Tobacco giant Altria (NYSE:MO) is possibly the most diversified tobacco company on the market. This is because it owns around one third of brewing giant SABMiller (OTC:SBMRY). To Altria and its investors, this stake is worth billions, contributes around a billion a year in income to Altria's bottom line, and gives the company diversification outside of the contracting cigarette market.
However, due to the valuation method used for the SAB holding, Altria's current share price undervalues the company and its holding in SAB to some extent. The problem is that Altria will never be able to fully account for SAB on its balance sheet, so it's likely that it will never realize the true value of the SAB holding.
With this being the case, some have been calling for Altria to spin off or sell its SAB holding; but will this happen?
Altria owns just under 30% of SABMiller--27.1% to be exact. Based on the current price of SAB, which has its primary listing in London, this holding is worth £14.1 billion, or $23.6 billion based on current exchange rates. In comparison, Altria's current market cap is around $82 billion. With 1.98 billion shares in issue Altria's share of SAB is worth $11.91 per share.
Since 2008, Altria's annual income from its share of SABMiller has expanded at a compounded annual growth rate of approximately 16%. The investment now contributes $991 million to Altria's bottom line. Over the same period, Altria's income from smokeable products has grown at a compound annual growth rate of 4.2%.
The Altria/SAB issue is not as easy as it looks at first. You see, Altria's share in SAB is only booked on Altria's balance sheet at $6.5 billion. This is due to the equity method of GAAP accounting. As Altria's stake in SAB is less than 50% and the company only has three of the 11 seats on SAB's board, Altria does not exercise control over SAB and therefore Altria cannot fully consolidate SAB onto its balance sheet. The good news is that because Altria reported income of $991 million from its SAB investment last year, based on its book value Altria achieved a return on investment of 15.2% for the year.
Nevertheless, Altria cannot mark up the value of its stake in SAB. So Altira can only record the 'book value' of SAB on its balance sheet.
Here's the thing: if Altria decides to divest its holding in SAB, it would have to pay capital gains tax on any gains it realizes. The gains in this case would be in the region of $17.1 billion. The federal government would take 33% of this, and the Commonwealth of Virginia another 6%.
It does not need to be said that this would be an extremely tax inefficient way of doing things. What's more, after the government and state received their cuts, individual investors would then have to pay further taxes on their dividend income -- that is, if Altria paid out its gain as a special dividend. It's likely that the total amount of tax paid would be in the region of 50% all told.
The other option of course is a tax-free spin off, which would allow Altria to give the SAB shares to investors without divesting them.
Due to the tax issues it's not likely that Altria will sell its holding in SAB. A spin-off is possible, but once again, it's unlikely that the company will pursue this option. Indeed, as mentioned above, the SAB holding significantly contributes to Altria's bottom line and serves as a key asset for Altria's future growth. As the volume of cigarettes sold continues to decline, Altria's income from SAB will pay an ever-increasing role in its income growth.
Of course, the third option is that Altria has no choice in the matter. SAB has been subject to almost continual takeover rumors for around a decade now and Altria may just have to take the cash it's offered. It is widely expected that if a SAB buyout did occur, the buyer would have to offer a 30% premium. That would be hard to turn down.