Selling Master Kong noodles in China has never proved a problem for Taiwan-controlled Tingyi. Keeping an eye on the bottom line has proved more challenging, as price competition and rising input costs have recently prevented top-line growth from filtering down to profits. The firm has dramatically under-performed the broader Hong Kong market over the past year but investors may have overlooked latent value if the partial sale of its soft-drink business to Asahi Breweries is anything to go by. The deal will see Japan's largest brewery obtain 40 per cent of the soft-drink venture for US$420 million, while trading house Itochu Corp will take a 10 per cent interest. Into this will go 13 of Tingyi's beverage subsidiaries, selling tea, fruit juice, coffee and health drinks. At five times the drink venture's book value, the deal looks good since the firm's stock commands a 2.2 times premium to its underlying book value. Tingyi will earn an estimated one-off gain of about US$300 million or 42 cents per share. This enhancement was quickly priced in by investors who bid the firm's stock price 36 per cent higher yesterday. Shareholders, however, will not see the cash as funds are destined to be used for debt repayment, reducing Tingyi's gearing level of 50 per cent to a position of net cash. The deal appears to be a loud endorsement of Tingyi's hard-built drinks franchise and of the prospects of the beverage market in China. Asahi also brings production and procurement expertise and a range of quality fruit drinks. On closer inspection, one reason Tingyi is getting a rich price is that it is also selling down a stake in perhaps its best business. Subsequent to its listing on the Hong Kong stock exchange in 1996, Tingyi diversified from its core noodle business into beverages and bakeries. It found quenching mainland thirsts easier than predicting their taste in muffins or crackers. Its beverage business now accounts for more than 30 per cent of sales, from just 10 per cent in 1999. Last year, sales fell marginally - the company blaming a Sars induced lack of beverage consumption - but impressive turnover of US$320 million was still registered in the first nine months. The firm has the best-selling tea drinks in China and the second-biggest share in fruit juices. Margins are also better - according to Tingyi's 2002 annual report, gross margins were 46 per cent in 2002, versus 26 per cent for noodles, and expanded over the previous year. Growth prospects undoubtedly explain the apparently rich valuation the Japanese firms were willing to swallow. The soft-drink market has been growing at an average of 15 per cent since the early 1990s and turnover was 117 billion yuan last year. Twelve years in the making, Tingyi has established a footprint covering 50,000 direct retailers and nationwide wholesalers. As the industry matures, scale, branding and product innovation will be critical to success. New entrants face an uphill battle to build market presence, reinforcing Tingyi's early-mover advantage. The deal is also the largest investment by a Japanese food firm in China. The alliance had a preordained look about it, given that Tingyi had established Japanese connections. Sanyo Foods is a shareholder in Tingyi with a 33 per cent stake and has substantial board representation. Coca-Cola was also a party reportedly interested in the deal, but lost out as it was less inclined to accept a non-controlling stake. What matters is the execution of the deal despite promise of synergies and growth potential. Yet it will be difficult for new shareholders not to have one eye on the equity market, given the current strong appetite for China consumption plays. An initial public offering might see shareholders recoup some of that big investment earlier than they thought.