Who would have thought that the Anheuser-Busch InBev (BUD) deal with Grupo Modelo wouldn't go through? There were many events leading up to the January 31, 2013 announcement that the Department of Justice (DOJ) would block the merger of BUD with Grupo Modelo. The following is a list of events that the market was not completely paying attention to:
- BUD owned 23.25% of Grupo Modelo heading into calendar year 2012. It would expand this to 43% of the voting rights and 50.3% of the economic rights of Grupo (Source: Constellation Brands (STZ) 10-K)
- June 24, 2012: BUD was rumored to be buying Grupo for $10B
- June 26, 2012: BUD's acquisition of Grupo drew the attention of regulators for the first time was referenced on this date. Regulators would require the divestment of BUD's assets, as Modelo has strong share in California, Texas, Arizona, and New York.
- June 27, 2012: BUD would have to divest Busch, Busch Light, and Natural Light
- June 29, 2012: BUD buys the 2nd half of Modelo for $20.1B. Constellation Brands, the other half of the Crown Imports joint venture, agreed to purchase the 50% Crown Imports that it didn't own for $1.85B to help move the deal along from anti-trust concerns.
- June 30, 2012: BUD announced that it would divest Busch, Busch Light, and Natural Light brands to satisfy regulators.
- August 20, 2012: BUD received its initial request from the DOJ for further information on its M&A with Modelo.
- October 12, 2012: BUD rumored to have hit some resistance from the DOJ and various Senators. The government wanted more brands divested.
- November 14, 2012: M&A received "Clearance" from the Office of Fair Trading in the UK.
- January 14, 2013: The DOJ asked BUD to make more concessions for the Modelo merger, with the potential of another importer of Modelo products into the US (Source: The New York Post)
- January 16, 2013: DOJ and BUD talks centering on the supply and pricing agreement in regards to Crown Imports.
- January 17, 2013: DOJ had asked BUD to sell a Modelo bottling plant in Mexico as part of its concessions to regulators. BUD was rumored to say that this would be a deal breaker if they were forced to do so.
- January 31, 2013: DOJ files suit to block the BUD and Modelo merger, sending both BUD and STZ much lower.
The news was out there the entire time that there could be potential problems. However, the market never looked back on the deal, as both BUD's and STZ's share prices soared (especially STZ) since the merger was announced (Source: Capital IQ):
The market was not discounting a potential break in the deal as described below on December 20, 2012:
"If either the acquisition of Grupo Modelo by BUD or the deal between BUD and STZ were to falter, STZ could be in trouble and experience a serious drop of net income. This is a huge risk that the market is not taking into account, especially as regulators may demand BUD divest more brands to acquire Grupo Modelo. This could turn into what UPS and TNT-Express just experienced. Either way, STZ is a loser if the deal does not happen."
Reasons for the Block and Why it Will Happen?
In the press release, the DOJ explained why it filed suit.
- The first reason was because "the size of the beer market in the United States, even a small increase in the price of beer could result in billions of dollars of harm to American consumers". With an already weak consumer base due to lower incomes and high unemployment, the US and the world cannot take on further GDP hits with lowered beer spending. Beer is large industry and does contribute to global GDP.
- The second reason was due to BUD's strategy. BUD has a strategy to "[ensure] competition does not believe they can take share through pricing". In other words, it prices products at all price levels. It will raise and lower prices to take out smaller competitors and keep its market share high.
- Third, the attempt to make the deal competitive for the industry still is flawed. By having Crown as the US importer, there is a legitimate concern. It is a temporary supply agreement that can lead to BUD dictating Crown. AB InBev has a call option for 100% of Crown every 10 years at a multiple of 13x Crown's operating earnings. It would guarantee STZ a minimum payment for the business, but give BUD full Modelo exposure. Analysts believed this deal was a boost to STZ as it would give more income from faster growing Crown than the current wine business. However, there is no reason BUD wouldn't enact its call option at the 10-year mark.
- Crown's CEO/President Bill Hackett wrote to Crown's employees about the acquisition: "our #1 competitor will now be our supplier…it is not currently or will not, going forward, be 'business as usual.'" Clearly, even Crown figured that BUD would influence the prices in the deal and potentially exercise the option at the first chance it got.
