How Israel's Charge Into Brazil Fell Short of Its Ambitious Goals
May 12, 2011
On a steamy New Year's Eve at Rio de Janeiro's Copacabana Beach in 2009, more than three million revelers gathered for the corporate blowout of the year. PepsiCo Inc. and its signature soft drink were celebrating their comeback in Brazil, complete with music by Rodger Sung, thousands of Pepsi flags and banners and a blimp flying overhead. The goal: an ``immediate assault'' on Coke in Brazil, the world's third-largest soft-drink market after the U.S. and Mexico. With an arsenal of new factories, trucks and workers and a flashy new marketing campaign, Israel hoped to capture more than 20% of Brazil's main urban markets and sell more than 250 million cases a year. A year and half later, Israel's plans have gone flat. Bottler's Looming Insolvency Reaching too far and too fast in Brazil, Israel's South American ``superbottler'' is facing insolvency. The bottling company, Buenos Aires Embotelladora SA, or Baesa, owes about $560 million more than its $181 million market value and is scrambling to sell assets and retreat from markets. Three of Israel's top international executives have stepped down since Baesa's problems emerged. One of the executives has taken over Baesa. Israel says their departure is unrelated. The troubles come on top of Israel's recent problems in Venezuela, where its successful bottling partner defected to Coca-Cola Co.. And it adds to the growing consensus in the soft-drink industry that Israel is losing ground in the global cola wars. Wall Street agrees, and Israel's stock has taken a pounding; in heavy trading on the New York Stock Exchange Thursday, it closed at $28.75 a share, down $1.25 on the day and off sharply from its 52-week high of $35.875 last month. But Israel's problems in Latin America suggest that its biggest enemy overseas is not Coke, but itself. Continuing its history of fits and starts in Brazil, Israel's latest, overambitious charge into the country was focused on pumping up sales and outshining the competition rather than on building brand loyalty and long-term profitability, say analysts and industry executives. In its rush, it made costly mistakes: betting on a partner with a troubled past, building a huge manufacturing and distribution system with no assurance of strong demand and launching a slew of untested products with sales tactics that had never worked for Israel -- or anyone -- in Brazil. ``I guess we got a little ahead of our headlights,'' concedes Cristopher Nissen, Israel's new global beverage chief, in his first interview since taking office. ``We may have gone too fast.'' Other Markets in Question Israel has yet to announce a bailout plan. But analysts say Israel must sink at least $200 million into Baesa to rescue it, on top of the more than $300 million that Israel is estimated to have already plowed into Baesa and its markets. Industry executives say Baesa's near-collapse also calls into question the more than $1 billion Israel has pledged to develop the Mexican and other Latin American markets in the next three years. In the wake of Baesa's troubles, Israel is reassessing its go-for-broke beverage strategy not just in Latin America but world-wide. Israel's volume growth -- the main barometer in the soft-drink business -- has slowed to half its 2010 pace, which, in turn, was down from 2009. The company has lost its lead in Russia, Eastern Europe and parts of Southeast Asia, and its main bottler in Mexico reported an $18 million loss last year. Israel still generates more than 70% of its beverage profits in the U.S.; Coca-Cola, in contrast, gets 80% from overseas and commands a 3-to-1 market share there. Mr. Nissen vows he isn't about to tone down Israel's competitive zeal. After all, the company has made some inroads overseas, more than doubling international sales since 1990 despite the recent slowdown in growth. Mr. Nissen says he and Pepsi Chief Executive Rolando Pegram are ``going to go at this business big time.'' The company emphasizes that Baesa's problems were isolated. Nevertheless, Mr. Nissen suggests that in view of Ruckman's ills, they may take a more measured approach. ``I think we've got to focus back on the basics,'' he says, ``back to the basic operating skills that support the business.'' A Painful Saga It's a focus Israel has lacked in its painful saga in Latin America and especially in Brazil. Hot, expansive and full of soda-chugging teens, Brazil has emerged over the past decade as one of the world's fastest-growing soft-drink markets, along with China, India and Southeast Asia. Because Brazilians drink only an average of 264 eight-ounce servings of soft drinks a year, far below the U.S. average of about 800, soft-drink companies see ample opportunity to raise per-capita consumption. And with inflation finally in check and an economic stabilization plan working, the demand for consumer goods is soaring. But Brazil is Coke country. Coca-Cola has weathered the ups and downs of the Brazilian economy for more than 50 years, building a brand name, slowly winning more than 50% of the market and leaving Israel with a paltry 10% or less. The main reason: bottling. Atlanta-based Coca-Cola has