After a three-week-long courtship, it was announced on Monday, Oct. 12, that Anheuser-Busch InBev (NYSE:BUD) would acquire SAB Miller (NASDAQOTH:SBMRF) for a whopping $104 billion. Deals like this don't happen every day, and not just because of the sheer size of the transaction. The market share each company boasts individually, both globally and in the U.S., is staggering, and the combined entity would be a sheer goliath.
What many may not realize is just how long a road these global brewers have to take before any kind of a combination can take effect. Both have near-monopolistic control over beer manufacturing in numerous South American, Central American, and African countries. This, coupled with smaller-but-still-dominant shares in the U.S. and Europe, means that antitrust regulators in scores of countries will be coordinating to ensure consumers are not harmed. The battle for the future of beer is just beginning, and it is likely going to come down not to Wall Street investment bankers or executive presentations, but regulators and how they will choose to define the global beer industry. Here's what they're thinking.
Empire through acquisition
Neither AB InBev or SAB Miller is a stranger to dealing with investment bankers or antitrust regulators. What is now AB InBev began back in 2004, when Dutch brewer Interbrew acquired century-old Brazilian brewer Ambev. The combined entity, which became known as InBev, moved to acquire age-old American brewer Anheuser-Busch (maker of Budweiser) in 2008 in the midst of the global financial crisis.
SAB Miller, too, is the product of a succession of international "beer mergers." Originally founded in 1895 as South African Breweries, SAB has been the instigator of numerous combinations and partnerships, culminating in its acquisition of Miller Brewing in 2002.
As each entity has grown larger and larger, each successive acquisition has attracted more and more attention from international regulators. AB Inbev's 2013 acquisition of Mexican brewer Grupo Modelo, for example, was nearly blocked by the U.S. Justice Department. It was finally approved only after AB InBev agreed to sell Grupo Modelo's entire U.S. business to Constellation Brands. U.S. regulators, it seems, are not playing around when it comes to industry consolidation. This is not to say the U.S. is draconian in their policies, as it could be argued that Europe sports regulators far tougher than the U.S. Justice Department. Fortunately for AB Inbev and SABMiller, there is very little overlap in their European operations. So, for this reason, final approval for this huge merger is likely to be an American affair.
Introducing the Herfindahl-Hirschman Index
The Herfindahl-Hirschman Index (say that five times fast) or HHI, for short, is an index created by economists Orris Herfindahl and Albert Hirschman to calculate the competitiveness of a given industry. In a nutshell, the index is calculated by squaring the absolute value of each participants' market shares and summing the products. A market with just two equal participants, or a duopoly, would have an HHI Index of 5,000 (50² + 50² = 5,000). The U.S. Justice Department uses the HHI, among other qualitative factors, to determine if a market is competitive or not and considers an HHI above 2,500 to be subject to intense scrutiny. Unfortunately for ABInBev/SABMiller, the HHI for the U.S. beer industry today is already quite high:
|Company||2014 Market Share|
|All Other Brewers||16.7%|
Some back-of-the-envelope math yields a rough, current, U.S. beer industry HHI of 2,696 (44.2² + 26² + 6.7² + 3.9² + 2.5² = 2,695.99). We are aided in our calculation by the fact that "All Other Brewers" does not include a single player with a market share above 1%, including the multitude of fast growing craft brewers like Boston Beer.
Were the AB InBev/SABMiller union to be allowed, the competitiveness of the U.S. beer industry would go from what the Justice Department considers "highly concentrated" to more or less monopolistic. Jointly, AB InBev and SABMiller possess 68% market share. Adding the squares of its much smaller peers yields a hypothetical, and astonishing, HHI of approximately 5,366. Needless to say, given the Justice Department's desire to engender HHIs of below 2,500, things aren't looking good for this merger. The U.S. market is already less competitive than is desirable, and major concessions will likely be required for this deal to pass muster.
What is the Justice Department to do?
Another company benefited from the announcement that ABInbev would acquire SABMiller: Molson Coors Brewing Company (NYSE:TAP). Shares of Molson Coors popped over 10% the day the merger of its chief rivals was announced. Why, you ask? Well, as you may have noticed by now, the global beer industry borders on the incestuous. To discuss the multitude of partnerships, bottling agreements, and distribution arrangements between the world's top beverage manufacturers would require a lengthy research paper.
For our purposes, and those of the United States federal government, we need only be concerned with one key fact: SABMiller controls 26% of the U.S. beer market, not through its own operations, but through those of its joint venture with Molson Coors Brewing Company. The venture, known as MillerCoors, is 58% owned by SABMiller and is an attempt by the two companies to compete more effectively with -- that's right, you guessed it -- AB InBev. Which, of course, leads us to the inevitable conclusion that the Justice Department is likely to reach. For them to approve AB Inbev's acquisition of SABMiller, the latter company's entire stake in MillerCoors will have to be sold. Sound draconian? Perhaps, but this probable requirement may not be all that bad for the two companies.
It's not about America
Let's face it, being a giant brewing conglomerate isn't what it used to be in the good old U.S. of A. Shifting consumer tastes, and an increasingly innovative craft brewing sector, have led to a slow chipping away at the market shares of storied U.S. beer brands like Budweiser, Miller High Life, and Coors (all distributed, coincidentally, by either AB InBev or SABMiller). This has inevitably led the managements of both companies to look elsewhere in search of continued market dominance and growth.
The managements of these two companies are fully aware of the hurdles they will have to surmount in order to get this deal done. They are also, no doubt, aware that they will likely be required to sell SABMiller's entire stake in MillerCoors to Molson Coors (or another one of the few other potential buyers) in order to satisfy regulators. It sounds distasteful, but remember these companies think in terms of decades-long secular trends. Just a few market share statistics paint the picture: SABMiller has an over 95% market share in Peru, 92% in Ecuador, and a strong foothold in Africa (a likely major contributor to global GDP growth in the coming decades), where it predominates in a total of 31 African nations. This pairs extremely well with AB InBev's largely European, North American, Asian, and Brazilian footholds. Sorry, America, I hate to say it, but we are no longer a growth market coveted by multinational brewing conglomerates.
For believers that emerging markets like Africa, Asia, and South America will continue to outgrow the developed world in the decades to come, shares in AB InBev may very well prove to be a good bet. Emerging markets are clearly where the managements of AB InBev and SABMiller are placing their bets -- there's no other explanation for the more than year-long process, sleepless nights, and millions of dollars in investment banking advisory fees they are about to go through to get this merger done. The U.S. Justice Department will probably let these two behemoths join forces, but not before exacting more than a pound of flesh in order to ensure beer enthusiasts the world over will not see higher prices.
Sean O'Reilly has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.