I have been a long time investor in AB InBev, though I became one indirectly and accidentally, through a stake I took a long time ago in Brahma, a Brazilian beverage company . That company became Amber in 1999, which in turn was merged with Interbrew, the Belgian brewer, in 2004, and expanded to include Anheuser Busch, the US beer maker, in 2008 to become the largest beer manufacturer in the world. I made the bulk of my money early in my holding life, but Amber has remained in my portfolio, a place holder that provides me exposure to both the beverage business and Latin America, while delivering mostly positive returns. It was thus with trepidation that I read the news report in mid-September that AB InBev (which owns 62% of Ambev) had approached SABMiller about a takeover at a still-to-be-specified premium over the the latter’s market value. While it is entirely possible to create value from acquisitions, I have argued that creating growth through acquisitions is difficult to do, and doubly so when the acquisition is of a large public company. Since AB InBev’s control rests with 3G Capital, a group that I respect for its investment acumen, it would be unfair to prejudge this deal without looking at the numbers. So, here we go!
The Fog of Deal Making: Breaking down an acquisition
The first casualty in deal making is good sense, as the fog of the deal, created by bankers, managers, consultants and journalists, clouds the numbers. Not only do you see “control” and “synergy”, two words that I include in my weapons of mass distraction, thrown around casually to justify billions of dollars in premiums, but you also see them used interchangeably. When you acquire a company, there are three (and only three possible) motives that are consistent with intrinsic value.
- Undervaluation: You buy a target company because you believe that the market is mispricing the company and that you can buy it for less than its “fair” value. In effect, you are behaving like any value investor would in the market and there is no need for you to either change the way the target company is run or look for synergy benefits.
- Control: You buy a company that you believe is badly managed, with the intent of changing the way it is run. If you are right on the first count and can make the necessary changes, the value of the firm should increase under your management. If you can pay less than the “changed” value, you can claim the difference for yourself (and your stockholders).
- Synergy: You buy a company that you believe, when combined with a business (or resource) that you already own, will be able to do things that you could not have done as separate entities. Broadly speaking, you can break synergy down into “offensive synergies” (where you are able to grow faster in existing or new markets than you would have as standalone businesses and/or charge higher prices for your products), “defensive synergies” (where you are able to reduce costs or slow down/prevent decline in your businesees) and “tax synergies” (where you directly take advantage of tax clauses or indirectly by being able to borrow more money).
The key distinction between synergy and control is that control does not require another entity or even a change in managers. It can be accomplished by the target company’s management, if they put their minds to it and perhaps hire some help. Synergy requires two entities coming together and stems from the combined entity’s capacity to do something that the individual entities would not have been able to deliver. Note that these motives can co-exist in the same acquisition and are not mutually exclusive. To assess whether these motives apply (or make sense), there are four numbers that you need to track:
- Acquisition Price: This is the price at which you can acquire the target company. If it is a private business, it will be negotiated and probably based on what others are paying for similar businesses. If it is a public company, it will be at a premium over the market price, with the premium a function of the state of the M&A market and whether you have other potential bidders.
- Status Quo Value: This is the value of the target company, run by existing management and based on existing investing, financing and dividend policies.
- Restructured Value: This is the value of the target company, with changes to investing, financing and dividend policies.
- Synergy value: This can be estimated by valuing the combined company (with the synergy benefits built in) and subtracting out the value of the acquiring company, as a stand alone entity, and the restructured value of the target company.
Connecting these numbers to the motives, here are the conditions you would need for each motive to make sense (by itself).
|Undervaluation||Acquisition Price < Status Quo Value|
|Control||Acquisition Price < Restructured Value (Status Quo Value + Value of Control|
|Synergy||Acquisition Price < Restructured Value + (Value of Combined company with synergy – Value of Combined company without synergy)|
Which of these motives, if any, is driving AB InBev’s acquisition of SABMiller, and whatever the motive or motives, is the premium being paid justified? To make that assessment, I will compute each of the four numbers for this deal.
Setting up the AB InBev Deal
[drizzle]The first news stories on AB InBev’s intent to buy SABMiller came out on September 15, 2015, though there may have been inklings among some who are more connected than I am. While no price was specified, the market’s initial reaction was positive, with both AB InBev and SABMiller’s stock prices increasing on the story. The picture below captures the key details of the deal, including both possible rationale and consequences:
There were two key reasons provided to rationalize the potential deal. The first is geographic complementarity, since these two companies overlap in surprisingly few parts of the world, given their size. AB InBev is the largest player in Latin America, with Brazil at its center, and SABMiller is the biggest brewer in Africa. SABMiller’s Latin American operations are outside of Brazil, for the most part and while AB InBev has significant North American operations, SABMiller’s North American exposure is entirely through its Coors Joint Venture. While no specifics are provided, the basis for synergy seems to be that after this deal, AB InBev will be able to expand sales in the fastest growing market in the world (Africa) and that SABMiller will be able to increase its revenues in the most profitable market in the world (Latin America). The second is consolidation, a vastly over used term that often means nothing, but if it tied to specifics, relates to potential costs savings and economies of scale. While the absence of geographic overlap may reduce the potential for cost cutting, AB InBev can use the template that it has used so successfully on prior deals (especially the Grupo Modelo acquisition) to cut costs in this acquisition as well.
There are also negative consequences that follow from this deal. The first is that when anti trust regulators in different parts of the world will be paying close attention to this deal, and it