S&N wouldn't have begun action if they didn't think they had a case

THE trick-or-treaters didn't stop by 28 St Andrew Square on Hallowe'en. With hindsight it was a missed opportunity. If they had they would no doubt have received a warm reception. Upstairs, executives of Edinburgh brewer Scottish & Newcastle had gathered to mark the final day of chief executive Tony Froggatt's five-year reign and his return home to Australia. According to one source "morale was sky-high". But outside the demons were gathering.

"Sir Brian [Stewart, chairman] made a short speech joking that he hoped Tony would think about us when he was lying on the deck of his beach house near Sydney," said one insider. "Tony in turn joked that it had been hard living in the UK through the indignity of two world cup defeats."

With the share price peaking at a five-year high of 789p, it was smiles all round, or as one source said, "the atmosphere reverberated with positive vibes".

But earlier in the day S&N had initiated legal proceedings against Carlsberg, its partner in the Russia-based Baltic Beverages Holding company. In a carefully worded statement S&N requested an Arbitration Tribunal in the Stockholm Chamber of Commerce to confirm that Carlsberg had breached agreements over its joint venture.

Furthermore, it added, the Danish brewer was now obliged to offer its shares to S&N in accordance with the agreement.

Just hours later the Danes, led by Jorgen Buhl Rasmussen, chief executive of Carlsberg, hit back, rubbishing S&N's claims as "without foundation".

"While S&N is allowed to explore its options, this is a step too far," said an adviser to Carlsberg. "S&N needs to engage with the consortium, not its lawyers. It's wholly implausible that arbitration will result in S&N being able to acquire BBH. We don't believe they have a legal case whatsoever."

Inside S&N, a kitchen cabinet, headed by incoming chief executive John Dunsmore and comprising Sir Brian Stewart, Sir Angus Grossart and Philip Bowman, was assembled to fend off Carlsberg's bid. The battle for BBH had begun.

As one source close to S&N said: "It is a hell of an experienced team, they [S&N] wouldn't have begun legal action if they didn't think they had a case. This will be a very close fight."

Judging by recent history S&N are going to need every bit of experience they can get. Despite the cool exterior the Danes have a reputation for being probably the most unfaithful partners in the world. In the past four years, the Danish brewery group has ended joint agreements three times.

In 2003 it emerged that Carlsberg had dramatically called time on Charoen Sirivadhanabhakdi, its partner in Thailand. The jointly-owned Carlsberg Asia Pte Ltd was disbanded after a row over certain key agreements not being kept.

A year later Carlsberg ended its collaboration with Norwegian Orkla. The joint-venture company Carlsberg Breweries was closed and Carlsberg bought out the Norwegians. Press reports subsequently surfaced that the Norwegians were in the hunt for a major new merger, possibly with S&N, that would have reduced the power of Carlsberg's ownership structure.

In 2005 Carlsberg confirmed it would be selling half of its shares in South Korean brewery Hite. Although all three joint ventures ended amicably, rumours surfaced that Carlsberg decided to end the South Korean venture because it knew it could not succeed in becoming a decisive shareholder as the South Korean family would not let go of its firm grip of the company.

To understand Carlsberg's motivation one has to look at its complex ownership structure. The company is run as a foundation by five Danish professors who have a 25% shareholding, but voting rights of 51%. Under this ownership structure no competitors can acquire the firm. What the foundation fears is a destruction of its own market share.

As the brewing industry enters the next phase of consolidation the Carlsberg foundation is making sure it will not be pushed around by the likes of InBev and Anheuser-Busch.

Earlier this year the professors moved to change the statute of the Danish group's controlling shareholder, reducing their shareholding which allowed Carlsberg to double its equity and debt to give it up to a $12.7bn war chest for acquisition.

The strategy was clear: in a consolidating market where volume and presence determine the agenda, Carlsberg has to secure a strong position.

One source close to Carlsberg put it more succinctly: "Carlsberg has a lot of joint ventures. Their strategy is to take full control of them wherever possible. Obviously their other partners have their own strategy that they want to pursue, but basically joint ventures are often undertaken on the understanding that they will not last forever. They are right for the two companies at a certain stage for development, but companies and situations move on."

Or as one analyst said: "Carlsberg's strategic priority is to ensure that it does not lose its 50% stake in BBH... The only way for Carlsberg to be certain of keeping its 50% stake in BBH is to own 100%. The only way to get 100% is to buy S&N."

Carlsberg's bid with Dutch rivals Heineken valued S&N at 720p a share, or £8.7bn including net debt, which analysts say puts a value on BBH of £3.4bn - a billion pounds short of its true worth.

BBH is huge. Baltika is Russia's leading beer brand with a 36% share of that growing market. Sales grew 47% in the first half of the year, while S&N's UK sales were flat. BBH also has over a third of the market in Russia, roughly twice the share of its nearest competitor, Inbev.

Most analysts now agree that Carlsberg bungled severely, undervaluing BBH and accidently invoking the 'shotgun' clause in which an offer by one partner triggers an opportunity to be bought by the other at the same price.

To get a fair hearing, Carlsberg needs to raise its bid. Offering 800p would value BBH at £5bn but it has no guarantee of success. S&N argue that BBH is worth more because of its strategic value. Its kitchen cabinet has sat down with its lawyers, Linklaters, and worked out a tight legal case whereby it can gain full control of BBH.

Any deal put together by S&N would most likely involve a partner bankrolling the acquisition of Carlsberg's BBH stake which could involve SAB Miller or Anheuser-Busch.

Whatever the outcome the arbitration is likely to last for at least several months, if not a year, and there is no clear idea as to who has the stronger case.

One analyst said: "Regardless of what S&N and their lawyers and investment bankers say, Carlsberg are saying the opposite so we could be bogged down in a court battle for 12 months to two years, who knows? Nobody wants that, that is why a Carlsberg consortium bid at a sensible level, rather than 720p, is the most likely outcome."

Others are sceptical that S&N either has the firepower to buy Carlsberg's 50% stake or that if the tribunal ruled in its favour it can avoid the possibility that a new partner, either SABMiller or Anheuser-Busch, buying up the Carlsberg stake and then mounting a subsequent bid for the whole of S&N.

SABMiller could sell-off the UK, Belgium and Finnish businesses to Heineken while looking to dispose of the French operations to InBev thus giving it complete control of BBH.

But Anheuser-Busch, still a family-run firm, is also believed to be particularly interested in S&N.

One analyst said: "However you play out these different scenarios Scottish & Newcastle's time as an independent company is very limited. The only way I can see them retaining their independence is if they fundamentally believe they have this right to buy Carlsberg's 50% stake in BBH.

"If they believe that is true and under the original terms of the contract it allows them to buy it at a discounted price because Carlsberg's breached the agreement, then you can possibly justify the current evaluation of the shares as a stand alone business."

Whatever happens, one thing is clear: the marriage with Carlsberg is all but over. But on the evidence of Carlsberg's past relationships, Heineken must be wondering if it is next.