Regulatory Intervention Kills the Merger

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In late January of 2013, the U.S. Justice Department announced that it would file a formal legal complaint in order to block a proposed merger between Belgium-based international drinks powerhouse Anheuser-Busch InBev (NYSE: BUD) and Mexican beer distributor Grupo Modelo (OTC GPMCY)(MX: GMODELOC). In its announcement, the Justice Department cited the prospect of higher retail prices for the beer and spirit brands that the two companies sell in the enormous North American market.

It appears that a deal with rival spirits distributor Constellation Brands (NYSE: STZ) was not enough to prevent the apparent break-up of the merger. As the U.S. distributor of Grupo Modelo’s products, Constellation Brands stood to earn an even more lucrative distribution contract with the newly-merged entity.

On February 14, 2013, Anheuser-Busch InBev filed an amended merger agreement that may satisfy some of the Justice Department’s concerns. In particular, it involves the sale of a major Modelo brewery to Constellation and a “perpetual” agreement that secures Constellation’s right to distribute certain Grupo Modelo brands in North America. Although this amendment appears to have satisfied Constellation and may make the prospect of further legal action less likely, it is important to note that this new action does not satisfy all of the Justice Department’s concerns. As such, the deal’s passage is not yet assured.

About Anheuser-Busch InBev, Grupo Modelo and Constellation Brands

Anheuser-Busch InBev is one of the largest global beer distributors. Formed by the merger of European beer giant InBev and St. Louis-based Anheuser-Busch, the company owns over 200 individual brands of beer. Some of these are among the world’s most heavily-imbibed drinks. Notable holdings include Budweiser, Stella Artois, Michelob, Jupiler, Becks, and Harbin. The company distributes on a global basis and employs nearly 120,000 workers. In 2012, it had an EBITDA of $15.3 billion on gross revenues of $39.3 billion.

Grupo Modelo is a Mexico-based beer distributor that operates primarily in Mexico and North America. It brews and sells several well-known brands, including Corona, Modelo, Negra Modelo and Pacifico. It also manufactures several specialty brands for exclusive sale in Mexico. Grupo Modelo also operates a 1,000-strong chain of Mexican convenience stores and bodegas under the brand name “Extra.” In 2012, the company had an EBITDA of $2.3 billion on revenues of $7.8 billion.

Rochester, New York-based Constellation Brands is a smaller North American producer and importer of wines, beers, and spirits. Many of its most profitable holdings are mass-market wine labels like Robert Mondavi, Blackstone, Ravenswood, Clos du Bois and Ruffino. It will serve as the primary U.S. importer and distributor for Grupo Modelo’s popular Corona, Modelo, and Negra Modelo beer brands. Constellation employs about 4,500 people across the United States and had an EBITDA of $666.6 million on 2012 revenues of $2.7 billion.

How the Deal Fell Apart

The initial merger agreement between Anheuser-Busch InBev and Grupo Modelo fell apart as a result of a Justice Department lawsuit. Citing a potential lack of major competitors to the merged company and rival U.S. brewing giant MillerCoors (NYSE: TAP), the suit envisioned a duopoly that choked off smaller distributors and craft brewers and raised retail prices for popular brands like Bud Light and Busch.  Miller has almost $4 billion in sales and an $8.4 billion market cap which gives them pricing power far beyond the little brewers.  However, Miller is quite small compared to the giant Anheuser-Busch with a $140 billion market cap.

It is unclear whether these concerns had merit. However, it appears likely that the proposed merger can be salvaged in the wake of the second Constellation distribution deal. Given the existence of an outstanding Justice Department suit, it may not be helpful to speculate on the time frame of the deal. Although Anheuser-Busch InBev has expressed optimism that the merger can be finalized by the end of the first quarter of 2013, this may be overly optimistic. It appears more likely that the merger will not close until June of 2013 at the earliest.

Long-Term Outlook and Next Moves

Since the terms of the merger have not yet been finalized, it would be difficult to speculate on its potential returns. However, Constellation’s share price rose by more than a third on the news of the revised merger proposal. As such, it may behoove investors to watch Constellation for further news-related volatility. Given the non-liquid nature of Grupo Modelo’s U.S.-traded shares, Constellation may be the most profitable way to play the pending merger.

However, the North American beer market is facing significant secular challenges. In recent years, the craft brew market has exploded and now comprises nearly 10 percent of the country’s total beer sales. Globally, sales of branded beer are continuing to rise at a slower pace. Given that much of Anheuser-Busch InBev’s business comes from the U.S., it is unclear whether this trend will be enough to sustain the company’s fortunes. In fact, the beer industry’s next acquisition targets may well emerge from the upper ranks of craft brewers.

In short, much of the uncertainty that shrouded the proposed merger between Anheuser-Busch InBev and Grupo Modelo is gone. However, the deal is not yet assured. In addition, certain key details remain sketchy. Investors who wish to make a short-term play on the deal’s probable completion may wish to watch Constellation and make targeted purchases on share-price dips.

mthiessen has no position in any stocks mentioned. The Motley Fool recommends Molson Coors Brewing Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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