Financial Mail - Investors Monthly
Blowing the froth off the Mega-Brew deal
AB InBev has a fearsome reputation for ruthless and relentless cost-cutting. It will be building on this as the mega-merger with SA Breweries progresses, writes Ann Crotty
Legend has it that in 1999, when SA Breweries bought a controlling interest in Plzensky Prazdroj, a chill seeped through the bones of the citizens of Prague as they contemplated the appalling prospect of South African barbarians getting hold of their cherished Pilsner Urquell.
In early August it was the turn of the South Africans to feel a chill as they contemplated the purging of SABMiller executives by the Anheuser-Busch InBev barbarians. Not one member of the top team that created SA’s most successful corporate export feature in the executive of Mega-Brew, (the working title of the merged entity). Even Genghis Khan held on to capable conquered leaders who swore allegiance to him.
The message was clear. For AB InBev CEO Carlos Brito, it was no more Mister Nice Guy. No more making huge concessions to regulators and, after a £1 top-up on the offer price, no more sweeteners for SABMiller shareholders. From now on there would be no pretence about a merger. This was an acquisition and AB InBev was behaving like the archetypal acquirer. Having committed to handing over huge bucks to SABMiller shareholders, AB InBev obviously felt it had bought the rights to name the team tasked with extracting the returns.
Back in the Czech Republic things turned out well for local Pilsner Urquell fans. SAB (it had not yet acquired Miller) was relatively new to the European beer market and was keen to establish the sort of reputation that would help it to grow. So it pumped money into developing the beer, and in a nod to the brand’s heritage it revamped PU’s historical buildings, scattered around the Czech Republic. The relationship flourished.
For South Africans the rather distressing realisation is that AB InBev will also be trying to protect and enhance its reputation as it beds down its latest acquisition. That reputation is for being the world’s most cost-effective producer of beer. Its Ebit (earnings before interest and tax) margin is an eye-watering 32.5% and makes SABMiller look like a slouch, with an Ebit margin of around 26.7%. Analysts reckon the merged entity could generate Ebit margin of more than 33% on the substantially increased revenues.
Trevor Stirling of Bernstein Research says the culture of both SABMiller and AB InBev is very performance-orientated, “but the AB InBev culture is somewhat more numbers-orientated, much leaner and directionally more forgiving”.
Following the announcement that none of the SABMiller top team had made it to the Mega-Brew executive layer, it is evident AB InBev doesn’t want to risk holding on to an SABMiller executive who does not believe, with every fibre in his body, that there is no cost that cannot be cut. Or as Carlos Alberto Sicupira, co-founder of 3G Capital, the controlling shareholder of AB InBev, put it: “Costs are like fingernails, you have to cut them constantly.” Just the sort of comment to ensure that any SABMiller employee who stays on at Mega-Brew will start saving paperclips and re-using plastic cups. And don’t even ask about business class.
The image of AB InBev as the Walmart of beer is so ingrained
it’s difficult to imagine it’s less than a decade old and that the core team that drives the biggest beer company in the world has been together for less than 20 years. It was formed through the 3G Capital-backed merger of two Brazilian beer companies in the late 1990s. The acquisition of Belgium-based Interbrew in 2004 propelled the renamed InBev onto the global stage. Four years later it became the largest beer group in the world when it acquired Anheuser-Busch for $52bn in what, at the time, was the largest all-cash acquisition in history. It was an audacious move. Not only was a little-known entity acquiring the best-known beer brand in the world, the deal was being done in the face of a growing global financial crisis.
While not as audacious, the record-breaking SABMiller acquisition has required nerves of steel. In 2015 the global economy was still in a post-crisis mode, with investor and consumer sentiment fragile and susceptible to knocks from any front. In SA, President Jacob Zuma’s shock removal of finance minister Nhlanhla Nene in December had a devastating impact on one of SABMiller’s key reporting currencies. Months later the UK’s unexpected vote to leave the EU threatened, briefly, to derail the deal. The slump in sterling made the £44/share deal look considerably less attractive to non-sterling shareholders than it had a few months earlier. It also made a standalone SABMiller look a more attractive option.
