Why Taking the PepsiCo-Anheuser-Busch InBev Relationship a Big Step Further Makes Sense

Is an Anheuser-Busch InBev-PepsiCo deal as crazy as it sounds? Not even close.

Aug 30, 2014 at 2:08PM

Beer Selection

BookFinch, Flickr.

Ongoing consolidation in the global beer marketplace means another acquisition is likely a question of when, not if. 

Over the past decade, beer companies have participated in a bevy of big-time mergers and acquisitions, ranging from SABMiller's joint venture with Molson Coors in 2008, to the Anheuser-Busch-InBev merger shortly thereafter. Heineken's purchase of Asia Pacific Breweries two years ago, and Anheuser-Busch InBev's Grupo Modelo buy last year further fused the industry's biggest players together.

So, who's next? As crazy as it sounds, there are several reasons why a merger between industry leader Anheuser-Busch InBev (NYSE:BUD) and the beverage division of PepsiCo (NYSE:PEP) makes sense.

A budding relationship
Despite being legally separate, the two companies have built a unique partnership in recent years. In 2009, PepsiCo and Anheuser-Busch InBev established a joint procurement agreement in the U.S., designed to help them save money on items like office supplies, computers, and other materials. As Beer Business Daily editor Harry Schuhmacher told Reuters at the time, "It's like getting the benefits of a merger without the merger." The deal came during a period when Anheuser-Busch InBev was initiating other cost-cutting measures. Now the brewer's gross and operating margins are at 10-year highs.

More visibly, Anheuser-Busch InBev and PepsiCo began collaborating on in-store advertising last year. Because the brands view themselves as complements to the average partier -- not competitors -- the arrangement makes sense. The most iconic display was the duo's "Big Play HQ," which marketed Bud Light, Pepsi, Doritos, and Lay's chips before the 2013 Super Bowl. 

The two are also linked from a distribution standpoint. Ambev, the Brazilian beer maker under Anheuser-Busch InBev's control, has bottled and distributed Pepsi soft drinks in Brazil, Argentina, and much of Central America since the early 2000s. The company also produces and distributes PepsiCo's Gatorade in the region. Worth noting: The pair's arrangement expires in 2017, meaning Anheuser-Busch InBev could theoretically use contract renegotiations as leverage in any M&A talks.

Why a deal makes sense for Anheuser-Busch InBev
Throughout its history, Anheuser-Busch InBev has opted for inorganic growth to expand, meaning the growth came from mergers and takeovers rather than growth in sales of existing products. Ten years ago, AmBev and Interbrew merged -- the former faced limited sales opportunities beyond Latin America, and Interbrew desired a customer base outside of Europe. This kicked off a string of M&A activity, including purchases in China, Canada, South America, Mexico, and most notably, in the U.S. with Anheuser-Busch. Anheuser-Busch InBev is one of the controlling shareholders of Ambev, holding about 62% of the voting and total capital.

Now it may be time to add soda. Like many market leaders plagued by their enormousness, Anheuser-Busch InBev's sheer size means slower growth is likely on the horizon. A Bloomberg article earlier this year, in fact, reported that analysts estimate the brewer's compound annual sales growth rate will be just 4% over the next decade, 14 percentage points below its previous 10-year average. Anheuser-Busch InBev netted $43.2 billion worth of revenue last year.

A complete acquisition of PepsiCo wouldn't get past antitrust regulators, though a purchase of its soft drink division, PepsiCo Americas Beverages, likely would. The division booked a little over $21 billion in sales last year, and accounts for about one-third of PepsiCo's net revenues, but just 26% of its operating profit.

Assuming it is priced at roughly 3 to 3.5 times sales -- near the industry norm -- the beverage division would cost Anheuser-Busch InBev somewhere between $60 billion and $75 billion. The company doesn't have near that much cash, but it could finance the purchase through debt, much like InBev structured its Anheuser-Busch transaction in 2008. That acquisition cost $52 billion, with about $45 billion coming from lenders.

It's this scenario Wall Street continues to discuss. Banco Santander analyst Anthony Bucalo, for example, has said such a move could boost Anheuser-Busch InBev's business in the U.S. and Latin America. It's also possible a deal could allow Anheuser-Busch InBev to expand its joint procurement program to take advantage of further savings, since the partnership currently doesn't apply to drink production costs. 

Why a deal makes sense for PepsiCo
A deal also makes sense for PepsiCo. "[D]ivesting beverages would allow the company to shed an underperforming asset and focus on its dominant food and beverage businesses," Bucalo explained in a note to investors, published by Just-Drinks last year. Activist shareholder Nelson Peltz, who holds PepsiCo stock, echoes a similar sentiment. "Shareholders are not happy with the status quo ... we think the best path forward to unlock value is a spinoff of the beverage business," he told Barron's last week. 

In February, the company said it wouldn't initiate a spinoff of its beverage unit, citing strong free cash flow from the division. But the fact remains that there's simply no growth there -- beverage revenues fell 2% last year, and 4.5% the year before. And profits are down even further. By jettisoning the business, PepsiCo could focus more of its advertising budget on the higher-growth snacks division, a point Peltz also makes.

Keep your eyes open
From an investing standpoint, a merge of Anheuser-Busch InBev and Pepsi's beverage unit could be good for shareholders on both sides. Anheuser-Busch InBev would reignite slowing sales, while a PepsiCo sans its beverage division would be more profitable over the long run.

Although the picture is different now, M&A activity has been kind to both sets of investors in the past. In the years following the Anheuser-Busch merger, Anheuser-Busch InBev stock is up over 180%. PepsiCo bulls were similarly rewarded after the company spun off Yum! Brands in the late nineties. Nothing is guaranteed, but given the fact that a deal makes sense for each side, it's worth keeping an eye on.

Are you a smart dividend investor?
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Jake Mann has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs, Molson Coors Brewing Company, and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers