Anheuser-Busch Inbev (BUD) has announced the terms of financing for its $104 billion acquisition of SABMiller for $68 per share (it works out to 44 pounds per share on the London Stock Exchange.) Verizon Communications, which currently holds for the record for one-time corporate borrowing as a result of needing $49 billion to buy out a joint venture with Vodafone in 2013, is about to be surpassed by 3G’s current strategy to take on $70 billion in debt to complete the SABMiller transaction. About $55 billion of debt will come from bond offerings.
This debt binging is entirely predictable for those that have studied the history between the partners at 3G Capital. The origins trace back to 1989, when Jorge Paulo Lemann, Carlos Alberto, Sicupira, Marcel Hermann Telles, and Roberto Thompson Motta got their hands on Brahma, a declining Brazilian brewer that had the highest costs of any company doing business throughout the country.
Lemann, a former professional tennis player, was settling into his life’s second career by paying attention to young talent that had a passion for running businesses well. Of note, he met a young man named Carlos Brito and paid for the entirety of his tuition and living expenses at Stanford Business School without requiring any commitment from Brito in return.
The Lemann led team chose to take on debt immediately in order to upgrade beer machinery and lay off 30% of the Brahma work force, sextupling profits between 1989 and 2004. During this time, Lemann and the rest of 3G was quiet on the acquisition front–using the 1990 onward period to reduce balance sheet debt and morph into the larger Ambev to become one of the key players in the Brazilian beer market. The move only required moderate debt and share dilution–nothing unusual in the world of mergers and acquisitions. It should be noted that Brahma became known for low-cost manufacturing, rather than robust sales growth, during this period of sextupling profits.
In 2004, the 3G-led Ambev began to show international ambitions, tripling its debt to take on Belgium’s Interbrew. It took fifteen years to get there, but 3G finally had its hands on two brands that showed promise of cross-national appeal: Stella Artois and Beck’s. The deal was quickly put together by Vicente Falconi, who thought that the famous, national beer brands was a ripe area for cutting costs.
Shortly after the merger, Lemann called upon his mentee, Carlos Brito, to manage the Belgio-Brazilian conglomerate. Brito had been winning praise at Royal Dutch Shell for cutting the production costs of petroleum production at oilfields throughout the country. But spending the late 1990s and early 2000s in the oil sector did not mean that Brito was naive unfamiliar with the workings of Big Brewery–far from it!
After graduating from Stanford Business School in 1990, Lemann hired Brito as an analyst for Brahma and arranged for him to travel to the United States to learn the best practices at Anheuser-Busch. This opportunity was a creature of its time–in the 1960s, 1970s, and 1980s, the beer industry was interwoven with national pride. If you were in the United States, you had Bud Light. If you were in Mexico, you had Corona. If you were in Brazil, you had Skol. If you were in Ireland, you had Guinness. If you were in Australia, you had Victoria Bitter. If you were in India, you had Kingfisher. Beers were thought to be highly regional with limited room for cross-border expansion (for instance, Anheuser-Busch succeeded in getting Canada hooked on Budweiser, but it was believed that these brands would not convert well overseas.)
Anheuser-Busch had exceptional hubris in hindsight, continuing this practice even until the 1990s once brewing companies began to view overseas brewers as actual competition. Anheuser-Busch continued to give its practice tips to overseas competitors willingly in hope that they would adopt similar best management practices, and then when Anheuser-Busch would come knocking with a buyout offer years later, the streamlining process would be much smoother because the acquired brewer would share processing and cultural similarities.
Instead, this open-information policy sowed the seeds of Anheuser-Busch’s eventual takeover. When Brito visited Anheuser-Busch in the early 1990s, he paid special attention to the company’s ambitious international expansion efforts Canada–eventually Budweiser into the best sold brand in the country. He learned about marketing–bid heavily on all sports teams and cultural traditions that inspire happy thoughts, and tap into that happiness by slapping Budweiser logos over the experience. Increase productivity by giving workers bonuses for finishing tasks early–a tactic later embraced by FedEx when they permitted workers to leave as soon as they finished the day’s work (this practice has since been discontinued for negligence/legal liability reasons.)
