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October, 2006

U.S. Tobacco Cooperative

With Sampoerna Deal, PMI Grows Sales in Indonesia

STAFF REPORT


Philip Morris International’s (PMI) acquisition of Sampoerna, one of the top three kretek manufacturers in Indonesia, caught many in the industry off guard when it was announced in March 2005. By May 2005, the deal was done, and analysts were already acknowledging that the purchase was a logical step for Philip Morris and its investors and that the positive synergy between the two companies was certain to pay dividends.

“Philip Morris has been doing business in Indonesia for over 20 years and Marlboro has a 50% of the white stick market share,” said director Andrew White, one of four senior PMI executives appointed to the board of PT HM Sampoerna Tbk. “But the white segment is only 7% of the total market in this, the fifth largest tobacco market globally. We knew we needed to be in the kretek segment to compete effectively in Indonesia; we knew Sampoerna, and that it was a company with strong brands, distribution and management, so it seemed like a natural fit.” [In 2003, the company had acquired trademarks of Sampoerna’s subsidiary Sterling Tobacco Corporation in the Philippines and in early 2005 entered into a distribution arrangement in Indonesia with Panamas, a wholly-owned subsidiary of Sampoerna.]

And such seems to be the case, as within Sampoerna corporate circles one hears words like “seamless”, “smooth” and “easy” describing the take-over process.

Most of the existing management remains in place, and as PMI settles into the driving seat it is well aware that this is a thoroughbred, innovative and successful corporation it has acquired, with a depth of social vision and corporate philosophy that exemplifies the ethos PMI strives to present in itself.

“One of the most profound examples of the social ethic Sampoerna puts into practice is that it has its own search & rescue team, which we refer to as SAR,” White commented. “With a fleet of boats, trucks and a helicopter, Sampoerna SAR was the first rescue team to reach Aceh after the 2004 tsunami, and after the May 27 earthquake this year in Jogjakarta was also first to arrive and give immediate relief.”

Sampoerna has three Third-Party Operators producing its brands in the area where the earthquake struck as well as a marketing office in Jogjakarta, and it immediately mobilized to provide medical care and food relief to victims as well as immediate cash relief to its employees and the TPO employees who were affected. Damage to their homes was assessed and cash assistance provided to help rebuild quickly.

Samopoerna is very focused on corporate social responsibility. It has a long policy of empowering its employees, such as through training schemes for retiring workers and their families so they can diversify and learn other skills, and through the outstanding work of the Sampoerna foundation, which is focused primarily on education initiatives, to which 2% of the company’s annual profits are donated.

Currently, the foundation is involved in a project called SQIP (School Quality Improvement Program) to improve teaching skills and scholastic curriculums in select schools in different regions around the country and turn them into showcase schools of excellence within three years, a first of its kind project. Sampoerna will support the project by earmarking its most recent annual donation of Rp 48 billion to sponsoring five schools, which the Company will help to select.

Beyond CSR, the Sampoerna business model, while proven sound, is in some respects far from PMI’s experience to now.

“We came into this acquisition with a view not to change what was already working,” recalls White. “Don’t make changes for the sake of making changes was our mantra. The reason for our attitude was that we respected the way the company was being run. While we realized that there was much that Sampoerna could learn from PMI, we also realized that we could learn a lot as well.” The company’s relationship with its third party operators (TPO) is an example of a strategy that might simply never have occurred to PMI, and would seem on the surface to be something it would not endorse. Essentially, in addition to its 5 manufacturing facilities, Sampoerna had 25 third-party operators hand-rolling its brands in locations across East and Central Java. To an outsider, it might not seem to make much sense to have so many facilities producing essentially the same brands. But in the context of the Indonesian market, the TPO model is an effective and viable manufacturing solution for hand rolled kretek. In essence, Sampoerna supplies the tobacco, cloves, sauce, paper, banderols — everything needed to produce the kretek — to a TPO who employs the hand-rollers, manufactures the kreteks and turns over the finished product to the company.

“When we took over Sampoerna, it was operating 25 TPOs,” said White. “This is not a typical PMI model, but after we studied it, we realized it is an effective and socially productive solution. It provides tens of thousands of well-paying jobs in the regions, where unemployment is high, and it’s cost-effective. Since the acquisition, we have expanded the program and added another seven TPOs already, and by August we’ll add one more for a total of 33.”

TPOs employ mainly uneducated women who would otherwise not have an income, East, West and central Java and Yogjakarta. Over 54,000 persons are employed by the TPO’s, which brings the total workforce engaged in producing Sampoerna’s brands, both directly or indirectly to over 100,000.

Although Dji Sam Soe, the flagship premium hand-rolled brand is performing well, machine rolled kretek sales are steadily improving against hand-rolled. Sales of A-Mild continue to grow, with new customers believed to be finding their way to the brand from other company’s portfolios.

“We are not seeing any evidence of cannibalization of our other brands as A-Mild grows,” commented White.

Based on 2005 figures, Sampoerna controls 22.2% of the kretek market, PMI’s Marlboro controls 50% of the white market, bringing their combined total market share to over 26%, which would just edge out kretek segment leader Gudang Garam to put Sampoerna/PMI in top place.

Although they remain in fact two separate companies, an agreement reached at a June 2006 EGM (extraordinary shareholders meeting) will allow Sampoerna to license its brands to PMI to be manufactured and distributed overseas, except in the US, while allowing Sampoerna to enter into a similar agreement with PMI to license and distribute its products within the tax and duty-paid market of Indonesia.

“Our shareholders approval of the board’s licensing proposals gives us the flexibility to enter into these agreements when and if we decide it makes sense for the business, and does not a signal of an impending strategy shift,” noted While. “But it does indicate a high degree of cohesiveness and synergy between the two companies and bodes well for the future of the company.”


Tobacco International - October, 2006

SMOKE Magazine - Cigars, Pipes, and life's other desires


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