Marlboro maker Altria Group (NYSE:MO) gave investors good results in 2016, with total returns of around 20% rewarding those who stuck with the company. A host of challenges continues to face Altria, including ongoing pressure from regulators, consumer advocates, and plaintiffs' attorneys seeking to cause difficulties for the tobacco giant. Yet even though some favorable moves with its core business were noteworthy in 2016, Altria's biggest win came in avoiding an even bigger hassle from the IRS. Thanks to the way it worked with Anheuser-Busch InBev (NYSE:BUD) to structure the beer company's merger with SABMiller, Altria saved billions of dollars and will continue to benefit from beer-industry strength in the future.
Preventing a big IRS payday
The primary problem Altria faced with the SABMiller merger with A-B InBev was the prospect of huge capital gains taxes. Altria's history with SABMiller goes back to its sale of Miller Brewing to South African Breweries 15 years ago. In exchange for the beer unit, Altria received a stake in SABMiller. That was a favorable way to handle the transaction from a tax perspective, but it also meant Altria had almost no tax basis in its stake in SABMiller.
Fast forward to late 2015, when Anheuser-Busch made its offer for SABMiller. A-B InBev wanted to pay the vast majority of the $107 billion it offered for the beer company in cash, avoiding any dilution for its shareholders. Yet with Altria having a 27% stake in SABMiller, the nearly $30 billion it would have received as a result of accepting a cash deal with A-B InBev would have created a huge problem. Corporations generally pay taxes on capital gains at their ordinary tax rate, which is as high as 35%. That would have meant about a $10 billion tax bill for Altria if it had structured the deal as an all-cash transaction.
Understanding the importance of getting Altria's approval of the deal, Anheuser-Busch InBev made a different proposal. Instead of requiring cash, Altria was allowed to receive A-B InBev shares in exchange for the vast majority of its stake in SABMiller. The beer giant also ended up offering a similar deal to other investors, but to discourage many of them from accepting stock, the company required that the A-B InBev shares have a five-year restriction on resale before holders could exit their positions. Because the stock portion of the consideration for the deal preserved tax-deferred treatment for Altria, the IRS didn't get a big windfall in the form of capital gains taxes.
The final score for Altria
As it turned out, Altria got most of what it wanted. Because some other investors took advantage of the stock-based deal, Altria ended up getting slightly more cash than it had originally anticipated. Rather than $2.5 billion to $3 billion, Altria ended up with about $5.3 billion. That increase boosted the capital gains tax bill by several hundred million dollars, but it still achieved the main purpose of avoiding a potentially much larger tax bill. Moreover, Altria ended up spending some of its cash on additional Anheuser-Busch InBev shares in the open market, boosting its final position in the beer giant above the 10% mark.
Many investors never realize just how much wrangling there can be in discussions of potential mergers and acquisitions, and tax issues often play a vital role. Here, a simple change in the way a deal was structured meant billions of dollars in savings for Altria, but it required both Altria and Anheuser-Busch InBev to cooperate in order to unlock the tax break and deny the IRS its due.
Longer-term, pent-up capital gains could eventually require Altria to pay tax if it sells its shares of Anheuser-Busch InBev. Yet given the positive attitude Altria executives have expressed about the future of the beer industry, it's likely the tobacco giant will maintain its A-B InBev shares long after the five-year transfer restriction expires -- making it an even bigger potential win for longtime shareholders.