Yum! Brands, Inc. (YUM), Diageo plc (DEO), PepsiCo, Inc. (PEP): The Next Asian Bubble?

Asia is clearly the big growth story these days, and for good reason. However, with every growth story there are, invariably, excesses that take place. One that’s “brewing” in the region today is beer and spirits. With the prices being paid in recent transactions, it looks like some companies will require impressive growth from the region to make their deals work out.

Asia

The big story in Asia is China. Clearly that country is going through an industrialization that has moved it well beyond its largely agrarian past. The transition has been difficult at times, and will likely continue to be so for the near future, but, overall, citizens are increasingly entering the so-called middle class.

That’s an important milestone financially, because it means that an increasing number of citizens have disposable income. Having lived through the West’s industrial revolution, what those new middle class folks will do with their money is pretty clear—they will spend it. How, exactly, they choose to spend will be different in many ways, but it will rhyme well enough for companies to take advantage of the growth potential.

Of course China isn’t the only nation in Asia, and others are either following along on China’s coattails or are ahead, often well ahead, of the giant country in their efforts to become developed nations. However, until recently, many investors and plenty of companies simply didn’t dare tread in Asian waters. China’s advance has materially altered that dynamic.

Yum! Brands (YUM) Never Expected Being Slapped With a Rubber ChickenThe Next Bubble

One important habit change as people inch up the socioeconomic scale is to eat better. This includes such things as eating out more often, which companies like Yum! Brands, Inc. (NYSE:YUM) and McDonald’s Corporation (NYSE:MCD) hope to take advantage of, but it also includes eating better. Rice and beans can provide carbohydrates and protein, but rice and beef (chicken, pork, etc.) tastes better to a lot of people.

Drinking habits are similar, with beverage companies like PepsiCo, Inc. (NYSE:PEP) and The Coca-Cola Company (NYSE:KO) aggressively expanding to take advantage of the trend. Simply put, the more you make the more prepackaged drinks you tend to consume in a year. Beer and spirits is another industry that will see increased sales. Though these beverages always seem to have strong underlying demand, consumers often trade up to higher prices fare when they have more money to spare.

In fact, with the purchase prices being paid for some Asian alcohol companies, this area is looking particularly bubble like.

Paying Too Much

Bloomberg recently ran an article highlighting that merger and acquisition, and joint venture activity in Asia is heating up. Deepa D’Souza, a consultant with Indian firm Mintel, summed up the problem when she told Bloomberg, “…There are not enough suitable assets available and so there is a race to pick up whatever is around…” That sounds like a recipe for disaster for the purchasing companies that get caught up in a feeding frenzy.

For example, Heineken recently paid what appears to be among the richest valuations ever for an Asian brewer when it agreed to buy a controlling stake in Asia Pacific Breweries. The nearly $6.5 billion deal is about 35 times earnings. While the industry is likely to see growth, beer typically isn’t a high margin business in the region, making 35 times earnings a pretty risky multiple.

Diageo plc (ADR) (NYSE:DEO), meanwhile, is moving into India, the other big Asian country that most people don’t realize is even a part of the region. It is buying a majority stake in United Spirits for more than $2 billion. Although the deal is facing some troubles on the regulatory front in India, most expect it to be cleared. The Financial Times described the price as “high for deals in the sector, but not out of kilter with multiples paid in India…”

Too Expensive

Despite the prospects for growth and, to some extent, increased efficiency savings, it is disturbing to see companies paying at the high end of any range for acquisitions. It may sound obvious, but the more you pay, the harder it is to make money.

It’s also interesting to see that beer giant Anheuser-Busch InBev NV (ADR) (NYSE:BUD) actually sold a Korean brewery several years ago in an effort to reduce debt. Kohlberg Kravis Roberts & Co. bought South Korea’s Oriental Brewery from the beer giant in what now looks like a prescient move. Using some of the multiples being thrown at other companies, KKR & Co. L.P. (NYSE:KKR) is set to make a nice profit on the deal.

Interestingly, however, the sale includes a safety valve of sorts for Anheuser-Bush InBev, which has the right of first refusal to buy back the company. That option helps protect InBev from allowing others to buy a brewer it helped to build up. Still, stopping its competitors could prove costly, since KKR has no particular reason to settle on a cheap price. Debt, then, could be a bigger issue for InBev if it buys the brewer back.

Still, the simple fact that this was the operation that the beer giant choose to sell could be telling. Perhaps management thought the market had less compelling growth prospects and, thus, the brewer was a less desirable asset. The company’s hands on knowledge of the business is a notable part of this equation. KKR, meanwhile, may have just seen an asset that the Asian investment momentum would benefit.

Watch What You Pay

Investors often say that you should buy a stock with the mindset that you are buying the entire company. So, in some ways, investing can be very similar to mergers and acquisitions. How much would you pay to get into the Asian beer and alcohol market? If a company you own is paying what you think is an inflated price, watch out, it very well might be.

Yours,

The article The Next Asian Bubble? originally appeared on Fool.com and is written by Reuben Gregg Brewer.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.