noyes at their Denver offices about strategic and operational considerations.  They are optimistic about their ability to achieve scale across the company’s markets, and we believe they have many places to deploy cash at high internal rates of return for years to come.  Liberty LatAm is focused on long-term cash generation at the expense of near-term GAAP earnings, which we support.  In fact, this near-term softness in reported earnings provided the opportunity to build the position at compelling prices.

Through the first nine months of 2019, Liberty LatAm grew organic revenues by 2% and operating cash flow by 6%.  Liberty LatAm’s fixed network (broadband) remains the company’s most compelling business due to its size and natural monopoly characteristics.  Revenues and margins are defendable, and Liberty LatAm has a long runway to build out its fixed network in Chile, Central America, and the Caribbean at incremental returns in excess of 20%.  The mobile business is less attractive generally, although it still produces sufficient returns in markets where the competitive profile is reasonable.  That is not currently the case in Panama, a four-player mobile market that has been a meaningful drag on Liberty LatAm’s overall results in recent years.  Given the significant financial distress of the fourth player (Digicel) and the government’s recent lift of its ban on consolidation, we expect there will be at least one — if not two — fewer players in this market soon.  This move would materially improve profitability in Liberty LatAm’s #2 market.  Elsewhere in Central America and the Caribbean, Liberty LatAm is instituting best practices, leveraging the scale of the Liberty complex to improve its products (set-top boxes, modems/Wi-Fi routers, cheaper procurement), and rationalizing costs.  This work should reveal itself in the financial results over the next several years.