Based in Lima, Corporación Lindley SA bottles, distributes, and markets soft drinks, fruit juices, water, sports drinks, and concentrate 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). We have followed the business for some time, and since the fall of 2014 we have visited Peru three times to meet management and to survey execution at the point of sale. This research suggested that execution could be improved and that certain parts of the business needed more investment. The underlying fundamentals of the company’s end markets are attractive, however. In Peru, annual per capita consumption of Coke products is only 220 eight ounce servings, which is smaller than the 250 in poorer Bolivia. As a frame of reference, per capita consumption is 720 in Arca Continental’s Mexican territory, while per capita consumption in Chile and the U.S. is greater than 400. We expect countries with per capita GDPs similar to Peru to steadily switch to ready-to-drink products over the next 20 years. We were intrigued by the business given these attractive demographic tailwinds, but we were hesitant to invest given the company’s operational challenges and capital needs.
Fortunately, in September 2015, Arca Continental agreed to acquire a controlling interest in the business. Controlling distribution territories in Mexico, Argentina, and Ecuador, Arca is one of the Fund’s longest and best-performing holdings, and in our opinion, it is one of the best Coke bottlers in the world. Armed with investment capital, Arca’s team is uniquely positioned to build and execute a plan to seize all of the operational opportunities that we discovered at Lindley. Their initial plan for improving the business includes a number of initiatives:
- Overhaul point of sale execution to drive revenue gains:
- Improve display/presentation and product mix, while also introducing additional products that will be new to the Peruvian market;
- Expand single serve sales, which is more profitable than selling large, familial sizes and is only 40% of current company volume (Mexico has 60%+ single serve);
- Refine price segmentation, including a better packaging mix;
- Introduce route to market analysis to better segment customers; and
- Increase cooler penetration in stores (Peru lags many markets).
- Materially improve distribution across the Lindley network to improve customer service and decrease delivery costs:
- Re-think distribution to mom & pop stores, with an opportunity to bring in-house the 85% of this effort that is currently outsourced to a 3rd party (controlled distribution is more consistent and more responsive);
- Build a vending machine network; and
- Reconfigure company-wide distribution given the new state-of-the-art plant that is now on-line south of Lima and the opportunity to bring drinks from Arca plants in Ecuador to Lindley’s customers in Northern Peru.
- Remove/reduce costs from Lindley’s cost structure by using Arca’s economies of scale on a number of fronts, including greater purchasing power on raw materials, lower insurance costs, and cheaper software usage and implementation.
This improvement plan has been in motion for the last six months or more. We visited with Arca’s team in Ecuador, Peru, and Mexico earlier this year, and Arca’s first quarter report shows that the company is already making progress in Peru. Through these aforementioned efforts, we believe that Arca will be able to grow Lindley’s revenues, profit margins, and cash flow at growth rates well above average over the next five years. Additionally, management has a proven track record of these types of gains as it has improved operations and grown profits substantially in the years following all of its previous acquisitions. From a valuation perspective, the per share price we paid for the Fund’s stake in the business represents an enterprise value of around 7.5x 2016 EBITDA, which is unadjusted for the profitability gains that we expect under Arca’s ownership/control. Latin American bottlers have typically traded at 9.5x EBITDA.
We are optimistic about the prospects of this new investment. We believe that, in Arca, we have an ideal partner to maximize the potential of an already strong and growing business in a country that will increase its consumption of Coca-Cola and related products over the coming decades. We hope to be long-term investors in Lindley.
This post has been excerpted from a Cook & Bynum Capital Management Letter to Partners.
This document shall not constitute an offer to sell, or the solicitation of any offer to buy, any interests described herein, which may only be made at the time a qualified offeree receives a confidential private offering memorandum describing the offering and related risk factors. Past performance is no guarantee of future results.