It is well known that Altria (NYSE:MO) owns a near 30% economic interest in SABMiller (NASDAQOTH:SBMRY). However, what investors often fail to realize is how much this holding is worth to Altria and how much SAB has contributed to Altria's growth over the past few years.
What many investors fail to relies is the fact that Altria's holding in SAB is actually one of the fastest growing parts of the group. Specifically, since 2008 Altria's annual income from its share of SAB has jumped from $467 million to $991 million as reported during 2013; a compounded annual growth rate of 16.2%.
In comparison, Altria's income from smokeable products has grown at a compounded annual growth rate of 4.2%. If Altria's income from SAB continues to expand a 16.2% per year, income from the holding will begin to rival cigarettes as Altria's main income source with a decade.
What's more, considering the fact that Altria's initial investment in SAB was $6.5 billion, an income of $991 million for fiscal 2013 indicates an annualized return on investment of 15.2% -- not bad.
Despite the fact that Altria's share in SAB is booked on the company's balance sheet as only being worth $6.5 billion, it is actually significantly more than this. Specifically, SABMiller's primary listing is in London, where presently the company has a market capitalization of approximately GBP 45 billion, or $75 billion. Altria holds a 27.1% stake in SABMiller, worth about $22.4 billion.
Why does Altria understate its holding in SABMiller? Well, this understatement results from the generally accepted-accounting-principles, or GAAP, equity method of valuation. Specifically, Altria's stake in SABMiller is less than 50%, and the company only has three seats on SABMiller's 11-seat board, so Altria does not exercise control over SABMiller .
As a result, Altria cannot fully consolidate SABMiller onto its balance sheet, and neither is the company allowed to mark the stake up to its current value. So, Altria can only record the book value of its SABMiller holding on its balance sheet. Still, my data above shows that Altria's share of SAB has grown at a compounded are of 28% per annum, it would still for a rational management team at Altria to dispose of the holding .
Is Altria likely to sell? No, I doubt it because the company's management has previously answered this question by stating that the tax on realized gains would mitigate much of the capital gain from the sale. Altria would sell its SAB share for a price far in excess of book value and as a result the company would have to pay 33% federal and 6% state taxes on the gain -- ouch.
Nevertheless, a tax-efficient spin-off would be a possibility.
Why not a full takeover of SAB?
With a market capitalization of £45.5 billion ($76 billion) a complete takeover of SAB by Altria is unlikely as the share Altria does not own would cost an additional $53.2 billion, while Altria's own market cap is only $75 billion.
However, further diversification by Altria into the beverage sector would complement the company's existing portfolio. At current prices, Constellation Brands (NYSE:STZ) has a market capitalization of just around $15 billion, which is a much more suitable acquisition size for Altria
The time is right
Altria could make a 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.
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.
So overall, Altria's share in SABMiller is undervalued but it has also become a major income stream for Altria during the past few years.
As a result, Altria is unlikely to sell the holding and investors can rest safe in the knowledge that an ever increasing portion of Altria's income is coming from alcohol, a product with a more sustainable outlook than Altria's traditional cigarette offering.