Description

Thesis:  The partial-stock election option in the ABI – SAB deal offers an opportunity for long term investors to earn a near private-equity like return in a stable, investment grade, moderately-levered, market-leading beer company with top flight management, high current dividend yield (nearly 4%) and no fees.  For private individuals and/or investors not subject to near-term liquidity restrictions, the stock election is like buying ABI at a ~18% discount, while maintaining the ability to hedge with liquid stock during periods of market turbulence, in exchange for a five-year lock-up.  Under conservative assumptions, this election can return ~10 – 13% annualized over 5 years, or a return multiple of ~1.7 – 1.9x, while bull case assumptions provide a return of ~12 - 15%, or up to a ~2.0x multiple (our expectation is a 2.0x return and a ~15% irr).  At the higher end of this range, the return approximates that of private equity, which typically invests in high yield, cyclical businesses, whereas ABI is a much more stable business with a dominant, investment-grade franchise (making the risk/reward much more favorable).  With potential upside in the bull case based on faster growth (due to improving macro environment and/or revenue synergies), strategic actions, and/or, especially, synergies in excess of ABI’s public targets (and the buy-side is more likely to expect the higher end of the return range), we think the partial stock election looks particularly attractive.             

Background:  With today’s SABMiller shareholder approval of the acquisition by Anheuser-Busch InBev, the only decision left for SAB shareholders to make is whether to elect for the cash or partial stock option.  The cash alternative provides GBP 45.00 while the partial stock election pays GBP 4.6588 plus approximately 0.484 restricted shares of ABI NewCo.  The restricted NewCo shares will have the same dividend and voting rights as publicly traded ABI NewCo shares listed post-deal, however these shares will be unlisted with transfer restrictions and a five-year lock-up.  SAB is currently trading just shy of the cash deal option (last px GBP ~44.89), while the current value of the partial stock election – assuming no discount on the restricted stock – is worth GBP 53.65 (or a 19% premium to the cash option). 

The reason for this disconnect is that there are likely to be very few marginal buyers of private securities subject to a long lock-up, and this election was essentially created to allow the 2 largest SAB shareholders (Altria and Colombian family controlled Bevco, which together own ~40% of SAB) to roll their shares into NewCo with minimal tax impact.  The particularities of the restrictions, including a requirement that electing holders must place the entirety of their position into the share election, seems designed to minimize the attractiveness of this option to very long-term shareholders only.  In the case of elections in excess of the issuance limit of 326mm shares of NewCo, SAB electing shareholders will be pro-rata adjusted (including Altria and BevCo).  This pro-ration would kick in when about 2% of non-Altria/BevCo shareholders elect stock.  At max pro-ration (which is essentially impossible), an electing shareholder would receive 41% of his position in the partial stock election.  At a more realistic 10 – 20% estimate of non-Altria/Bevco stock electing shareholders, an SAB shareholder will receive 80 – 90% of the partial stock election value.  In either case (both max pro-ration and near-minimum pro-ration), the implied price paid for ABI NewCo shares is ~18% discount to ABI’s current trading levels – it’s just a question of how much of your position gets converted into stock.           

Pro Forma ABI: 

The Founder of 3G Capital Jorge Lemann and his partners make up the controlling shareholders of ABI, and they have a very strong track record of successfully integrating large acquisitions (see, e.g., Inbev and BUD) and operating with ruthless efficiency in cost-cutting.  Lemann is held in high esteem by Warren Buffett, with whom 3G partnered in taking over Heinz in 2013, and is well-known for his zero-based budgeting cost cutting methodology.  With the SAB acquisition, ABI will enlarge its market leading beer company into a truly global powerhouse with a more attractive growth forecast than both similar sized consumer staples and its brewer competitors

-          Over the next three years, PF ABI is expected to grow revenues and EPS at nearly 6% and 15.5% CAGR respectively compared to its consumer peer average of 2-3% and 7.5% respectively

-          PF ABI will also grow faster than its brewery and alcohol peers which are expected to average 4.0% and 8.3% respectively (ex-TAP, which will grow due to the divestiture of SAB’s stake in their MillerCoors JV)

o    PF ABI is expected to outpace other brewers thanks to enhanced exposure to faster growing developing markets and superior scale.