He also learned about politics–namely, how consumer unrest can be settled by making superficial concessions. When Anheuser-Busch first introduced Budweiser to Canada, it offered to make trivial donations to Canadian education and mention that hundreds of jobs would be created as a result of this international expansion. Four years later, when Brito was knocking on the doors of Pestalozzi Street with a $52 billion check for shareholders–he privately expressed astonishment that Anheuser-Busch’s Board was dickering over terms like keeping Anheuser-Busch in the merged company name, maintaining the stable of Clydesdales, and affirming the commitment to the St. Louis Cardinals’ Busch Stadium.
Brito happily ceded ground on matters like the name of the new company–he cared about securing workforce autonomy, and was elated that the old Anheuser-Busch Board did not seriously try to tie his hands with workforce management. In the seven years since taking on $35 billion in debt to merge Inbev with Anheuser-Busch, he has slashed the workforce by 20% and cut an estimated 2,500 jobs in North America (though Anheuser-Busch does not disclose the official numbers.)
You may wonder–what tactic does Brito use to achieve these cost cuts, given that he’s never going to visit places like the Jacksonville, FL brewery. In a speech to Stanford Business School students in 2009, he tipped his hand–he mentioned that the combined Anheuser-Busch Inbev beer conglomerate had 90,000 employees, yet he only considered 250 of them indispensable. After receiving pushback for his comment, he analogized to sports–claiming that people do not get upset when teams name MVPs and note that some players are more exceptional than the rest, yet he receives frequent criticism for regarding most employees as ultimately dispensable.
He may not share this view publicly anymore, but it is clear that Brito manages the international brewing operations with this principle in mind. He identified the forty most powerful men and women throughout the entire company’s operations, and gave each of them highly aggressive cost-cutting targets. It was $2.1 billion plan–if the 2014 targets would get met, a pool of $1.2 billion was available to be split between the 40 executives. And if a 2019 target was met, then another $900 million would be split between 40 men and women. To encourage tactic sharing and collaboration, the bonus is based in part on the percentage of key executives that meet their target–the bonus is higher if all 40 executives meet their target compared to only 15 meeting the target.
It creates skewed outcome incentives that leads to insanely aggressive cost-cutting measures. You have highly intelligent executives that ordinarily make $500,000 to $2.5 million per year that can receive a $52 million payout under a best case scenario if they meet the wildly high targets. And meet these targets they did. Back when St. Louis executives ran the brewery, the profit margin was 8.2% on each can of beer sold. Now, it is 19.6%. That’s never been seen before in the beer industry.
Some of this cost-cutting was potentially harmless. Removing corporate jets and in-house barbershops seemed like a sensible way to lower the cost structure in a slow-growing industry. Moves like slashing the workforce and switching workers to lower quality health-care plans no doubt decreased the morale of the firm, and has a strong deterrent on recruiting exceptional talent. But other actions do affect the brand directly in a way that consumers slowly start to notice. Suppliers have grown agitated by Anheuser-Busch’s insistence to take twice as much time to make payments for ingredients, and executives have embraced thinner bottles and cheaper barley malt, rice, yeast, and hops that go into production. Anheuser-Busch also raised the costs of products by 12% at the same time the ingredient and bottle quality of the national brands was diminishing.
The takeoff of the microbrew industry–which accounted for 4% of market share at the time of the Anheuser-Busch merger with Inbev–has expanded to almost 10% in the seven years since the merger take place. The rising success of this niche, trendy competition is at least partially the result of Anheuser-Busch Inbev producing inferior products by diluting the brand quality.
People sometimes wonder–what is the numerical value of all this? If you cut costs, treat employees in a discardable fashion, and reduce the quality of the brand, how do these tactics manifest themselves in the numbers? The answer is: One. During every year since the merger with Anheuser-Busch, the core portfolio of brands has lost a little over one point of market share per year. Back in 2008, the combined Anheuser Busch and Inbev sold 106 million barrels of alcohol. At the end of 2015, that same product portfolio will only sell a bit over 95 million barrels of alcohol.
