Successful Exit of Lindley Investment
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 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 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.
 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.
 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.