-          Given ABI’s superior growth prospects and yield, it is fairly valued relative to its peers

o    PF ABI trades at ~24x ’18 EPS vs. Brewer avg of ~20x (ex-SAB & TAP) and consumer staple avg of 19.5x, however the full benefit of synergies isn’t expected until years 3 or 4

§  Meanwhile, public ABI yields 3.1% vs ~1.7% for Brewers and 2.6% for Consumer staples while projections assume relatively quick de-levering from closing LTM leverage > ~4.8x to ~3x in 3 years, at which point ABI will have the ability to increase its dividend and start buybacks

·         However, the adjusted yield on stock-elected ABI NewCo shares is even higher at ~3.74% (given the discount purchase price)

o    Looking out to 2022E, the approximate point at which the restricted ABI stock would become transferable, ABI is trading at a ~17x multiple

-          ABI projects $1.4b per year of synergies 4yrs post-closing, excluding any revenue and cashflow synergies, and in addition to SAB’s current standalone cost savings goal of $1b by 2020

o    Will cost $900m in first three years to realize on-going synergies

o    Synergies are incremental to SAB’s stand-alone $1.05 billion cost savings target by 2020

§  SAB’s cost saving initiatives would translate to ~600bps of EBITDA Margin improvement from ~33%  – which would get them to ABI levels

o    ABI’s projected $1.4b in synergies is ~9.1% of SAB’s ‘16E sales of $15.3b or 7.4% of projected ‘19E sales

§  Beverage sector synergies average ~5% of sales according to UBS, meanwhile food consumer staples average 5-7% (Kraft Heinz was ~8%)

§  ABI/Modelo did $1b of cost savings (up from original $600m target) equating to 16% of modelo sales over 4 years (vs. 9.6% original target)

§  On Budweiser, ABI initially estimated $1.5 billion of cost synergies (~10%) and delivered over $2.25 billion (~15% of sales), of which $1.3bn was achieved via ZBB with the balance from economies of scale in procurement and marketing and the roll out of global best practice.

§  Meanwhile, MillerCoors JV did 12%, SAB/CUB did 8% & Heineken/FEMSA did 7%

-          Every 1% increase in synergies as a % of SAB sales translates to ~$150m and results in ~120bps of incremental accretion to stand-alone ABI

o    $1.4bn in PF synergies requires a combined EBITDA margin of ~42% vs. ABI  LTM EBITDA Margin of 38-39%

§  ABI EBITDA margins are up ~6-7% (from 33%) since 2008 BUD deal, which only took 3 yrs. to get from 33% pre-deal to ~39% in 2011

o    In LatAm, the case for ABI drastically improving SAB’s margins is strong

§  SAB’s margins range from 35-40% vs. ABI’s 45-50% (Brazil 50%, Argentina 45%)

o    In Africa, SAB’s margin of 30% is similar to that of ABI’s Mexico margins prior to their cost saving program, which added 2,000bps, however it is unclear if similar progress can be made in Africa

o    In Europe SAB is only slightly below ABI with 24% vs. 27% for ABI

-          Synergy opportunities exist up and down supply chain, as it would allow for increased direct and indirect purchasing scale, as well as making vertical integration more attractive (Glass, aluminum, grains)

o    Better leverage existing assets and capabilities - Fixed costs as a % of sales for ABI are ~17-18% (~$7.6b) vs. SAB’s 23-24% (~$3.7b), by comparison Carlsberg and Heineken have 30% and 38% respectively

§  Assuming SAB could reach similar level of fixed costs as % of sales, this would be $0.8-1.0b

o    Increased footprint to leverage R&D spending for liquid, packaging, and delivery

o    Corporate/HQ costs are $111m of EBITDA for SAB

o    More opportunities for people development; increases retention

o    Brito cites SAB’s diverse mgmt. teams as being asset in regions where ABI has no presence

-          Cross-selling and Branding Opportunities – Adding SAB’s strong Intl and Local brands along with enhanced product mix (premium, etc.) are seen as further opportunities for PF ABI/SAB

o    These revenue synergies HAVE NOT been factored into ABI synergy estimates and represent UPSIDE

o    ABI already has 200 brands, including 16 power brands with $1b in annual sales, and recently bought out its JV partner with the aim of establishing Budweiser, Stella and Corona as leading international beers. The enhanced footprint will help ABI grow these and its other power brands, as well as employ extended price ladders (particularly as premium share grows in EM)

o    Global brands have been important driver for ABI, as their revenues were up 8.4% in Q2’16 and 7.2% in H1’16, vs. overall revenues which fell -2.2% and -6%.

o    Advertising likely also a synergy given ABI’s current spending, SAB would enjoy the benefits of enhanced presence (to illustrate, ABI currently sponsors 20-30% of Music and festivals in North America, 2^nd only to KO and slightly ahead of PEP, while MillerCoors is a distant 4^th.)

