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

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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

AB InBev CEO Car­los Brito

Pic­ture: SUN­DAY TIMES

The world’s ap­petite for beer, along with clever and au­da­cious deal-mak­ing, has fu­elled the rapid rise of AB InBev.

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