Following a publicized and contentious monthlong courtship, the No. 1 and No. 2 brewers are combining to create a massive entity controlling 30% of the global beer market. The new company would generate over $60 billion in annual revenue and have a market capitalization north of $200 billion.
Anheuser-Busch InBev(NYSE:BUD) and SABMiller(NASDAQOTH:SBMRY) expect to realize billions of dollars in synergies and enjoy a truly worldwide reach, but the combined entity still needs to clear regulatory hurdles and manage a ballooning debt balance before the union is official.
A full transcript follows the video.
Sean O'Reilly: A brewing behemoth is born, on this consumer goods edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly joining you here at Fool headquarters in Alexandria, VA. It is Tuesday, Oct. 13, 2015, and with me today is the insightful Vincent Shen. How's it going, Vince?
Vincent Shen: How are you doing, Sean?
O'Reilly: Not too shabby. Last week we mentioned briefly that an already gargantuan company, SABMiller, and AB InBev were in talks to merge. Those talks have now borne fruit, and we're not getting a giant. We're getting a leviathan. This thing is going to be massive. I'm going to make this joke -- it's probably not even a joke -- are there any antitrust concerns over this deal? This is going to be huge.
First, give our listeners some high-level background of what's been going on between these two companies. SABMiller was playing hard to get. What's been going on?
Shen: This was very much a public negotiation.
O'Reilly: This was like watching high schoolers flirt.
Shen: The rumors came out mid-September, and we talked about this a little last week. Rumors came out mid-September that Anheuser-Busch InBev would approach SABMiller with some type of buyout offer. Obviously, stocks reacted very positively for SABMiller on that news. Over the next few weeks, the approximate gauges of what the offers would be started leaking out. Generally it was valued around 100 billion pounds.
SABMiller confirmed they were in talks, and the discussions got heated at times based on some of the rhetoric that Anheuser-Busch management was pushing into headlines and how SABMiller was rejecting their latest offer, and things like it "lacked credibility". Ultimately, in late September, early October, the offer price was just over 40 pounds. The offer on Wednesday, Oct. 7, it went up to 42.15. The following Monday, Oct. 12 -- you can see how quick the pace is picking up here -- it went up to 43.50, and then ultimately this morning, they came to an agreement in principal at about 44 pounds, or $67 per share.
O'Reilly: As things progressed, investors clearly saw the writing on the wall.
Shen: Yeah. Ultimately, it's not all that surprising. If they were going to come to a deal they need to come to it about this time, because there's some regulations in the U.K. that say you have to put out the formal offer, which is required by tomorrow, Oct. 14. They were already pushing up against that.
O'Reilly: I had forgotten, but I know the U.K. is funny with shareholder treatments and all that.
Shen: Exactly. As part of the press release that was rolled out today, they basically said the management of both companies have agreed to the key terms of the deal, and at the same time, were asking for an extension of that Oct. 14 deadline for two weeks because of the fact that this is such a large, complex deal. They need that time to iron out details.
O'Reilly: That happened in the financial crisis. One of the U.K. banks needed to be rescued and sold, and another bank was going to buy them, but they didn't have time to get all the shareholders to vote -- which is U.K. law. It's very funky over there.
Shen: Yeah. There are some other parts of it. If they had missed that Oct. 14 window for the formal offer, they'd have to wait about six months. They're not allowed to approach with another offer.
O'Reilly: You used to work in investment banking, and now you're a Fool, and we love it. Did anybody get any sleep when putting this deal together on a crunch time like that?
Shen: Some of the teams that were involved as advisors for both these companies -- I think Lazard was involved, Goldman Sachs, a few others ...
O'Reilly: Midnight oil was burned.
Shen: Including the management teams. Everybody at these companies is going back and forth. For such a large deal, high profile, it would have been a lot of long hours.
O'Reilly: What does an "agreement in principle" mean, exactly? That's like "I want to merge with you, but I'm not sure".