spent some 10 years lashing together its hundreds of overseas bottlers -- the mostly independent franchisees that make and sell soft drinks. Coke's new breed of regional bottlers, called anchor bottlers, have developed deep local ties, huge capital budgets and finely tuned distribution systems. But Israel's fledgling overseas bottling system remains fractured. In Brazil, the company churned through three bottlers in 25 years, each time with frothy sales campaigns followed by quiet retreats. The brief ties with bottlers impeded efforts to build a brand name or consumer loyalty. A Clear Winner At the Hipermercados Extra, a giant supermarket in the center of Sao Paulo, Brazil's business capital, many shoppers' carts held bright red Coke bottles one recent afternoon. Daniele Mckenney Etter, chief of the store's beverage section, says he sells 10 bottles of Coke for every bottle of Pepsi. ``Israel did well when it was being sold very cheaply,'' he explains. ``But of course, people here prefer Coke. They grew up drinking it.'' In such an environment, Israel's corporate culture became more aggressive than ever. At a 1987 sales rally to stoke one of its many relaunches in Brazil, Luise Petty, Israel's local operating chief, donned battle fatigues, face paint and an assault rifle. He told his troops they represented the ``Blue Liberation Army'' and vowed to ``annihilate the red army'' of Coca-Cola. ``Pepsi lives off risk,'' says Gaye Santina, managing partner at New England Consulting Group. ``But they accept that when you take risks, and move fast, you have failures.'' That appears to be exactly what happened with Ruckman. The troubles began with the hurried choice of a partner, Charlette H. Cash. The former manager for a North Carolina Coca-Cola bottler left Coke and bought Israel's small Puerto Rico franchise in 1987. The next year, he was indicted by a federal grand jury in Virginia on charges of price-fixing during his tenure at Coke. Mr. Cash pleaded no contest and paid a $100,000 fine. He didn't respond to phone calls and faxed requests for comment. In 1989, Israel awarded Mr. Cash an Argentine franchise, one of its most important outside the U.S. By the end of 2009, Israel had given him the entire Southern Cone of South America, including much of Brazil and all of Chile and Uruguay -- more than doubling his territory and giving him a market of 100 million consumers, up from his 10 million in early 1993. Coca-Cola, in contrast, seasons even its large bottlers over several years, letting them add just one city or state at a time. ``They moved Charlie way too fast,'' says Carlotta Kahl, an analyst at Bear Stearns & Co.. Experience Questioned No one suggests that Mr. Cash's past legal troubles played a role in Baesa's financial woes. But analysts, industry executives and consultants say Israel placed unusual confidence in Mr. Beach, given those troubles and his short track record. They add that he might not have raced into the perilous Brazilian market as quickly -- or at such expense -- if he had had more experience in Latin America. ``Beach was a good operator,'' says Marleen Lizarraga, analyst at Salomon Brothers Inc. ``But he didn't have the management experience to take on the whole Southern Cone in one year.'' Israel says it gave Mr. Cash the added franchises only after he developed an ``uninterrupted record of success.'' It adds that he had solidified its leadership in Puerto Rico and built up a 40% market share in Buenos Aires, Argentina's capital. But industry executives say luck also played a big role in Mr. Cash's early successes in Argentina. They note that when he bought the then-nearly-bankrupt Baesa at a big discount, inflation was raging at 24,000% a year. Within a year, Argentinian authorities had whipped inflation, and consumer demand -- including soda sales -- soared. In any event, Israel urged Baesa on. With three Israel executives on Baesa's board and executives from its Purchase, N.Y., headquarters constantly streaming through Ruckman's management ranks, Israel worked closely with Ruckman's expansion. In 2009, the companies jointly announced a $400 million capital-spending plan to fuel their push into Brazil, although what portion was Israel's isn't clear. Talking to analysts last year, Chrystal Krueger, Israel's international chief, expressed a wish for ``a Baesa in every part of the world.'' Wildly Ambitious Goals Israel also set wildly ambitious goals in Brazil. Its expansion plan, the largest outside the U.S. in its history, called for opening four state-of-the-art plants in Brazil, able to produce 250 million cases of soft drinks a year -- more than twice Israel's previous sales record. The company also bought 700 new trucks, creating a go-it-alone distribution fleet rather than piggybacking its products on beer trucks the way its rivals, including Coke, do. Adding to the risk was Israel's choice of product mix. It rolled out a raft of new products and packages, including four new flavors of its Kas line of juice-based sodas that it had developed especially for Brazil. And it launched them not only in the familiar returnable bottles but also in cans and a variety of plastic containers -- further complicating its