AB InBev-SABMiller Merger At Last Coalesces, Creating a Global Behemoth

SABMiller seems to have finally come around, on the fifth time of asking, after an imminent bid for a takeover by Anheuser-Busch InBev (NYSE:BUD) was agreed in principal by its board just before the deadline day of October 14. ^[1] The two breweries have asked for permission from British regulators to extend the deadline until October 28 for AB InBev to come up with a firm offer. Let’s take a look at why acquiring its largest rival, and British beer behemoth, was in AB InBev’s best interest.

AB InBev Continues To Pursue Consolidation In Beer

AB InBev’s history offers testimony to the company’s acquisitive character, documenting how the brewer has looked to acquire companies that hold dominant or promising positions in local markets, to further its reach in beer. Inbev was formed in 2004, when the Belgian company Interbrew and the Brazilian company Ambev came together. In 2008, InBev and Anheuser-Busch combined to form Anheuser-Busch InBev, with around $54.8 billion required to fund the deal. The $20.1 billion deal to complete the acquisition of the Mexican Grupo Modelo followed in 2013, and the re-acquisition of the South Korean Oriental Brewery for $5.8 billion early in 2014 further highlights AB InBev and its largest shareholders 3G Capital Partners’ strategy for the future.

We have a $120 price estimate for Anheuser-Busch InBev, which is above the current market price.

See Our Complete Analysis For Anheuser-Busch InBev

The Brazilian private-equity firm 3G Capital Partners was behind the huge Kraft-Heinz merger earlier this year, and is known to pursue global expansion through massive mergers and acquisitions. According to a Goldman Sachs report, AB InBev spent 86% of its market capitalization on acquisitions through 2004-2007, and 103% of its value on acquisitions through 2008-2011. Financing the massive SABMiller combination will significantly raise AB InBev’s debt to normalized EBITDA ratio, which rose to 2.48x as of 30 June 2015. The company’s optimal capital structure, historically, remains a net debt to EBITDA ratio of around 2x. AB InBev is said to be lining up $70 billion of debt financing, to help in its massive takeover of SABMiller. ^[2]

The Nitty-Gritty Of The AB InBev-SABMiller Deal

SABMiller previously rejected private bids of £38 and £40 a share, and a very public proposal of £42.15 ($64.80) per SAB share, made last Wednesday from AB InBev. ^[3] The Belgian-Brazilian  firm then stepped up the heat on Monday, revising its proposal to £43.50 a share on Monday, and the newest bid is set at £44 ($67) a share, a substantial 50% premium on SABMiller’s price before news of a possible AB InBev takeover created a significant stir. The proposal comes in two forms — one is all-cash, and the other is a mix of AB InBev shares and cash. The partial share offer is to attract SABMiller’s two top shareholders — Altria (27% stake) and Bevco, which manages the Santo Domingos’ 14% holding. They would receive 0.483969 unlisted shares and £3.78 a share for their holdings in the British brewery, which equates to £39.03 per SABMiller share, representing a premium of approximately 33% to the closing SABMiller share price before the news came out. By accepting this proposal and keeping stake in the combined brewery, Altria and Bevco will avoid the large tax bills following the sale of their holdings.

Intricacies aside, what this deal entails is the coming together of two of the biggest forces in beer. AB InBev, the number one in global beer volumes, had revenues of about $47 billion last year, and by acquiring SABMiller, annual sales will rise to over $64 billion. This will be the third-largest M&A transaction in history, after the Vodafone AirTouch-Mannesmann deal of $172 billion in 1999 and the Verizon Communications-Verizon Wireless deal of $130 billion in 2013, with the combined company controlling approximately one-third the global beer volumes.

But why SABMiller? Why not continue with acquiring smaller players, such as craft breweries or brewers that hold strong positions in the tough-to-penetrate Asian or African markets, where AB InBev lacks solid presence?

Can’t Find A Way To Grow In Traditional As Well As New Markets? Consolidate

AB InBev has a solid 46% market share in the U.S., but this stronghold has been weakening in the last few years. The brewer might be feeling out of luck in Anheuser’s home market, where domestic beer demand is continuously waning. That doesn’t bode well considering the biggest brands for the company are domestic beers Bud Light and Budweiser, which have consistently lost market share.

The other beer segments — imported and craft — are growing in the U.S. at the expense of domestic beer, but AB InBev hasn’t been able to gain much from this growth. Due to anti-trust issues following the Grupo Modelo acquisition, Anheuser had to give up the likes of Corona and Modelo, which are fast growing imported beer brands, to Constellation Brands in the U.S.  On the other hand, despite the acquisitions in the fast growing craft beer segment, the incremental volumes contributed are far too small to offset the larger declines of Bud Light and Budweiser. To be precise, only around 2% of AB InBev’s U.S. volume is craft beer.

So the SABMiller acquisition could mean that AB InBev is reverting to what it does best — selling domestic beer brands in bulk. This will add significant incremental volumes for the company, and the positives will lie in synergies and cost-cuts, which could increase profitability.

On the other hand, the combination between these two companies could take AB InBev to a point of strength in Africa, from having virtually no presence. SABMiller dominates the beer industry in that region, with roughly 30% of its revenues coming from South Africa and the rest of the continent in the last fiscal year ended March 2015. In addition, SABMiller’s strong presence in countries such as Colombia (its third largest market) and Peru could further strengthen AB InBev’s already flourishing Latin America business. So there is a lot of new opportunity in terms of Africa and Asia, and synergies in Latin America, that fuel AB InBev’s interest in SABMiller. It might have been tougher for AB InBev to go in solo in its efforts to penetrate the Asian and African markets.

Synergies And Cost-Cuts Make The SABMiller Acquisition Attractive

Cost-cuts, lowered overhead expenses, and economies of scale would enable AB InBev to extract more profits from the SABMiller unit. Operating margins for AB InBev stood at 33% last year, more than that for any other brewer. Around 40% of the brewer’s beer production capacity is concentrated in Latin America, allowing the brewer to enjoy low labor and raw material costs, and economies of scale in the region. Anheuser-Busch InBev already boasts high industry-leading operating margins, and the combination could prove beneficial, as more profits could be squeezed out of SABMiller, whose operating margins presently stand at 19-20%.

In addition, this merger might introduce various constraints on, and barriers to entry for, other competing players in the global beer market, given the pricing power, strong distribution channels, and marketing muscle that the new company will possess.

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Notes:

1. Anheuser-Busch InBev and SABMiller Reach Tentative Agreement on Merger, nytimes.com [↩]
2. SABMiller accepts new $106 billion AB InBev takeover offer, reuters.com [↩]
3. SABMiller rejects AB InBev’s £65bn takeover offer, ft.com [↩]