§  Marketing investments as a % of ABI’s sales has grown from just over 10% in 2010 to ~14%-15% in past two years (SAB is ~14.5%), as marketing becoming more important in developed markets to battle craft trends 

§  ABI under-indexes in fast-growth craft (8% of sales) despite acquiring 5 craft brewers since 2011 and as a result ABI has suffered -50bps market share losses in US over last 5 years

-          Global footprint - increased growth and geographic diversity is a key attraction to acquiring SABMiller as it boosts ABI’s organic growth profile through greater EM/developing market exposure, as LatAm is 22% of SAB Sales (31% of EBITDA) and Africa is 28%, and these two markets are the bulk of what ABI plans to keep

o    PF ABI  – Developed market exposure decreases from 45% to 34%

o    ABI currently has no presence in Africa, while PF SAB, Africa would represent 12% of PF 2015 sales and 10% PF 2015 EBITDA, giving it a market leader position in South Africa and allowing ABI to call itself the “First Truly Global Beer Company” (SAB adds Australia too (41% market share))

o    SAB’s LatAm assets particularly attractive to ABI given their overall fit and lack of overlap

o    SAB is market leader position in Colombia, Peru and Central America, while ABI is currently highly dependent on Brazil market (68% marketshare) and to a lesser extent, Argentina.

o    ABI is over-exposed to the US and Brazil as these together comprise 52% of sales (38% PF), and have relied on price increases rather than volume over last few years

o    PF SAB, LatAm would represent 31% of Revenue (29% prior) and 39% of EBITDA (37% prior)

o    Asian markets also offer opportunities, specifically Vietnam and India (ABI already has strong presence in China and S.Korea)

-          Overall Market Growth - Global alcohol sales expected to increase 3% thru 2020, an uptick from +2% since 2010

o    Beer grew ~2.8% in the last 10 years, but slowed notably in the last few years, to ~1% in 2013-2015

o    In 2016, Global alcoholic beverage sales expected to rise +3%, (4% in spirits, 2% in wine and 3% in Beer)

o    In 2015, ABI revenues declined -7.3%, and consensus predicts another -1% drop in ’16 (due to FX and Brazil weakness)

o    SAB revenues declined ~-9% in 2015 (FX), yet consensus has sales rebounded ~5.5% in ‘16

o    In the US, demand for spirits and craft beer is driving growth and eating market share from traditional larger brewers, while Europe has seen volumes decline even more

-          Market Share of Top Brewers

o    ABI has ~20% global market share (doubled in past 10 years, thanks to Inbev (added ~4%) and other acquisitions)

o    SAB has ~11%, up ~3% from ~8% in past 10 years.

o    PF ABI/SAB would have 27% total global market share (by volume due to significant divestitures)

o    Heineken has 9% up ~3% in past 10 years

o    Carlsberg ~6% up ~4% in past 10 years

o    TAP after acquiring rest of Miller Coors JV will have ~6% (up from 2.5-3% 10 years ago)

Projections / Valuation of PF ABI (assumes some developed beer market recovery, 3 years to realize synergy targets followed by modest margin improvement and slower growth in the out years):

Pro-ration Possibilities:

Future ABI Value and return:

Catalyst

Risks:

-          Illiquidity – this is clear; if you may need the money before 5 years are up, this isn’t for you

-          Market exposure – this can be mitigated by hedging publicly traded ABI from time to time (not recommended as a pair; just pointing it out)

o    Over last 2 years beta was 0.73 for ABI

o    Over last 5 years beta was 0.6 for ABI

-          Synergies disappoint

-          Beer market growth, especially in developed markets, fails to recover

-          Craft beer continues to steal share from ABI in US

-          Dividend stays flat or, if revenues disappoint, is forced to be cut in order to reduce leverage

Catalysts:

-          Increased target synergies

-          Over the longer term, achievement of synergies

-          Strategic possibilities within beer space likely limited, however sell-side speculates on non-alcoholic beverage deals