Through it all, Brito seemed unfazed. In an effort to deal with signs of growing discontent he added a mere £1, believing most SABMiller shareholders were by now bound to the deal.
A major difference this time around is that there is not much fat to cut and, unlike Anheuser-Busch, which was coasting on its previous glory, SABMiller management featured among the leaders in the global industry. But there’s little doubt that in the three or four years leading up to last November’s offer, Brito and his team, in that very precise way they have, identified scope for cost-cutting. Already on the block is the UK corporate headquarters and its 500 employees. And as Stirling remarked in a note to his clients, the application of AB InBev’s frugal culture will eke out still further savings. “For instance, all levels of management in ABI
AB InBev will be trying to protect and enhance its reputation as it beds down its latest acquisition
travel coach/economy unless transatlantic and even the CEO stays in modest hotels.” (Of course, AB InBev management may find that travelling to some parts of SAB’s African operations requires private jets and upmarket hotel accommodation.)
In addition, SABMiller’s decentralised management structure is the source of some inefficiencies and had already been targeted by the group’s business capability programme, which aims to cut annual costs of about $1.5bn. “It is likely that ABI management could drive this initiative harder, faster and deeper, with much less tolerance for resistance from ‘regional barons’,” Stirling said.
Though there’s almost no overlap in operations, the merged entity should be able to extract some synergies through joint purchasing of suppliers. And of course there’s AB InBev’s “zero-based budgeting” so loved by the MBA brigade, which requires every single expense to be justified anew every year.
The scope for cost-cutting in SA has been muddied by the detailed list of conditions imposed by the competition authorities. The conditions include a nod to the impressively low tax rate that has helped boost AB InBev’s bottom line with AB InBev’s acknowledgment of the interests of various SAB stakeholders and “the South African society in general, including complying with the letter and spirit of the South African tax laws”.
Conditions that add a few billion rand to the cost of the acquisition will probably be easier to navigate than the restrictions on any retrenchments. Paragraph 8.3 does provide AB InBev with some wiggle room through the use of voluntary separation arrangements and voluntary early retirement packages. But whatever happens with these arrangements the number of SAB employees must remain unchanged for five years. That SAB employees cannot reasonably refuse to be redeployed in line with the Labour Relations Act may give AB InBev scope to redeploy executives to lower-paid jobs.
Last November, when Brito announced an offer price that was almost 50% above SABMiller’s pre-speculation trading level, the feeling was that the generous £69bn price tag could only be justified by some serious cost-gouging. In the following months the cost of the deal edged higher as AB InBev made requested and unrequested concessions to regulatory bodies across the globe. Out went Miller in the US, Snow in China and every brand in Europe. AB InBev will end up with less than 50% of SABMiller’s pre-merger annual turnover.
The result of all of this is that Mega-Brew will not account for one-third of the global beer market as the simple one-plus-one calculation would have suggested. It’s unclear how it affects the claim about the merged entity owning 50% of the global profit pool, given that a huge chunk of the disposals relate to the high-profit US market but an even larger chunk relates to China, where margins are thin.
Some analysts reckon the slew of disposals will make an enormous deal much more manageable and is what AB InBev had planned from the start. Whether or not that is the case it’s unlikely that Brito had planned on selling off the Chinese business for just $1.6bn. This was the price SABMiller’s government-backed joint venture partner, China Resources Enterprise, was willing to pay for SABMiller’s 49% stake in CR Snow, which analysts had valued at about $5bn. All-in-all, AB InBev is set to get in the region of $21.5bn from the disposals.
AB InBev’s chillingly efficient ability to operate on an extremely low cost base is a major factor in the creation of an excessively large beer group. But it might not have been possible if Brito and the 3G Capital team had not been able to access funding at record-low interest rates.
The deal is likely to be earnings-accretive from year one, which is great for SABMiller’s major shareholders Altria and Bevco, who are taking scrip instead of cash. But it’s expected to take up to 10 years for Mega-Brew’s returns to match its cost of capital.
AB InBev’s chillingly efficient ability to operate on an extremely low cost base is a major factor in the creation of an excessively large beer group