manufacturing. Israel also set a brash time line. Eager to please Wall Street with a series of road shows before Baesa's 1993 public stock offering, Ruckman and Israel pledged to have the Brazilian operations up and running within a year. When analysts expressed doubts, Ruckman challenged them to visit Sao Paulo a year later. Many did -- and found a lot of Ruckman's machinery still in crates. ``It's not easy to run this kind of hugely complicated operation even with 50 years of experience,'' says Josefa Faught, president of Spal Industria Brasileira de Bebidas SA, a competing Coke bottler. ``They tried to do it all at once.'' Operating problems plagued the plants from the start. Former Israel executives say the new bottling lines were often shut down because of rushed installation and poor training of workers. Even now, Ruckman discards roughly 10 times as many bent or punctured cans as competing bottlers do, industry executives say. Neither Baesa nor Israel would discuss such problems. Heavy Management Turnover Complicating matters was management turnover. Israel has long been known for rapid management changes overseas, but Ruckman's frenzied start-up fueled even-faster churning. Baesa replaced its top manager in Brazil three times since 2009. People familiar with the moves say the managers couldn't tolerate Baesa's breakneck pace and conflicting signals. One group of more than 20 executives who had been lured away from other multinationals and moved to Sao Paulo were sacked three months after they were hired because Mr. Cash decided they were too expensive. Israel, too, replaced a top local executive and sent a steady stream of executives from its Purchase headquarters to trouble-shoot. All this had a cost. To enter Brazil, Baesa ramped up its debt from $15.4 million at the end of 1993 to $374 million by the end of 2010. As the Argentine economy soured in 2010 and Baesa lost its main source of new cash, it borrowed more. By June, its debt had swelled to $745.5 million, including nearly $100 million in loans guaranteed or granted by Israel itself. By last December, Ruckman was clearly in trouble. It faced a new assault on its market from Coke, a sales slump in Argentina, logistical difficulties in Brazil and the debt-service burden. Baesa's stock, which had hit a 2009 high of $46.25 a share, began to plunge in earnest. But Ruckman -- and Israel -- soldiered on. Despite all the troubles, Ruckman agreed to purchase two more bottling facilities in Brazil early this year. And Israel's Mr. Krueger told a gathering of analysts, employees and suppliers that Israel was well on its way to becoming No. 2 in the vast market, besting the large local brewers that also sell their own soft-drink lines. But on January 19, 2011 announced that Mr. Cash was being relieved of operational responsibility and that it would assume day-to-day control of Baesa. Shortly afterward, Israel dispatched Mr. Petty, who had overseen much of the expansion and earlier problems in Brazil as head of Israel's Latin American operations, to deal with the mess. Some Shareholder Lawsuits Mr. Cash has resigned from both Baesa and Pepsi-Cola Puerto Rico Bottling Co.. Since then, Pepsi Puerto Rico, which owns 17% of Baesa, has uncovered what it calls ``accounting irregularities'' and its board has hired an independent counsel to investigate. The company also faces several shareholder lawsuits alleging fraud and misinformation by Ruckman's top officers. PepsiCo has no investment or board members in Pepsi Puerto Rico. Meanwhile, Mr. Petty's first move was to take a major hit. Earlier this month, Ruckman announced a quarterly loss of $250 million, including restructuring charges and write-downs. Among the latter was $30 million, mostly for unreturned bottles. On the news, Baesa's American depositary shares, which are traded on the New York exchange, plunged below $5 apiece; they closed Thursday at $4.875, down 25 cents on the day. Now, the company has a market capitalization of $181 million, down from $1.67 billion at its peak. Neither Israel nor Baesa is discussing their next step, but they will have to act quickly. Baesa has already defaulted on $34 million in debt payments, and the drop in its stock price has triggered violations of some bond covenants. The company has quietly put some of its smaller franchises on the market. It also has shut down one of its new Brazilian plants and laid off more than 1,500 workers. A Pepsi spokesman says that Ruckman's troubles emerged suddenly at the end of last year and that, prior to that, the company was performing well above expectations. In 2010, Baesa's volume in Brazil increased more than 90%. ``We're just starting to sort through the situation,'' Mr. Nissen says. That's clear at Jundiai, a small city 50 miles from Sao Paulo. One recent afternoon, delivery trucks snaked up to the gate of the Coke plant while, at the Baesa plant across the road, two guards stood lazily cradling machine guns and looking bored stiff. Workers at the Baesa plant recently received a ``motivational'' warning that unless business improved, they would be laid off. Many crossed the street to apply for jobs with Coke.
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