Shen: It's not final. The management has agreed to the key terms. It's obviously very important. That's been the hold-up this whole time. Ultimately, they've agreed that they're going to recommend this deal to their shareholders. At the same time, there's going to be a break-up fee, naturally.
O'Reilly: Of course.
Shen: There's a lot of hurdles here, not only with shareholder approvals, but with regulatory approval. With the breakup fee, what we're going to see ...
O'Reilly: Oh my God! A $3 billion breakup fee? Sorry, folks. I just saw the note here.
Shen: Paid by Anheuser-Busch InBev to SABMiller if the deal fails to pass.
O'Reilly: I almost want the deal to fall through if I'm SABMiller. Holy smokes!
Shen: Like I said, the terms, 44 pounds per share for cash. That's a 50%-plus premium to the 29.34 that the SAB shares were trading at before all the rumors came out. This was mid-September prices.
O'Reilly: We were talking about it last week, and SABMiller was playing hard to get and saying they thought they could do better for their shareholders. The whole time I was thinking they were one of the largest beverage companies on planet Earth. How were they going to double their share price otherwise?
Shen: Fifty percent premium -- I'm sure they were very happy that they were able to stretch that out. Ultimately when the first offer came in at 40 pounds, it was generally guided that they were looking for something closer to 45 pounds, and this got them there.
O'Reilly: The other cool aspect of this deal, U.K. shareholder regulations aside, is SABMiller has a very interesting and enormous shareholder in Altria (NYSE:MO), which is ...
Shen: Yeah. This offer, the 44 pounds per share in cash is basically for everyone except SABMiller's two big shareholders. That's Altria and BevCo. That's basically the representative company for ...
O'Reilly: A bunch of P/E guys, right?
Shen: The Colombian family, the Santo Domingos, I believe. Altria owns 27% of the shares and BevCo owns about 14%. They have pretty sizable ...
O'Reilly: That's 40%, yeah.
Shen: Over 300 million shares. The thing is, they're getting a special deal here which will help reduce the amount of cash that Anheuser-Busch is going to have to put up for the purchase price. They're going to get 0.483969 of a restricted share, plus 3.7788 pounds cash for each share of SABMiller they hold. That's equivalent to about 39 pounds per share.
O'Reilly: But they're getting more stock, which implies more upside.
Shen: They're seeing a discount to the cash price that the other shareholders receive. The thing with the restricted shares is, they don't trade on public markets, and they have a five-year lockup from the closing date of the acquisition, assuming it does close. After that five-year period, they convert to ordinary Anheuser-Busch InBev shares on a 1:1 basis.
O'Reilly: Do they have the same voting rights?
Shen: Yes. They rank equally for dividends and voting rights, and they also still get their director nomination rights.
O'Reilly: So it's really just a five-year time stamp?
Shen: It's just the five-year lockup that's the most substantial thing to keep in mind here, to keep them ...
O'Reilly: Well, I'm sure these rich families didn't want to pay the capital gains taxes for the cash deals.
Shen: Yes. That was also a huge proponent of this. You've got to understand, when Anheuser-Busch was going through this whole process and making these offers, a lot of it had to market to these two shareholders since they're such a significant ...
O'Reilly: Yeah. It's wooing your future in-laws.
Shen: Exactly. That's a good way to put it. Helping them avoid those major tax bills through these restricted shares/cash offer I'm sure helped push them very much in the right direction. Even on an earlier offer of 42.15 last week, Altria had already supported the deal. So it was sort of getting Bevco, which was voting with the board of SABMiller when they were rejecting it, to get everybody on board.
O'Reilly: Right. Before we move on to discussing what the combined entity will look like, I wanted to point our listeners to a newly redesigned focus.fool.com. There, you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com.
If you're just joining us, I'm here with the incomparable Vincent Shen. We're talking about what will essentially have a monopoly on global beer sales. What's this combined entity? Should the merger between SABMiller and AB InBev go through -- what's it going to look like? They're operating in 150 countries. This is going to be nuts.
