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.
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.
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