Ambev (ABV), Brazilian's largest brewer, has taken a beating lately. Likely, this is due to Brazil's inflation concerns. This gives investors a rare opportunity to invest in a stock that is about to unlock billions in "hidden" tax savings.
Ambev's Proposed Restructuring
On May 13th, the company announced the intention to propose a corporate restructuring to transition the company's current dual stock capital structure (comprised of voting common shares and non-voting preferred shares) into a new, single-stock capital structure comprised exclusively of voting common shares. Management noted in its SEC filing, the move "simplifies the shareholder structure and improves corporate governance, increases liquidity of shares and increases the flexibility of the company to manage its capital structure." The Stock Swap Merger will result in a new holding company called AmBev SA. Equal value will be ascribed to the preferred and the common shares.
You should. Brazilian companies have two payout streams to investors: dividends and interest on own capital. IOC payments are tax-deductible and limited by the greater of:
· 50% of the adjusted net income for the year or
· 50% of the retained earnings reserves from the prior year
Brazilian companies look to maximize the IOC amount they can pay since it is a tax shield. In the past, Ambev has had to fall well short of the maximum due to the low amount of retained earnings on its balance sheet. Only 11% of its payout to shareholders came from interest on capital. This means they have been missing out on a huge tax break. That is about to change.
Ambev intends to file an F-4 (required for the registration of certain securities by foreign issuers in connection with exchange offers and business combinations), which will shed light on the pro forma size of shareholders' equity:
· According to Ambev's published material fact, the proposed valuation of the minority preferred shares held by Fundação Antonio e Helena Zerrener Instituição Nacional de Beneficência (better known as FAHZ), has been set at R$81.31 per share, or approximately R$97 billion.
· The F-4 will disclose the criteria used to value the remaining 62% of shares held by Anheuser-Busch InBev [Ambev is a subsidiary of Anheuser-Busch InBev (NYSE:BUD)]. If the same valuation method is used for ABI shares as was for FAHZ shares, the incremental valuation would be another R$158 billion, for a grand total shareholders' equity increase of R$255 billion (or US$113 billion as of today).
Payout implications: Ambev will be able to significantly boost the proportion of dividends it pays as interest on capital.
· Since Ambev's retained earnings will likely increase by half of the R$255 billion (half will be allocated to capital stock and half to capital reserves), the previous limitation on IOC payout will no longer be an issue (in fact, they will now hit the reserve limit).
· It is estimated the proportion of IOC payout as a percentage of total payouts will jump from 11% to 50% or more.
Positive impact on earnings. The potential increase in IOC may reduce Ambev's tax rate from 19% to 8.5% (which, as of the date of this note, will result in a 13% earnings increase).
Share buybacks, reinvestment and new dividends. With the new capital structure comes new flexibility. The company will not be stifled by required cash payments and can use the cash to invest in itself – something it hasn’t fully been able to do since the Modelo acquisition. Further, the company can (and likely will) announce share buybacks and other cash distributions.
Downside: This transaction will bring a reduction in return metrics due to the increase in shareholders' equity. For example, 2014E ROE may drop from 43% to 10% (potentially lower depending on how the ABI shares are valued). It could also potentially affect valuations on the current balance sheet, which may negatively impact ROA. While neither of these relate to operational performance, it does reduce the stock's attractiveness relative to its peers.
... On the other hand, the price to book drops from 8.4x to 1.9x (or less depending on the ABI valuation) … which may look pretty interesting to some.
Ambev is a stable company with a diversified beverage portfolio across multiple distribution lines. It is penetrating a growing middle class in Latin America. It has a wealthy parent. And now, it will have a simplified capital structure with permanent positive earnings implications. In a volatile market like this, and in the global search for yield, I'm an investor.