David Peacock, whose current claim to fame is trying to come up with a stadium plan to keep the St. Louis Rams in St. Louis, rose to prominence by being a close advisor to the Busch family and played a strong role into turning Bud Light into America’s foremost national brand through expansive sports advertising and an exclusive sponsoring relationship with the NFL. Peacock offered possibly the most important insight into the 3G strategy at Anheuser-Busch: “They need a transaction at least every three to four years to get growth.”
He is, without a doubt, correct. McKinsey and Co. analyzed the market share changes at Anheuser-Busch Inbev since the 2008 acquisition. During the subsequent six years (this report was released at the end of 2014), McKinsey reported that: 19% of market segments experienced growth, 23% stagnated within a percentage point of 2008 levels, and 58% experienced market share loss.
The insult of the strategy is that it lives off the contributions of predecessors. The informal contract is that each generation of management should take a brand and improve it a little bit for the next generation, providing nice shareholder returns in the interim. 3G provides no such improvement; it effectively thumbs its corporate nose at the previous generations of management by saying, “You could have made higher profits on this, but didn’t.” It pockets the difference, but does not leave behind a better brand for the next generation of stewards. In fact, it leaves a bill: Eventually, some management team will be tasked with restoring confidence in these brands and accepting higher input costs as a necessary condition for improving the quality and winning back lost consumers.
Meanwhile, the merry-go-round is taking another swing, this time picking up SABMiller for $104 billion. It is on pace to control one out of every three beers sold in the world, although antitrust regulators in the United States and China may force some divestments that will lower this amount. The $100+ billion debt burden, with interest payments north of $3 billion, will be over 10x greater than next year’s expected profit.
Moderate debt for a combined SABMiller-Anheuser Busch-Inbev would likely be in the neighborhood of $30 billion to $50 billion. Anything in between $50 billion and $70 billion would be classified as unusually high debt. The $100+ billion debt burden is probably near maximum leverage, and I imagine that Brito and the rest of 3G will use the 2016 through 2019 stretch to get debt down below the $70 billion level. It seems to be the corporate strategy–get debt down from extremely high to unusually high, make a large debt-fueled acquisition, and then cut costs while getting the debt back down from extremely high to unusually high all over again.
Diageo seems to be the next jewel that Anheuser-Busch Inbev will look to add to its crown, although some are speculating that non-beer beverage companies like Pepsico or Coca-Cola may also come into play. Although Brito himself said the future focus will be preferably on beer, his mentor Lemann has joked about slashing Coca-Cola’s 100,000 employee staff, saying “We’d love to take a look at Coca-Cola. We could run it with 200 people.” A possible clue will be offered in the next year–right now, Anheuser-Busch Inbev currently bottles Pepsi products in Latin America, while SABMiller is a bottler of Coca-Cola in Africa (Africa is the one continent where Coca-Cola’s famously efficient distribution channels have yet to take hold.) My take is that Coca-Cola has more room for Anheuser-Busch to cut the workforce than PepsiCo, although PepsiCo would stand to benefit more from improved machinery efficiencies. I would recommend paying attention to see what bottling operations Anheuser-Busch Inbev chooses to continue after this transaction–will it be bottling Pepsi in Latin America two years from now, or bottling Coca-Cola in Africa? Whichever bottling operations continue under the Anheuser-Busch Inbev umbrella, I would make that company a slight favorite for 3G’s future acquisition target after Diageo.
Anheuser-Busch Inbev is not a business like Visa, where more and more people are making swipes across the world for ever-escalating amounts. The beer industry doesn’t lend itself to that kind of growth, but most importantly, the management style at 3G does not lend itself to improving brand performance. I see it as a consolidator–it must constantly acquire and then cut costs because the final act after cost-cutting involves going back to the drawing board of hiring, improving ingredients, and increased advertising budgets. 3G has shown no desire or skill in this area. Shareholders of this combined megabrewing conglomerate will probably continue to earn more than satisfactory returns, but it will perpetually hinge on the addition of a new company into the fold. David Peacock was correct–something needs to happen every three or four years to keep the story going. The strategy works as long as there is somebody else doing things the old-fashioned way that is willing to be bought out at a premium.
Originally posted 2015-10-19 20:44:08.
