Spring came and with it the tobacco world became even more concentrated. On 14 March 2005, Philip Morris International announced the purchase of Indonesian tobacco company PT HM Sampoerna. A move that was surprising in more than one way.
Since mid March, one cannot help imagining the Marlboro man, being enveloped not only in his usual scent of horse and campfire smoke but also by the spicy and somewhat exotic smell of cloves. Philip Morris International (PMI), together with Philip Morris USA part of Altria Group and the world’s leading manufacturer of cigarettes, has announced the acquisition of PT Hanjaya Mandala Sampoerna, Indonesia’s third largest tobacco company behind Gudang Garam and Djarum.
PMI said it had entered into agreements to acquire a 40 per cent stake in Sampoerna from a number of Sampoerna’s principal shareholders, and proceeded to make a public tender offer for 100 per cent of the remaining shares at a price per share of Rp 10,600 (US$ 1.13 per share), a premium of 20 per cent over the price of Rp 8,850 (US$ 0.95) on Thursday, 10 March 2005.
Assuming all shares are tendered, the transaction values Sampoerna at about Rp 48 trillion (US$ 5.2 billion) including net debt of around Rp 1.5 trillion (US$ 160 million). PMI said that it would pay cash for all shares tendered and expects the transaction, when completed, to accrete modestly in 2005 to the diluted earnings per share of Altria Group. The transaction will be debt financed through a bank credit facility arranged for PMI and its subsidiaries. The tender offer is expected to be completed within about 90 days and is subject to customary regulatory review.
Surabaya-based Sampoerna, which mainly manufactures kreteks, the cigarettes made with tobacco and cloves typical of Indonesia, had an estimated domestic tobacco volume of 41 billion units in 2004, generating net revenues of around Rp 9.0 trillion (US$ 1.0 billion). Its operating income was estimated at about Rp 3.1 trillion (US$ 360 million) in 2004, up 19.5 per cent against the previous year. Sampoerna has strong kretek cigarette brands, including Dji Sam Soe and A Mild in its premium portfolio and A Hijau in the medium price segment, and held a 19.4 per cent share of the market in 2004. Its shares are listed in Indonesia on the Jakarta and Surabaya exchanges. In 2004, Sampoerna exported 6 billion sticks to Malaysia.
Apart from manufacturing kreteks, the company also has a printing business for cigarette papers, a plastic packaging business, retail stores where it sells its cigarettes and a wholesale business.
Kreteks represent 92 per cent of the total Indonesian cigarette market, which is estimated at 210 billion units annually. Among world tobacco markets, Indonesia with 141 million smokers ranks fifth after China, the United States, Japan and Russia. According to Manny Goldman, a US consumer products industry consultant, the country is a prime growth target for Philip Morris International. More than 62 per cent of Indonesian men smoked in 2001, up from 53 per cent in 1995, according to the latest official data. Analysts have projected that the number of smokers is likely to grow by at least 5 per cent this year.
The deal came as a surprise in two respects. First, Philip Morris, until now exclusively a producer of white cigarettes, will enter a market segment that is completely new to the company. PMI has been present in Indonesia for more than twenty years. Currently, PMI holds – primarily through sales of Marlboro – about 50 per cent of Indonesia’s white cigarette market, which accounts for under 9 per cent of the country’s total tobacco market.
“The decision to acquire Sampoerna is in part attributable to limited smokers in the developed countries and rising production costs due to higher excise tariffs imposed on the product,” an analyst with BNI securities said.
The second surprise was that Sampoerna actually was not really for sale. The company is a family business, which was founded in 1913 by Liem Seng Tee in Indonesia’s second largest city, Surabaya. According to PMI estimates, Sampoerna’s market capitalisation was about Rp 35.7 trillion (US$ 3.8 billion) as of the end of February 2005. Sampoerna operates three major cigarette manufacturing facilities in Indonesia. Its main facility is located in Pandaan, a central location between Surabaya and Malang in East Java. The other two are in Surabaya and Malang. For 2004, the company expects to generate net revenues of Rp 9.0 trillion (US$ 1.0 billion) and achieve an operating income of Rp 3.1 trillion (US$ 360 million) and a unit volume of 41 billion.
