On January 31, the U.S. Department of Justice filed a lawsuit to block the proposed $20.1 billion purchase of Grupo Modelo (GPMCY.PK) by Anheuser-Busch InBev (BUD), claiming that the deal would hurt competition and raise prices. The market widely expected that the deal would pass regulatory scrutiny because Anheuser-Busch InBev already owns half of Grupo Modelo, and Mexico's antitrust regulator approved the transaction in November.
Shares of both alcoholic beverage companies, as well as most of their large competitors, immediately declined after the U.S. Department of Justice filed its complaint in Washington D.C. (U.S. v. Anheuser-Busch InBev SA/NV; 13- cv-00127), arguing the transaction violates antitrust law because it would eliminate substantial head-to-head competition that currently exists between BUD and Modelo. Anheuser-Busch InBev is the owner of Bud Light, the best-selling domestic brand of beer, among many other brands, while among Grupo Modelo's many brands exists Corona, the best-selling imported beer in the United States.
Several other large brewers also declined in response to the suit, and it could be that the industry is now primed for a period of underperformance, as investors cycle out of the brewers. Many brewers appreciated substantially in 2012, including increased valuations due to this proposed merger, and the potential for even further subsequent industry consolidation. Therefore, this antitrust suit may mark peaking brewer prices in the near-term, and a now brewing period of underperformance.
The combined businesses of Anheuser-Busch InBev and Grupo Modelo is estimated to have sales of nearly $50 billion in 2013, which works out to quite a few 6-packs. In the Department of Justice's release on the suit, Bill Baer, the head of the department's antitrust division, commented that "If ABI fully owned and controlled Modelo, ABI would be able to increase beer prices to American consumers." Mr. Baer added that, "This lawsuit seeks to prevent ABI from eliminating Modelo as an important competitive force in the beer industry."
The proposed deal clearly contemplated antitrust concerns, as it included the sale of Modelo's stake in Crown Imports LLC, a joint venture between the two companies that distributes Corona, Modelo, Pacifico and Tsingtao branded beers, among others, in the United States. Under the arrangement, Constellation Brands (STZ) was to acquire Modelo's interest. The Department of Justice was apparently not sufficiently satisfied with the maneuver.
According to the Department of Justice complaint, "ABI internal documents acknowledge that Modelo has put 'increasing pressure' on ABI by pursuing a competitive strategy directly at odds with ABI's well-established practice of leading prices upward." In other words, the Department of Justice believes that Modelo's competition with the beer giant helped keep beer prices down, and that its absence from the market will result in higher prices.
In Anheuser-Busch InBev's statement regarding the Department of Justice's action, the company stated that the lawsuit is "inconsistent with the law, the facts and the reality of the marketplace," adding, "we intend to vigorously contest the DOJ's action in federal court." Grupo Modelo issued a substantially similar statement to the Mexican stock exchange while also providing notice that it no longer expects the deal to close in the quarter.
Last June, Anheuser-Busch InBev agreed to buy the remaining 50 percent of Modelo that it didn't already own, and indicated that it primarily pursued the deal to increase its growth profile in the emerging markets, where beer sales are growing faster than they are in the United States. Corona is exported to more than 180 countries and would become a flagship brand for Anheuser-Busch InBev, much like Budweiser has become since InBev NV acquired Anheuser Busch in a $52 billion deal in 2008. Before that merger, InBev's primary brands were Stella Artois and Beck's, both of which continue to sell well in the United States, Europe and globally.
The U.S. is currently the second largest beer market, with China being the world's largest consumer of beer. Anheuser-Busch InBev is world's the largest producer of beer, with SABMiller Plc (SAB) in second place. Modelo is Mexico's largest brewer and controls about 60 percent of Mexico's beer market through its Modelo, Pacifico and Victoria brands. Almost all other Mexican beer sales involve Dos Equis and Tecate brands, both of which are owned by Heineken NV (HINKY.PK).
Anheuser-Busch InBev controls just under half of the U.S. beer marker, while its closest competitor, MillerCoors LLC, a joint venture between SABMiller and Molson Coors (TAP), controls just over one-quarter of the market. The U.S. Department of Justice believes that both ABI and SABMiller have been forced to offer lower prices and discounts for their brands to discourage consumers from selecting competing Modelo brands. I guess this means the Department of Justice calculates that U.S. consumers would prefer a Corona to a Budweiser, Miller or Coors branded beer if the prices were the same. Annual U.S. beer sales total about $80 billion.
If the deal were to have gone through in its proposed form, Constellation Brands was to acquire Modelo's half of the Crown Imports LLC joint venture in a deal valued at $1.85 billion. The Department of Justice may be concerned that despite the divestment of half of Crown Imports, Anheuser-Busch InBev would retain the power to terminate its distribution deal with Crown Imports after ten years.
Constellation declined more than Modelo or Anheuser-Busch InBev in response to the Department of Justice's antitrust claim. Constellation anticipated that the deal would significantly increase its earnings due to an increased share of the lucrative U.S. market. Constellation, which supports Anheuser-Busch InBev's pursuit of Modelo, believes that the deal would make Crown Imports a more independent and competitive entity and continues to hope for a resolution that will allow it to take a share of Crown Imports. Nonetheless, the Department of Justice is not concerned with Constellation's opinion.
Given the perceived likelihood that Anheuser-Busch InBev would acquire Grupo Modelo, and the corresponding perceived likelihood that Constellation would acquire a stake in Crown Imports, many investors had allocated into these stocks, among other competitors, in attempts to make profit through merger arbitrage and to invest in the next probable takeover candidates. The blocking of this deal, therefore, has hurt the entire industry, where most brewers have performed exceedingly well in the last six months. Now, many merger arbitrage investors who though that they had identified a safe way to make a small margin may sell-out of losing positions, further exacerbating these responsive losses.
Despite the immediate and substantial declines to hit many of these brewers, given the strong performance almost all brewers have recently had, it appears likely that their weakness will continue. For example, though STZ was down about 18 percent on January 31, the brewer is still up about 53 percent over the last 12 months. Similarly, despite BUD falling about six percent, it is still up over 45 percent over the last year, and Grupo Modelo is still up over 28 percent in the last 12 months, even after declining about 7.5 percent on January 31, in response to the Department of Justice suit.
Moreover, it is unlikely that any other large deals will be contemplated within the industry unless Anheuser-Busch InBev either wins the suit filed by the U.S. Department of Justice or otherwise settles with the department through the submission of a modified agreement that does not put so much control behind any single brewer. Risk-averse investors may want to wait this round out.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.