The Anheuser-Busch Plan To Buy SABMiller

I have not covered Anheuser-Busch stock nearly as frequently as some of the other companies that have the top slots in a consumer market segment. My hesitation for covering the stock has been a product of the Belgium headquarters which require heavy dividend taxation regardless of whether you make the investment in a regular brokerage account or a tax shelter, and the company’s staggering debt load. They have $51 billion in debt.

Last August, I argued that Anheuser-Busch would be unlikely candidate for significant earnings growth and dividend growth for the medium term, as I publicly disagreed with analysts calling for 9% annual growth. I made that prediction because I saw revenues stagnate, and I knew that retained earnings would be needed to bring the debt down to more manageable.

The 3G team did not grow the brand, but they managed to only lose a point or two of market share while drastically reducing costs. That is how shareholders earned their returns.

But there are limits to the 3G way. At no point has the 3G team ever shown the capacity to build a brand the old-fashioned way by increasing affinity, gaining market share, and achieving organic growth. When costs can no longer be cut, this leads to stagnation.

And it shows up in the numbers. Anheuser Busch made $5.54 in profits last year, will make $5.65 this year, and is on pace to make $5.75 next year. That is a company keeping pace with inflation; it is not the hallmark of a company building wealth for shareholders.

This earnings stagnation means that the 3G needs to repeat what it did at Burger King (add Tim Horton’s) and Heinz (add Kraft) because the team possesses the skill set to combine franchises and cut costs. That is their game.

That is why Anheuser Busch is trying to become a monolith $275 billion company by merging with SABMiller. It will give Anheuser Busch the opportunity to create value the only way it knows how–by getting rid of people and drastically lowering the costs. I imagine that Anheuser Busch will give SABMiller very attractive offer, as it needs the transaction to go through. There is no other way, consistent with 3G’s current skillset, to raise earnings per share by a very high amount over the next five years without doing this deal.

The political angle that makes life interesting is that tobacco producer Altria owns a 27% economic and voting interest in SABMiller stock. This is relevant because it means that Altria likely doesn’t want a huge tax burden from a cash buyout. It has a sweet gig right now taking SABMiller dividends, paying no taxes on them to the British government, and using that cash to augment operations and pass on to shareholders as beer prices rise and volumes grow modestly.

But a SABMiller takeover could result in a huge capital gains tax bill if it is a cash buyout, and it would also make Altria susceptible to Belgium taxes in addition to American taxes on every theoretical AnheuserBuschInbevSABMiller dividend that it collects. I’m not sure Altria is ready to make peace with that.

The manifestation of Altria’s 27% interest in SABMiller is that three of the Board of Directors seats come from Altria. My expectation is that they will push for a corporate inversion that switches Anheuser-Busch’s headquarters from Leuven, Belgium to London, United Kingdom. If that happens, Altria could maintain the status quo of collecting beer dividends without paying an additional tax due to the U.S.-U.K. Tax Treaty. It would also reopen Anheuser Busch as a potential investment to American shareholders that were put off by the requirement of Belgium taxation and American taxation on each dividend payment. We will see whether the 3G commitment to cost-cutting includes uprooting their own lives.

The funding of this deal, if it goes through, will also be noteworthy. Anheuser-Busch only has $8 billion in cash, which may sound like a lot, but is locked up in countries throughout the world for liquidity purposes and is still less than the $10 billion that the company uses keeps on hand for operating purposes. I’m not sure the cash would be used to make this deal.

And there is also already $50 billion in debt on the balance sheets. Anheuser-Busch has already secured clearance to borrow $50 billion in debt from banks to fund this takeover, and it would also need to come up with about $30 billion in share dilution to satisfy the likely premium required to executive this deal. Plus, there is the $20 billion in debt that SABMiller carries on its balance sheet that will be transferred to Anheuser Busch’s balance sheet.

This means we are talking: $30 billion in share dilution, plus $70 billion in additional debt ($50 billion taken on to complete the acquisition, and $20 billion required from SABMiller’s current debt obligations). Combine this with the $50 billion in debt currently on the balance sheet, and you will be looking at a company carrying $120 billion in total debt while diluting existing shareholders 17.5%.

What does Anheuser Busch get in return? An additional $3.5 billion in current profits from SABMiller alone. Right now, Anheuser-Busch makes $9 billion per year in profits. It would emerge as a company making $12.5 billion annually in profits against $120 billion in debt. The expected share dilution would increase the share count from 1.5 billion to 1.76 billion. That means earnings per share would increase from $5.65 this year to $7.10 per share before the cost cuts start to take effect.

The reason Warren Buffett partners with 3G is because of what the company does during the first five years of cost cutting. It grew profits from $2.50 in 2010 to $5.54 in 2014 (that is actually a five-year period because I am measuring from the start of 2010 until the end of 2014.) The magic stopped after that, but the 2010-2014 period of rapid earnings growth from a stodgy high-quality industry is why Warren Buffett enjoys working with these guys.

That is 121% profit growth in five years. That is why Berkshire owns a quarter of Kraft-Heinz. Anheuser Busch would likely try to replicate with SABMiller the same process that occurred when Inbev merged with Anheuser Busch. If that happened, the $7.10 per share in profits realized by the combined megabrewery in 2016 would grow to $15.69 per share in 2020.

There are still too many moving parts to perform a concrete analysis. To be clear, all of these estimates are my extrapolations based on the current credit facilities available to Anheuser Busch Inbev. If the amount changes, or the company does not max out the proverbial credit card, or the final offer is much higher or lower than the premium I estimated, then the future projections will change substantially. You should understand this is a preliminary analysis, with my using the known numbers to take guesses at the incomplete figures.

I’m curious to see the political angle of how Altria fits into this, and whether a significant amount of stock will be issued to fund the transaction and whether headquarter relocation will be up for grabs. I’m also curious to see whether Anheuser-Busch will become the first company in the world to owe $100 billion in balance sheet debt.

This potential represents two competing forces. You have 3G’s inability to grow earnings after implementing significant cost cuts against the backdrop of receiving a new slab of marble to chisel all over again. It is also likely true that people will make more money buying now compared to those waiting for the dust to settle.

Every time something like this happens, I read people say: “I’m going to wait for the deal to go through, see where the headquarters ends up located, and take a look at the annual reports that show a couple years of combined numbers. I want to get a feel for the earnings and dividend growth of the combined company.”

The problem is that everyone takes this approach, and the increased certainty always translates into higher valuations absent general economic deteriorations around the globe.

The caveat is that this is not Benjamin Graham’s idea of a conservatively financed balance sheet. Why buy Anheuser-Busch with $100+ billion in debt when you can just buy Berkshire that is about to immediately accrete 10% in earnings from the Precision Castparts acquisition and still have +$25 billion in cash on hand that is being replenished at a rate of $2 billion per month? The answer to my hypothetical is that 3G delivers more earnings growth during the first five years of drastic cost cutting compared to what you’d get from a mature Berkshire. I can tell you where each path leads, but I can’t definitively say which one is the best for you to take.