--Coke Femsa sees annual capital outlays in Philippines of $120 million-plus

--Room to raise volume sales, improve profitability in market -CFO

--Philippines's per-capita consumption of Coke products is low versus Latin America

(Updates throughout to incorporate executives' comments from conference call)

By Amy Guthrie and Anthony Harrup

MEXICO CITY--Mexican soft-drinks bottler Coca-Cola Femsa SAB (KOF, KOF.MX) sealed its proposed entry into Asia Friday via an agreement to buy 51% of Coca-Cola Co.'s (KO) operations in the Philippines for $688.5 million, with the option to acquire the rest within seven years.

The acquisition of Coca-Cola Bottlers Philippines Inc. marks Coca-Cola Femsa's first move beyond Latin America, where it's the largest Coca-Cola bottler and a frequent investment partner with the Coca-Cola Co. in a variety of projects.

Coca-Cola's Philippine operations include 23 production plants and close to 800,000 customers, with expected sales of 530 million unit cases in 2012, Coca-Cola Femsa said. The country's economic growth prospects, western habits, preference for Coke products and young demographics make the Philippines "the best country" for Coke Femsa to start operating in Asia, Coke Femsa Chief Executive Carlos Salazar told analysts during a conference call.

Under the agreement, aside from the option to buy the remaining stake in Coca-Cola Bottlers Philippines, Coca-Cola Femsa has an option to sell its stake back to the Coca-Cola Co. in the sixth year after the acquisition, which is expected to close in early 2013. Because of this put option, the Coca-Cola Co. wants to weigh in on the annual budget and business plans for the Philippine operation over the next four years, Coke Femsa Chief Financial Officer Hector Trevino said.

Coke Femsa projects annual capital outlays in the Philippines of $120 million to $150 million over the next two years, Mr. Trevino said, while the company hopes to fund those needs at the local level. The Coca-Cola Co. has infused $600 million of capital into the operation since 2010, he added. Future capital expenditures will target bringing some of the bottler's extensive third-party distribution network in-house, so that the company will have direct access to customers. Coke Femsa also plans to invest in production to maximize efficiency and consolidate output at fewer, larger factories.

Coca-Cola Femsa began looking at the Philippines operations early last year with a view to an eventual acquisition. The deal values the entire operation, which has projected sales for 2012 of $1.1 billion and earnings before interest, taxes, depreciation and amortization (Ebitda) of $100 million, at $1.35 billion. Coke Femsa plans to finance the purchase via bank loans, maintaining a conservative net leverage ratio of 0.7-times.

Annual per-capita consumption of Coke products in the Philippines, at 129 eight-U.S. fluid ounce bottles, is low versus many countries in Latin America, but higher than much of Asia. For comparison, Mexicans consume 728 bottles a year, South Koreans 84 and the worldwide average is 92. In terms of volume sales, the Philippines is one of Coke's 10 biggest markets.

About 70% of the carbonated beverages consumed in the Philippines are returnable products, which require complex distribution networks. Coke Femsa officials said they plan to promote one-way, disposable packaging in an effort to improve the business's price mix and profitability. The company also sees room to raise per-unit prices as Filipinos enjoy greater spending power.

The Southeast Asian country's economy grew 7.1% in the three months ended September from a year earlier, making it one of the fastest-growing economies in Asia. Remittances from Filipino workers abroad have expanded in the double-digits in recent years, while young Filipinos at home are enjoying unprecedented opportunities in services jobs such as at call centers. The country's median age is 22.

Mr. Salazar said that a whopping 70% of the country's GDP is driven by domestic consumption, and that 40% of consumption goes toward food and beverage. With a population of 95 million, the Philippines is similar in size to Coke Femsa's home market, Mexico. The company also sees many cultural and structural similarities between the Philippines, a one-time Spanish colony, and Latin America.

Coca-Cola's distribution network in the Philippines is fragmented and concentrated on mom-and-pop retailers, much like the business in Latin America. Still, the foray represents a major test for Coke Femsa, Mr. Salazar conceded, as it entails working across time zones and in a new language, Tagalog.

Credit Suisse analysts said the Coca-Cola company's keeping a 49% stake is positive as it lowers the risk for Coca-Cola Femsa. "KOF is buying its way into what could potentially become a whole new Southeast Asian opportunity (very long-term). We think there are not that many bottlers in a position to have such serious global aspirations," Credit Suisse said in a note.

Credit Suisse sees the transaction adding about 9% to Coca-Cola Femsa's overall sales volume, and about 2% to its Ebitda. The Philippines business' Ebitda margin of 9% is far below the 20% margin that Coke Femsa reports in Latin America. Mr. Trevino attributed part of that discrepancy to lost revenue in the distribution chain, as Filipinos spend $600 million on Coke products that the bottler is not currently capturing. Bringing more distribution in-house will help the bottler cut out the middleman to improve top-line revenue.

Write to Amy Guthrie and Anthony Harrup at mexico@dowjones.com

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