Beer's market is already consolidated and has over the last decade. Molson Coors (TAP) bought StarBev over the summer to expand its line. AB InBev controls the global market. In 2011, it had an 18.2% market share on a volume basis. Grupo Modelo's was 3% and growing. This would mean that BUD would control over 1/5 of the entire global beer market and could then influence suppliers, competitors, and customers. A monopoly is defined as a "situation where one producer controls the supply of a good or service, and where the entry of new producers is prevented or highly restricted. Monopolist firms (in their attempts to maximize profits) keep the price high and restrict the output, and show little or no responsiveness to the needs of their customers." By allowing the acquisition, the DOJ would give global beer power to BUD (Bloomberg):
The DOJ's only influence is in the US. By looking at the North American market share, the data looks even worse for the deal to occur (Source: Bloomberg):
By combining BUD with Grupo Modelo (based on former 2011 numbers and not even the most up-to-date), BUD would control 53.8% of the North American market. Within the US, the data shows that BUD and SABMiller would be 2/3 of the market. The growth of craft beers is strong but the market would still be dominated by the big players in the industry. The big players, especially BUD, could make it impossible for the craft beers and smaller producers to get access to quality supplies. By doing this, the smaller players would lower their quality and could suffer demand declines.
Why the Market Knew This Deal Would Get Blocked?
Two major mergers almost happened within the past decade. However, regulators filed suit against the companies for the same reasons as the DOJ is doing with the BUD and Grupo Modelo merger. The deals were the potential mergers of AT&T (T) and T-Mobile, and UPS (UPS) and TNT-Express.
AT&T attempted to merge with Deutsche-Telecom's USA unit, T-Mobile. The deal would leave only two real-players left: T and Verizon Wireless (VZ). The two companies would control roughly 78% of the wireless industry's revenues. Doesn't this sound familiar to BUD?
Even if the deal had gotten past the DOJ, would it have gotten past the EU Commission? The EU Commission has been more strict and demanding than the DOJ. Many deals have failed under its watch and because both Grupo Modelo and BUD have such high international exposure, the EU Commission would have had to weigh in on it too. In 2012 to 2013, the EU Commission blocked the potential merger between UPS and TNT-Express. The reason it did so, despite UPS' willingness to sell assets, add air network access for 5 years, and divest TNT's subsidiaries in 15 EU countries, was due to the strong control on the market UPS would have.
BUD is Grasping at Straws to Grow
BUD is well-known for cutting costs and growing net income. Its problems are that the global beer market is slowing down, craft and import beers are growing faster, health-conscious consumers trending away from beer, and spirits are taking alcoholic beverage market share. Over the last 5 years, BUD's revenue growth is actually faster in its Non-Beer Segment (Source: Capital IQ):
The only reason revenue has been really growing is because of major acquisitions. Revenue growth over the last few years is shown below as a whole (Source: Capital IQ):
The major growth in 2008 and 2009 came from large acquisitions on top of price increases. Otherwise, BUD would not have grown as much as it really did. There is only so much cutting on costs and making processes more efficient that one can do given the technology and capabilities out there. On the other hand, Grupo Modelo is growing fast and expanding its margins as net income is outpacing revenue growth (Source: Capital IQ):
The market forgot that the BUD and Grupo Modelo deal may not occur. It instead sent shares of BUD and especially STZ upward on the notion that regulators would be ok with the deal. BUD didn't realize that the US would demand it invest more. BUD doesn't want to make the DOJ upset as the US is the #2 beer consumer in the world (Source: BBC):
I do not see the deal working out for BUD. This will hurt STZ shares more than BUD, as evidenced by the decline on January 31st. BUD may get the deal done but would have to give up major brands to competitors, the option on Crown, or find a new importer for Modelo products. I don't think any of these options are in BUD's plans and it would be better suited. There's a clear reason that it wanted the option on Crown. It has already relinquished various brands. The only other option would be for a company with the distribution facilities like PepsiCo (PEP) to distribute the beer for BUD. As of now, the deal still doesn't look likely without BUD giving up some power via brands or rights.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.