Acquiring Jim Beam and the Skinnygirl
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Who doesn’t love a good takeover? A large company acquiring a smaller company for a significant premium is something that we’d all love to see, but not something we should expect. Takeovers are very unpredictable. That unpredictability means not all potential takeover stocks are worth investing in. An investor could be waiting a very long time for a takeover-payday that may never materialize. If the underlying fundamentals of the company are lacking, that makes the wait all the more risky. With that in mind, let’s look at Beam (NYSE: BEAM) to see whether this potential takeover stock deserves a place in your portfolio.
Formally known as Fortune Brands, Beam is the 4th largest spirits company in the world, the 2nd largest in both the United States and Australia, and the largest US-based spirits company. Through a combination of organic growth and acquisitions, Beam has turned what was a bourbon-heavy liquor company into one with a much more diverse liquor-brand portfolio. Some of their many brands include Jim Beam (No. 1 bourbon worldwide), Sauza Tequila (No. 2 tequila worldwide), Teacher’s Scotch Whisky (No. 1 Scotch in India, No. 2 in Brazil) and Skinnygirl (one of the fastest-growing spirits brands in the United States).
The liquor industry is a defensive industry. People buy liquor in good times and bad; in good economies and bad economies. Last year, Beam became a pure-play company in this defensive industry. In July of 2011, Fortune Brands completed the sale off its golf division, using the net proceeds of about $1.1 billion to pay down debt. In October 2011, Fortune Brands spun-off its home furnishings and hardware businesses. This spin-off resulted in a $500 million tax-free dividend, which was used to pay down additional debt. What remained was their liquor business, renamed Beam, now a pure-play global spirits company with significantly less debt and a potential takeover stock.
As a takeover target, Beam is the only major pure-play liquor company that does not have significant barriers for another company to acquire it. Of the likely names, there are three liquor companies with the size to acquire Beam. These three companies are British liquor-giant Diageo (NYSE: DEO), the French-based Pernod Ricard (Nasdaqoth: PDRDF.PK) and the privately held Bacardi (the first, second and third largest spirits companies worldwide, respectively), with much of the speculation talk focusing on the largest, Diageo.
Some of Beam’s recent actions, however, don’t paint the picture of a company looking to be acquired. Beam’s acquisition of the Cooley Distillery earlier this year seemingly makes it more difficult for Diageo and Pernod Ricard to easily acquire Beam. Before the acquisition, the Cooley Distillery was the last remaining independent distiller of Irish whisky; one of only three major producers of Irish whisky. The other two major producers are each owned by Diageo and Pernod Ricard. In regards to Irish whisky production, acquiring Beam could possibly present anti-trust issues for either company.
Even without this issue, it should be made clear that Beam will not be acquired in the relative short term. The reason for this is the manner in which Beam was spun-off. It was done using a complicated tax-avoidance transaction called a "Reverse Morris Trust,” a tax law that applies to companies that engage in tax-free reverse mergers. This law specifies the requirements for a tax-free reverse merger, including how long a company must remain a separate company before it can then be acquired. To keep this reverse merger tax-free, Beam will have to remain a separate company for some time in order to avoid retroactive tax liability. Investors looking to buy Beam for its takeover potential should keep this in mind and make sure their time horizons are long-term.
Because of all of this takeover speculation, Beam’s valuation is seen as a red-flag by some analysts. Beam’s trailing and forward earnings both trade at a fairly significant premium to its mid-cap peers, Jack Daniel’s maker Brown-Forman (NYSE: BF-B) and Constellation Brands (NYSE: STZ). One would argue that Beam deserves to trade at a premium to its similar-sized peers specifically because of its takeover potential. However, if investors ever tire of waiting for a takeover or if a takeover becomes less likely, this valuation could be an issue going forward.
I believe acquiring a company like Beam would make sense for the likes of Diageo, Pernod Ricard and Bacardi. And investors seem to agree. Since trading as a separate company in September, Beam’s stock price has increased over 35%, with the S&P up a little less than 8% over the same period. For those considering Beam, waiting for another European-inspired pullback before pulling the trigger might be the prudent decision. Unfortunately for those currently on the sidelines, during the most recent May-long European-pullback, Beam was actually up more than 5%. As I mentioned earlier, liquor is a defensive industry. Beam’s stock performance in May certainly illustrates that point perfectly.
WhichStocksWork has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Beam and Diageo plc (ADR). 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. If you have questions about this post or the Fool’s blog network, click here for information.