Is Altria (NYSE:MO) about embark on an acquisition spree, and could it target Constellation Brands (NYSE:STZ)? This may be a bold claim to make, but I feel that there are now a number of factors that make a deal like this likely.
First, interest rates are still low and Altria just refinanced a bunch of its debt to lower its weighted average cost of debt. Interest rates could be going up soon, so the company might want to act fast. Second, cigarette consumption within the U.S. continues to decline and Altria is suffering. Third, after several years of lacklustre performance, Constellation's sales have recently started to take off. Finally, a partnership between Altria and Constellation would fit well with Altria's share of SABMiller (NASDAQOTH: SBMRY).
Why not a full takeover of SAB?
Altria already owns around 27% of SABMiller, and with a market capitalization of £45.5 billion ($76 billion) a complete takeover of SAB by Altria is unlikely -- the share Altria does not own would cost the company an additional $53.2 billion.
For some, this may seem confusing as Altria's share of SAB is only booked on Altria's balance sheet as being worth $6.5 billion. This understatement results from the equity method of generally accepted-accounting-principles accounting. You see, as Altria's stake in SABMiller is less than 50%, and the company only has three seats on SABMiller's 11-seat board. Altria does not exercise control over SABMiller, and as such cannot fully consolidate SABMiller onto its balance sheet. The company is also not allowed to mark the stake up to its current value. As a result, Altria can only record the book value of its SABMiller holding on its balance sheet. As I covered above, however, this holding is actually worth much more than it first appears.
In the search for diversification away from the cigarette sector, which is in secular decline, it is likely that Altria could make an additional acquisition in the alcoholic beverage space. An acquisition of this kind would complement the company's existing portfolio. At current prices, Constellation has a market capitalization of just under $15 billion, which is a much more suitable acquisition size for Altria.
The time is right
It makes sense that Altria would swoop on Constellation now as Constellation has just started to turn itself around after years of stagnant earnings. This growth is a result of Constellation's acquisition of the Grupo Modelo's U.S. beer business from Anheuser-Busch InBev for nearly $5 billion. When Constellation reported its third-quarter fiscal results at the beginning of January, net sales soared 88% to $1.4 billion and operating income exploded 129% to $364 million. According to management, along with the acquisition, most of this growth was driven by new marketing campaigns and expansion activities within Mexico. All of this contributed to higher sales volumes in the summer months and fall holiday season .
A perfect fit
Constellation is not just about beer, however. The company sells its own wine as well, and wine sales ticked higher by 3% throughout the reported period to outperform wider wine market growth. Actually, Constellation's wine division would make yet another addition to Altria in itself. Altria already owns the Ste. Michelle wine company, which contributed $609 million to the company's sales for fiscal 2013. Although Constellation's wine sales outperformed the wider market they did not outperform Ste. Michelle's, which expanded 10% during the fourth quarter and 8.6% for full-year 2013 .
Altria and Constellation would make a great fit, though I must emphasize that there is no deal being discussed as of yet. Still, both companies are well managed and well placed for growth over the next few years. What's more, diversification like this would really help Altria move away from the toxic tobacco industry; over the long-term, the company really needs to consider options like this. I'm not saying that Altria-Constellation will happen, but Altria is likely to go on the acquisition trail in the near future.