Shen: Keep in mind the deal value at about $104 billion is going to be one of the top five biggest mergers ever. It's a huge deal. Even as you mentioned previously, each of these companies by themselves are already in the top five brewers in the world. Combining them -- the one and two -- it's really a huge amount of consolidation for the industry.
AB InBev already has 200 brands -- 16 of them generate $1 billion-plus in annual sales.
O'Reilly: And we're talking about the entire beer section at the store.
Shen: Some of their brands that are famous that everybody knows are Budweiser, Stella Artois, Corona, Becks. SABMiller's portfolio includes a lot of international brands that AB InBev wants access to like Peroni, Grolsch, Pilsner Urquell, Miller, so the combined entity would have $64 billion in revenue and they'd control about 30% global market share.
It gets even better for the U.S. You've got to keep in mind that Anheuser-Busch InBev already has a dominant market share in markets like the U.S., Canada, Mexico, Brazil, Argentina, and Belgium. Dominant means anywhere from 40% to 80%. I think they have a little over 50% in the U.S., as high as 60% in Belgium, 70% in Argentina.
SABMiller, on the other hand, is presenting them with even more opportunities in Central and South America, but also very importantly would be in Africa. Currently AB InBev has no real foray in Africa.
O'Reilly: Africa's GDP growth is actually awesome over the last 10 years. This is a growth market now.
Shen: Exactly. Combining that with the fact that there's supposed to be a huge jump in the legal drinking population, growing middle class, that's a high-growth market that the brewer right now, beyond craft beer sales in the U.S., is looking for growth. Access to those markets is obviously a big part of this transaction. The combined entity is really going to be massive.
O'Reilly: A minute or two ago I made a joke about it, but it's no small stretch to say here in the United States we're talking about 50% to 60% of the beer aisle at the grocery store with these companies.
O'Reilly: They operate in a bunch of countries, but what are U.S. regulators going to say?
Shen: The regulatory hurdles will not be small with the deal at all, keeping in mind that the top five brewers already account for half of all market share globally. Regulatory authorities with previous deals that have happened in the past five to 10 years have already shown some concern over the amount of consolidation that's been happening.
In 2013 -- and this is part of AB InBev's ongoing affinity for acquisitions -- when they acquired Grupo Modelo for $26 billion that year, the Department of Justice required that Modelo divest its U.S. business to Constellation Brands for $5 billion. That included all the U.S. rights to Corona. That could be a very good parallel for what we might see here.
O'Reilly: It was one quarter of the size.
Shen: Yeah. Like you mentioned, the combine entity will have 70% market share for the U.S. in beer. In order to address that level of what is amounting very quickly to a monopoly ...
O'Reilly: It's basically this company, Boston Beer, and a bunch of small, regional brewers. That's what we're talking about now.
Shen: I think we could expect ... especially in the U.S. -- keep in mind that SABMiller has a joint venture with Molson Coors (NYSE:TAP). They have a 58% interest. Coors will probably end up buying that out.
O'Reilly: How does Coors feel about that?
Shen: I'm sure they're pretty happy. I also want to mention that the Miller Coors joint venture controls about one quarter of the market, too. Again, very significant. Most of the market concentrated in just a few players' hands. In China is another place that analysts have cited as a likely place where divestitures are going to be needed.
SABMiller has a partnership with China Resource Enterprise, which is the largest beer company in China. It has a 49% interest in the Snow brand, which is the most popular brand there. They're likely to have to part with that as well.
O'Reilly: I can't imagine that divesting the Snow brand would placate U.S. antitrust regulators.
Shen: You've got to keep in mind, this is going to be a whole bag of agencies.
O'Reilly: All the antitrust guys in each country are going to call each other.
Shen: While the U.S. side, we talked about the joint venture that is going to need to be dissolved most likely. There are going to be other stipulations that are required in the other regions they operate as well.
