Benjamin Paz is an international strategic management consultant and US-based university professor in business. He has extensive experience running the banana operating units for the multinationals for many years. Here he gives his analysis of the recently announced banana megamerger.
When listening to the quarterly multinational companies’ investor guidance calls, I hear a constant phraseology used about continued headwinds, the need to right-size overheads and the desire to own more fruit sourcing. Well, it seems Chiquita CEO Ed Lonergan has found the solution to those issues by wooing Fyffes CEO David McCann with the enticement of a megamerger for the fresh produce business.
It took a set of new eyes at Chiquita to finally comprehend the severity of the headwinds the company was really facing. Its historical dominance in the European market, which it fought so hard for after the EU imposed the Banana Import Regime, has vanished. Last year’s European shipment volume of 33.2m boxes was below the number licenses it was granted by the EU. Meanwhile, its exit from Asia and inability to penetrate other emerging markets on a sustainable basis has left the company with no choice but to recoil to the North American market, which now accounts for 58.2 per cent of its total banana volume and 60.8 per cent of total revenues. However in doing so, it has caused a mini banana contract price war resulting in back-to-back years of price declines (4.6 per cent in 2012 and 2.3 per cent in 2013).
Leveraging its iconic brand into other fruits and fruit snacks has failed – look at the Danone joint venture. These initiatives have proved costly in terms of management focus and capital, but ultimately futile, forcing the company to pursue the only viable option, a ‘back-to-core strategy’. With fewer assets to sell, fewer processes to outsource and limited financial resources with which to grow the business or expand its operations, the only option available was making growers believe the company could better manage their farms through farm leases or joint ventures – a difficult sell for growers to believe.
Chiquita’s salad business has also proved to be a burden, depleting resources from the fruit business and exposing the company to a highly competitive environment with no clear advantage in sight.
Chiquita’s merger appeal was well received by Fyffes, which is also suffering its own headwinds. The UK – Fyffes’ core market – is the most competitive banana market in the world. Losing market share to the discounters and online retailers, the traditional big four supermarkets have started an aggressive price war using ‘banana bullets’ as a loss leader – a strategy that has benefited UK consumers but failed to stimulate consumption and impacted the margins of the whole banana distribution chain. To protect their margins, retailers like Tesco are pursuing direct fruit sourcing initiatives, limiting Fyffes to a measly ripening service role. Or worse, they are integrating backwards into ripening (note Morrisons’ acquisition of Del Monte’s ripening rooms), bypassing Fyffes altogether.
The Irish company has successfully positioned itself on the continent due to opportunistic investments, quick decision making and by filling the gap left behind by the multinationals as they retrenched from their European operations. However last year, both Dole and Del Monte reversed this trend and increased their presence in Europe, impacting Fyffes’ 2013 results.
Fyffes has also capably leveraged its logistics/distribution network – its Colombia service is the most efficient shipping service to Europe and a big margin contributor. Unfortunately, the company doesn’t have the scale to replicate this elsewhere and growth is therefore limited to using liner services, resulting in basically thin trading margins.
Most of the company’s recent volume growth has been in the discount sector where it has little price leverage. This growth may have indirectly impacted on its relationship with other retailers because of their need to adapt to customers like Aldi, a retailer which has masterfully enacted wholesale prices to reliable suppliers without a clear arm’s length negotiation and has clearly followed a better procurement strategy than its competitors and avoided falling into the perils of direct sourcing.
Will shareholder approval be forthcoming?
The Chiquita-Fyffes merger should give new impetus to both companies that they would not have achieved separately. As a strategic plan the deal has potential: the challenge will be how the new Fyffes operating team implements vital changes. However, before taking on those opportunities, the merger must go through an acid test of obtaining shareholder approval.
A deal portrayed as a merger of equals will give Chiquita shareholders a diluted share of 50.7 per cent of the new company and the balance to Fyffes shareholders, who are clearly the winners, receiving a 38 per cent premium over the pre-merger prices. However, the deal will take time to close. In the interlude, Chiquita will have to announce two, if not three quarterly earnings and Fyffes at least one mid-year set of results –and these may not be pretty. 2014 has already been a challenging year and the ongoing crisis in Ukraine could have further repercussions for the banana business. Russia has emerged as an important banana market and alongside other emerging markets like the Middle East it has absorbed surplus volumes that would otherwise have impacted on traditional markets. Having said all that, negative quarterly news could have the opposite effect and heighten the need to merge. Nevertheless, potential joined EPS improvements will take time to materialise: this is a marathon not a sprint.
In terms of earnings, the US$40m synergy that would result from the merger is being compared to the equivalent of achieving an additional US$1bn worth of sales. Based on current operating margins, it is significant. However, taking into consideration the combined banana volume of both companies it represents less than US$0.25 per box. What’s more, it is not projected to be realised until the end of 2016 –what some may view as too little, too late. In the coming months, the merger team will need to focus on presenting shareholders with more specific synergies. They will want to avoid the classic post-merger claim that they new company would have lost more had he deal not gone ahead – the aim, after all is to make more money, not lose less.
Regulatory hurdles still to be cleared
On the surface, government approval should not face major headwinds. However, Chiquita’s iconic brand legacy may be an issue. The 2013 combined European sales volume of ChiquitaFyffes would be around 75m boxes – more than the volume Chiquita controlled in Europe prior to the Banana Regime. If Brussels pursues a country-by-country review, there may be some monopoly issues in markets such as the Benelux countries.
In North America, meanwhile, the three multinationals have a post-1980 record share of 87.5 per cent. Fyffes would increase this to 92 per cent and a possible deal between Dole and Banacol would raise it still further to 95 per cent. In the end, approval in the US will boil down to how the Federal Trade Commission decides to pursue the application. In the worst-case scenario, Fyffes could be forced to divest its 50 per cent stake in Turbana and an agreement between Dole and Banacol would be blocked.
In the meantime, talk of a merger and speculation about its outcome will be a major disrupting force at a time when focus on day-to-day operations is crucial. The threat of a third player entering the fray has receded, but should not be overlooked.
The merger will alter the industry game rules: there will be winners and losers, but the competitive flux of the business will remain. ChiquitaFyffes will have a more seasoned management team, but success will require a visionary company transformation and not just be limited to classical office consolidation, shipping restructure and a hands-off approach. Leadership is critically vital and will spell the difference between success and failure.
Industry facing uncertain future
In spite of the recent turmoil, the banana supply chain has done an acceptable job of controlling inflationary cost increases brought about by strengthening local currencies and declining prices. The breakeven volume of every banana farm has increased. As a result, an estimated 90,000ha of production have disappeared in Ecuador, while Colombia’s Banacol has filed for corporate restructuring and marginal players continue to disappear or be absorbed by bigger entities.
There have been productivity gains, but these have come most from packing lower grade fruit rather than technical breakthroughs. Focus on cost efficiencies should not be ignored, and while bananas should strive to remain the best value item in the produce chain, the sector must keep up with average price increases achieved by competing fresh fruits.
One thing is clear: restructuring of the banana business has only just begun.
About Benjamin Paz
Benjamin Paz is an international strategic management consultant and US-based university professor in business. He has extensive experience running the banana operating units for the multinationals for many years.
