(June 5): In the 1988 Seoul Olympics, Canadian sprinter Ben Johnson smashed the world record for the 100m dash. He leapt to the finish line in just 9.79 seconds, a timing that was then scarcely believable. His competitors included Olympic champions Carl Lewis and Linford Christie, who were blown away.
Johnson was feted as a god-like figure. The photo of his muscular frame crossing the finishing line was on every front page. He told reporters that his record would last 100 years.
However, within days of the race, joy turned to dismay. To the shock of his supporters, Johnson had failed a drugs test. A performance-enhancing substance called stanozolol was found in his urine. Stanozolol helps athletes get stronger and build muscle mass.
Johnson was stripped of his medal and record. He has lived in disgrace since.
In the pharmaceutical industry, Johnson’s rise and fall was mirrored by Valeant Pharmaceuticals. The Canadian company, which was valued at US$86 billion at its peak, was led by Michael Pearson, a former McKinsey consultant.
Like Johnson, Pearson was ahead of his peers in the industry. Valeant’s stock rose 40-fold during Pearson’s eight-year tenure that had begun in 2008. Its operating profits grew 10-fold.
Pearson expanded Valeant by acquiring smaller pharmaceutical companies and cutting costs. The deals were financed by debt.
In August 2005, Valeant’s frailties were exposed. It was revealed that Valeant had improper relationships with a mail-order drug company called Philidor. Philidor was pricing its drugs well beyond the means of consumers. This led to investors zooming in on Valeant’s vulnerabilities.
Valeant was a blatant example of a roll-up company — a company that creates growth by acquisition. Growth by debt-financed acquisition was Valeant’s drug. Like stanozolol did for Johnson, it made Valeant appear invincible.
Investing in a roll-up oriented company is risky. The more successful an acquisition, the higher the market’s expectations of the next one. There is an insatiable need to feed the beast.
Once an acquisition disappoints, the precipice falls. Valeant had US$30 billion in debt by 2016, which was three times its sales — a dangerous position. The stock lost 91% of its value in the year prior to March 2016. Pearson’s career ended in disgrace.
Today, there are two roll-up companies that are feted, although they carry serious risks. They both produce beverages that provide comfort — beer and coffee.
ABInBev could lay claim to be the Valeant of beer. The multinational company, which listed its Asian arm (Budweiser APAC) in Hong Kong last year, produces more than 50 beer brands. These include Budweiser, Stella Artois and Corona. One out of every four beers in the world is produced by ABInBev.
It seems to have an ominous similarity to Valeant Pharmaceuticals. Its growth strategy is built on acquiring rivals. In 2017, ABInBev bought its main rival SABMiller for US$103 billion to cement its grip on the beer market.
It then raised the price of beer. Budweiser APAC’s growth is dependent on premiumisation — the practice of introducing higher-priced beers. Valeant was bent on increasing the price of its drugs after acquiring smaller rivals.
Beer consumption is flat in rich countries and falling in emerging markets. Young people are spending more time in gyms than in bars in the West. If the acquisitions are taken out of consideration, ABInBev has not raised beer volumes in the past decade.
Last week, the drowsy IPO market received a shot of espresso. JDE Peet, the world’s second-largest consumer coffee company, listed in Amsterdam and raised US$2.5 billion ($3.5 billion). This is the first major listing in the Covid-19 era.
However, investors should gulp down a stiff cup of coffee rather than a glass of champagne. JDE Peet’s growth seems to be driven by deals and not organic growth. It could be the roll-up of coffee.
JDE Peet controls brands such as Douwe Egberts, Kenco and Peet’s Coffee. It has acquired famous local brands such as Old Town and Super Group. Its real Ebitda growth in FY17–19 is more modest than the headline CAGR of 10%. That may not be growth levels that deserve 17x EV/Ebitda in the middle of a pandemic.
As the Seoul Games have shown, those who win the race may not retain the title.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer (Exotix Capital)
