Tuesday, June 17, 2014

Big Dream: Anheuser-Busch InBev (BUD) / Coca-Cola (KO) Merger

This morning KO's stock price popped up on a comment by David Winters that Buffett and 3G are planning to take KO private.  He said that there are indications that something is going on, including press reports in Brazil regarding something related to 3G, KO and Buffett.

Now, I don't want to speculate on mergers and that's not what this blog is about, but it can be fun sometimes to do so.  I would usually ignore this sort of noise in the market.  Oh, and Becky Quick from CNBC called Buffett and he immediately said there's no chance 3G/BRK will take KO private.  It is way too big being bigger than the Heinz deal ($180 billion versus $23 billion for the HNZ deal).

But something has been nagging me for a while now and it was reinforced after reading the very interesting book, Dream Big: How the Brazilian Trio behind 3G Capital - Jorge Paulo Lemann, Marcel Telles and Beto Sicupira - acquired Anheuser-Busch, Burger King and Heinz.

It's really a great book that tells the story of the rise of the folks at 3G.  All business success stories are very similar but what I kept going back to is how these guys started out small and kept building things up.  They tend not to buy something to sell, but to build up.  Each acquisition turns into sort of a platform for growth and further deals. And they also give a lot of freedom to employees to take risk and grow as long as they do so prudently.  Their acquisition of BUD was seen as a long shot but it eventually happened.  It was a "big dream" that was realized.

What will they do next with BUD?  I don't think they are in it to maintain the status quo.  That's why I thought they would bid for Pepsi's snack business, for example.   I also wonder about Burger King (BKW) too.  You know 3G is in it for the long haul, so they are not going to be content sitting on it; they will make it grow and at some point down the line there will probably be some deals there too once they finish modernizing their restaurants (they already finished franchising out all the restaurants).

OK, back to BUD.

A few years ago, BUD had some agreement with Pepsi on some procurement deal so they can save costs on procurement as they share many common inputs.  Of course, this should make Pepsi too a target of a potential deal for BUD  (And in South America, beer companies also frequently sell the sodas too).

This procurement deal suggests that there would probably be some significant synergies in BUD selling sodas.  Imagine the synergies in procuring aluminum cans, and maybe even media/advertising.

And look at these figures comparing BUD and KO:

                                      BUD                    KO
Gross margin:                59%                     61%
SGA % sales:                 27%                    37%
EBIT margin:              33%                    22%

BUD's SGA includes stuff that may not technically be SGA; I just took whatever came in between gross margin and operating earnings.  In KO's case, I just took SGA as reported in the 10-K and there are other things in between SGA and operating earnings.  Also, there are probably a lot of differences in accounting standards that make a direct comparison difficult.

But in any case, this is just a quick look to see if KO might benefit from Zero-Based Budgeting (or whatever it was called).

And sure enough, as high margin and amazing KO looks, BUD is even better.

KO is very highly regarded and well-managed, but I can imagine that over the years with such a lucrative, high-margin operation, maybe there is a lot of waste that has built up over the years.  And maybe KO insiders are too generous to cut wasteful spending  (lifers sometimes have too many friends they don't want to offend).

So, maybe there could be some significant synergies between the tie-up between these two.  Getting KO operating margins up to BUD levels would increase operating earnings by 50%; that alone can pay for the premium that BUD would have to offer (presumably in a lot-of-stock / maybe-some-cash offering).

And then think of the obvious synergies of selling liquids in cans and bottles to similar retailers and other points of sale (restaurants/bars).

If what is in the above book is all true (and there is no reason to believe otherwise), this can create some huge value.

As a sanity check, here are the respective market caps and enterprise values of each:

                                             KO                BUD                       combined
Market Cap:                        $180 bn          $180 bn                  $360 bn
Enterprise Value                 $198 bn          $218 bn                  $416 bn

Yeah, that would be a huge deal.  Ridiculous, actually.  But this is a blog so I can imagine and fantasize about whatever I want!

But you know, I bet that somewhere within BUD is a spreadsheet that has all of this pro-forma-ed out on what a combined operation would look like and what synergies and costs-savings can be achieved and what the value-added would be.

Who knows, maybe it's on Brito's laptop, or maybe it's just some low-level financial analyst/intern doing it as an exercise at the suggestion of a mid-level boss.  But either way, the spreadsheet is there somewhere at BUD.  To be fair, the same one would exist for PEP, SAB Miller and every other big company that might make sense (or might not make sense).

Even a combined market cap of $360 billion (of course more if you include a takeover premium) is still way lower than the $560 billion market cap of Apple!  It's a different world.

So Buffett might have said "absolutely no chance of that" to a Berkshire Hathaway / 3G deal for KO, but he didn't say "absolutely no chance" of a BUD/KO deal, right?  And Buffett may participate too; he can buy BUD common or preferreds to help fund the deal.    So in a sense, it would still be a Buffett/3G deal, and Buffett's denial would still be true (maybe that's why he needed Quick to clarify the question to make sure that he is only denying that BRK will take KO private with 3G).

Both Buffett and Munger think Muhtar Kent is a great CEO and they seem to love him, but it's also true that Buffett really loves the guys at 3G and is impressed with what they are doing at Heinz.  HNZ too was regarded as pretty well run.  So who knows?  Maybe Buffett would really support a BUD/KO deal!

Also, BUD may have trouble doing more large beer deals due to anti-trust issues, so BUD/KO might make a lot of sense.


6 comments:

  1. BUD hasn't been on my radar since I owned it a while back before the buyout from InBev. I had owned BUD for many years in my dividend portfolio but it was "taken" away from me during the buyout. I haven't looked at it since. Thanks for highlighting it in this article.

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  2. Wow, now that would be a crazy M&A deal! I follow AmBev and always assumed BUD and AmBev would do a merger. I think AmBev is already selling PepsiCo products in South America.

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  3. someone at CoB&F highlighted a valid point. margins for BUD and KO aren't really that comparable as KO only sell the syrup.

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    1. Hi, yes, that's true even though KO bought the old CCE (U.S. bottling business) so does much of the bottling in the U.S.

      But even if it didn't and KO was a pure syrup operation, this would only strengthen the argument. How can BUD have so much better margins when KO has the better operating model?

      It makes KO look really lame.

      But again, there are other factors too (accounting) that I didn't examine closely.

      Thanks for reading.

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  4. http://www.valuewalk.com/2014/11/3-g-capital-coca-cola/

    More rumours.?

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    1. Yeah, but that's a bit small to make a run for KO. Maybe they don't use it to take out KO outright but to take a big stake in it Ackman/Allergan-like prepping for some other deal where another entity takes over KO. But even for that sort of thing, the fund is a little small.

      But something may have to happen. I think KO can't keep going like this and I doubt Buffett would like to see it continue like this either...

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