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. Last Updated: 07/27/2016

Sun's New Brews Search Out Russia's Tastes

It must have taken a lot of good salesmanship from Sun Brewing Group to convince foreign investors to chip $52.5 million into their Russian breweries.

Not only was the company entirely based in high-risk Russia with a little-known portfolio of five regional breweries, but even worse, the group was generating lots of red ink: Company financial statements show a loss for 1994 of $6 million.

But investors like Deutsche Morgan Grenfell, GT Management and the US Russia Investment Fund did come forward early last year in one of the first off-shore issues for Russian stock. Newly cashed-up Sun Brewing now hopes that 1996 will be a turnaround year.

Deutsche Morgan Grenfell, which took 19 percent of the stock, agrees that Sun Brewing is well placed to share in an expected boom in the Russian beer market. It predicts profits will grow strongly towards the end of the decade and reach nearly $80 million, close to a quarter of turnover, by the year 2000.

"Let's put it simply," said Joe Strella, Sun Brewing's upbeat COO. "The average Russian man would like to drink 50 liters of beer per year and he is drinking only 12 liters. That certainly leaves room for optimism."

Sun Brewing was started in 1990 by the Khemkas, an Indian trading family long involved in government-to-government trade with the Soviet Union. The Khemka trading group has a wide range of interests, but the idea of getting into Russian beer arose from two very basic observations. First, brewing has high returns everywhere in the world. Second, Russians are thirsty drinkers but the country lacks a single beer honed to suit Russian tastes.

The Soviet Union's favorite ale used to be the ubiquitous "Zhigulyovskoe" but this was hardly a brand -- the recipe was roughly standardized across the Soviet Union but never aggressively marketed. Sun's mission, according to Strella, is to create a beer for the "Russian working class."

Out of 400 or so Russian breweries, 140 were visited, and 40 were selected for further study. Some of the breweries were in incredibly bad shape, said Jim Nail, an equity analyst with Deutsche Morgan Grenfell.

Sun settled upon five breweries: Ivanovo, 300 kilometers northeast of Moscow; Kursk, a similar distance to the southwest; Saransk in the Volga region; and Perm and Yekaterinburg in the Urals. Sun started with small stakes in its target breweries to see how well it could work with the local management. If things worked out, it upped its share to a controlling stake and now holds 60 percent to 75 percent in each of the five breweries.

Sun does not go into details on the prices it paid to acquire the breweries, but it is understood the company kept its investment low. This was partly because it bought in the first stages of privatization and partly because it was able to broker a swap of Soviet-Indian trade debts for shares in breweries.

Faced with the need for large scale investment, Sun managed to share out its risk by raising money through an issue of Global Depositary Receipts, internationally registered stock that are proxies for Sun Brewing stock. The issue raised $52.2 million, valuing the total company at $133 million.

More recently, Sun Brewing has listed on the Luxembourg stock exchange. Although his share has been diluted to 40 percent, Nand Khemka is still the chairman of Sun Brewing.

The investment is very far from risk free. Almost all Russian breweries are loss-making, and a number have recently gone bankrupt, driven under by high taxes and a sharp decline in workers' average disposable income. Beer production fell from 331 million decaliters in 1985 to 176.5 million in 1995.

The industry's woes also affected Sun, which says it made a loss in both 1994 and in 1995.

But management hopes that, with the economy stabilizing, it will now be able to capitalize on a capacity for market growth. There are some positive signs: Sun's production doubled last year and so did turnover, to $50 million, said Strella. It made capital expenditures of $16 million, of which about $10 million went on improving beer quality.

Government help may also be on the way. Early this year, President Boris Yeltsin came to the brewing industry's rescue when he cut excise taxes on beer from 40 percent to 15 percent.

The next stage, the company says, is embarking on building a sales and distribution network and developing brands to sell through that network.

Beer is bulky and heavy relative to its value, and worldwide it makes sense to brew locally if at all possible.

To have national presence, Sun will need to buy other breweries, and extend its presence across Siberia and to the Far East. Acquisition of a sixth brewery is currently under discussion.

The marketing strategy is twofold: developing one or two national brands, and regional brands."We developed regional brands at each of our breweries because tastes change depending on the region," explained Strella. "People in the North like more bitter beers with higher alcohol content."

Sun's first move at a national brand has been the launch of Viking, which sells at a premium compared to other Sun brands.

"We decided to use the Viking name as it appeals to the Russian taste for strength -- with a foreign touch," said Strella. "We also use on the label a combination of English and Russian."

A brand slightly down-market from Viking is in preparation. "We believe," said Strella, "that there is a lot of room to make Russians more discerning in their drinking habits."

Improvements in brewing quality have been important to Sun's progress. More than anything else, Sun believes the key to success has been management. "We have over 16 nationalities working at Sun and that breeds a very special culture based on flexibility and creativity," said Strella, himself an expatriate.

Competition from imported beers is not acute but it is growing fast. In 1995 foreign beers accounted for only about 15 percent of total beer consumption, but that was a huge increase from 0.2 percent in 1992, according to Deutsche Morgan Grenfell. In some markets, including Moscow, the share of foreign beers, whose price is held low by massive smuggling and avoidance of import taxes, runs as high as 30 percent.

Sun also has competitors within Russia: Tver Breweries and Baltika in St. Petersburg, in which the Finnish-Swedish brewing group Baltic Beverages, owned by Pripps and Hartwell, has invested $27.5 million, according to brokerage firm Lenstroimaterialny.

With just 5 percent of market for bottled beer in Moscow, Tver is still a minor competitor. But, said Strella, "Baltika has developed a strategy very similar to ours and has been very successful at building its brands in Moscow and St. Petersburg." The brewery's Baltika beer has wide distribution in Moscow.

Baltika's strategy, however, has been to make investment in one single brewery, which inevitably limits its influence over the market. Baltika beer is now pasteurized, which gives it a longer shelf life, and will allow it and other Russian beers to be transported further than used to be the practice.

However, transport costs remain a significant factor in the beer market, giving local breweries a considerable edge. That fact, coupled with high import taxes, means other Western breweries will have to start brewing within Russia if they want to achieve a significant market share. Here Sun, already established, will have an edge in winning licenses.

Sun believes a super premium beer would sell in the higher end of the market and that Viking can compete already with some of the imported beers. "Our next move will probably to get involved in the super premium beer market," said Strella. "However we will not go into that alone. We will either buy a license or make a joint venture with an international brewery. Our strategy is not to multiply brands but to get into line extension -- a dark Viking beer for example, or into specialty beers -- why not a Christmas beer?"