The vendor of the controlling stake is Putera Sampoerna and his family, descendants of the company’s founder. Mr Sampoerna, 58, built up Sampoerna and turned it into the highly profitable business it is today. To sell out of its main business, especially a successful one, is highly unusual for an Asian family. In an interview, Mr Sampoerna commented on his decision, saying that the sale was the right thing to do because PMI was positioned to foster growth of Sampoerna in terms of sales of kreteks. Although Sampoerna for the past year had recorded the highest revenue in the past ten years, he stated, the cigarette business would get tougher in Indonesia. In order to sustain the growth, Sampoerna would have to venture overseas. The Sampoerna family, he said, was now looking for re-investments in other areas, possibly agriculture and infrastructure. Through the integration period and beyond Mr Sampoerna has agreed to serve as special adviser to the board of the tobacco company.
Market opens up again
Market observers argued that the Indonesian purchase was a huge slap in the face for British American Tobacco, Philip Morris’s arch rival, which is the industry leader in Asia and has been present in Indonesia since 1917; the company is listed on the Jakarta Stock Exchange. Its market share in the country, however, is still negligible, reportedly posting a loss of US$ 2 million in 2004. Besides, Philip Morris’ deal comes after BAT’s planned joint venture in China was blocked by the Chinese tobacco monopoly in January.
Tobacco analysts welcomed the Sampoerna acquisition. Michael Smith of JP Morgan called it a strong signal about PMI’s competitive intentions in Asia and a sign that the company was becoming more aggressive in the region, with a clear long-term focus on China, where it was said to have started a yet-to-be-announced joint venture last September with the Longyan cigarette factory in southeastern Fujian province to make Marlboros for the domestic market. Bonnie Herzog of Citigroup also finds more pros than cons.
All three segments of the industry, hand-made and machine-made kreteks as well as white cigarettes, she argues, are growing in a market whose growth averaged 4 per cent annually over the past 25 years. Besides, Sampoerna owns Alfamart, a chain of around 1,000 mini-marts, that helps leverage brands and could be an opportunity for Marlboro, as a white cigarette or even a kretek cigarette. The acquisition will also make PMI a stronger stand-alone company once Altria Group breaks up in three parts, Mrs Herzog points out.
PMI’s management, she says, expects to see more synergies in the way of revenues rather than cost savings, which are estimated at 3 to 4 per cent of revenues. Top-line synergies must be attractive, she argues, and are probably the driving force behind the acquisition from PMI’s viewpoint.
Sampoerna’s kreteks are considered to be high end, whereas its competitors Gudang Garam and Djarum are mainly active in the middle and lower-end market segment. According to Matteo Pellegrini, Philip Morris Asia-Pacific president, PMI plans to expand the market share of its latest acquisition to all market segments. They will thus make the company a tough challenger for Gudang Garam, especially if they also engage in the low-end market, the BNI Securities analyst argued, while it will be difficult for Djarum and Gudang Garam to topple Sampoerna in the middle and upper-end market, which are more sophisticated and are expected to grow as the country’s economy rises and consumers increasingly trade up to more expensive brands.
The acquisition of Sampoerna is, together with other recent deals, for example in the banking and telecom sectors, also a positive sign for the country, which for years had largely been a no-go zone for foreign investors. Having boomed in the 1990s, Indonesia’s economy contracted by 13 per cent in 1998 in the Asian crisis. Terrorism, such as the 2002 Bali discotheque bombing, and widespread corruption contributed to the country’s bad reputation. Now foreign investors are returning, profiting from Indonesia’s policy which allows them to buy about 100 per cent in every sector of the economy.
With its latest purchase, Philip Morris has entered a sector which is of great socio-economic importance. Kreteks are a manual business, and keeping the kretek industry unmechanised is a part of government policy to protect jobs. Sampoerna alone employs 20,000 people to hand-roll its cigarettes, rationalisation efforts will be limited – and that is only one aspect that makes the future development of PMI’s clove encounter interesting to observe.