This Elephant Deal Will not Happen (yet)

By Federico Zaldua - March 7, 2013 | Tickers: BUD, CCU, GPMCY, SBMRY | 0 Comments

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I just came from a Banking conference in Bogota, Colombia. Most people were consumer goods experts, and the talk revolved about brewers. Having worked at AB InBev (NYSE: BUD) , brewers are always a matter of interest to me. As a matter of fact, brewers are usually a matter of interest to most bankers, since its an industry that has been consolidating itself very aggressively for the last twenty years. Huge companies like AB InBev have been attaining what is every consumer goods company's (CGC) dream: market share dominance.

The reason is one I have explained many times: The business of a CGC is based on distribution and distribution. Fixed costs are a big chunk of the total costs a brewer has to face. If you dominate a market, then you not only have pricing power, but your fixed costs per unit of volume sold decrease to a relatively low level. As a result, your profitability levels soar.

Here in Colombia, the talk was about the next M&A phase in the beer industry. Most people are convinced that after AB InBev completes the Grupo Modelo (NASDAQOTH: GPMCY) deal – after the U.S. Department of Justice approves it – the next M&A deal might be between giants. Bankers speculate about a merger between AB InBev and the second brewer in the world, SABMiller (NASDAQOTH: SBMRY).

The reason for a deal between those two giants is the most simple one: There is almost no overlap between the markets both companies dominate. For example, SABMiller dominates Colombia (thanks to SABMiller's and Bavaria's merger in 2005,) South Africa and Australian markets (SABMiller acquired Foster's) while AB InBev dominates Brazil, Argentina, Peru, Bolivia, Uruguay and, from now on (after Modelo's acquisition,) Mexico.

All of the above being true, I am convinced most people are wrong. A deal between SABMiller and ABInBev is not going to happen anytime soon. My two reasons are also strong and are based on the fact that ABInBev's management is very focused on delivering value to its shareholders.  My reasons:

1. AB InBev's stunning 39% EBITDA margins not only come from the huge market share the company enjoys in most of the markets it operates, but also from its strict cost-cutting policies. The company puts into practice its policies into the acquired companies, boosting profitability. Hence, the higher the margin improvement room, the better for AB InBev. Grupo Modelo's case is significant since the Mexican market leader (the maker of the popular Corona brands) has an EBITDA margin of 29%. Therefore, potential synergies were just impossible to resist. SABMiller would not be irresistible. Its EBITDA margin is already high at 32%.

2. SABMiller trades at very high multiples. The second brewer in the world trades at 2013 14x EV/EBITDA, and ABInBev (trading at 2013 11x EV/EBITDA) will not make an expensive acquisition if it can't improve margins in a significant way.

Other deals make more sense for both companies. Just as a simple example, Chilean market leader Compania Cervecerias Unidas (NYSE: CCU) – which owns more than 90% of the Chilean market – trades at 2013 10.8x EV/EBITDA and has an EBITDA margin of just 21%. That means that there is huge room for improvement which  means that there is a lot shareholder value to be gained. In a few words, the huge deal that most people in the beer industry is expecting is not going to happen. At least for now. After Modelo, we shall see many smaller deals before either ABInBev or SABMiller hunt their next corporate elephant.

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