O'Reilly: OK. Antitrust problems aside, what other hurdles are there? We're talking about a large check.
Shen: Huge deal. Naturally, two obvious things other than regulatory hurdles are going to be how you're going to pay for it, and are they going to be able to integrate it well? Funding-wise, Anheuser-Busch InBev already has quite a bit of debt. They took on a ton of debt in 2008 when they merged with Anheuser-Busch and took on more debt with the Grupo Modelo deal, which was their bigger, most recent one.
With that said, they'll need to pay for the deal with mixed cash on hand and debt. The thing is, even keeping in mind that special offer for the restricted shares they gave to Altria and Bevco, they don't have nearly enough cash on hand. They'll still need at least $50 billion in debt. They're organizing that with lenders now.
O'Reilly: I have to think, though, given what companies like 3G Capital have done with Buffett and Heinz and all that, the appetite for strong consumer brands levering up in the debt markets still seems to be pretty high. I would speculate that they're probably going to come up with the money.
Shen: I think there's some credit that needs to be given to InBev, because when they took over Anheuser-Busch and the debt balance ballooned, they were able to bring that down. They were able to bring down the net debt level from $43 billion at the end of 2009 to about $25 billion three years later.
O'Reilly: Very impressive.
Shen: There's no denying the fact that for current shareholders, the risk profile for Anheuser-Busch InBev is going to go up. They pay a pretty generous dividend of about 4%.
O'Reilly: That's probably not going to go up.
Shen: Growth payout is probably going to be stagnant for a while as they work through that debt balance. Another interesting thing is, you're bringing up the Kraft Heinz deal, some of the integration is, InBev is also a fan of zero-based budgeting.
O'Reilly: Oh, no! Everybody's going to get fired!
Shen: They brought that to Anheuser-Busch and at the time, in 2008, the culture was generally wanting to squeeze every drop of efficiency out of Anheuser-Busch.
O'Reilly: For our listeners, this is from a previous show. Whenever 3G Capital, a big P/E firm that's teamed up with Buffett to buy Burger King and Heinz -- they go in there and slash everything. No more color copies. It gets ...
Shen: What zero-based budgeting means -- it's good that you're elaborating on that -- it's basically, instead of working your budget each year off the previous year's budget, you have to rejustify everything that you're spending on.
O'Reilly: Every penny.
Shen: That means really high efficiency, really incredible cost-cutting synergies, often layoffs, and they're re-evaluating everybody in the company to make sure they're adding the value they need to stay.
O'Reilly: And it's stressful.
Shen: Very stressful. Definitely a radical culture change when InBev took over, whereas Anheuser-Busch was previously a bit of a boys' club, more relaxed; some people were saying it was getting a little bloated.
O'Reilly: "We make America's No. 1 beer".
Shen: Exactly. They really went in there and shifted it radically, so it was much more efficient. We can expect to see something like that here where they recognized over $2 billion of synergies in the Anheuser-Busch InBev deal -- here you could probably expect ...
O'Reilly: Four or five, or something. That's nuts. That's the justification at the end of day here. You get AB InBev getting in on growth markets, and you also get the cost synergies because you need fewer trucks going to grocery stores. Have there been any estimates that you've seen for that at all?
Shen: It's a little early, but I'm just basing that off the previous deals and the fact that InBev has shown -- they've done so many deals recently. They have a lot of experience integrating their acquisitions. If they stay on point and stick to things like zero-based budgeting that they know, I think there's a lot of potential there.
That's on top of growth markets. While this deal is being negotiated, they're still thinking about some of their recent acquisitions and integrating their recent acquisitions of craft breweries that they've been picking up in the U.S. to get exposure to that growth as well. Clearly, this is a company that's very comfortable with buyouts.
O'Reilly: Got it. Cool. Very good. Thank you for your thoughts, Vince.
Shen: Thank you.
O'Reilly: I can't wait to see if and when this gets completed.
Shen: Yeah, exactly.
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