The merger of Belgian brewing group, Interbrew, and Latin American drinks force, AmBev, has certainly taken the industry by surprise if nothing else. As the dust settles, Chris Brook-Carter and Olly Wehring examine the deal and its possible impact on the new group's slightly stunned competitors.

If the luke-warm reaction that greeted the news that Interbrew and AmBev are to combine to create the world's largest brewer by volume is anything to go by, John Brock, the Belgian group's CEO, and his counterpart in Brazil, Marcel Telles, will have to mount quite a charm offensive to convince doubters of the strategic wisdom of this mega deal.

It is a PR battle that the companies have already begun to wage, with executives from AmBev meeting sceptical minority shareholders on Friday. Similar meetings on both sides of the Atlantic are sure to follow. There is no doubt that the sheer complexity of the transaction proposed last week has contributed to the cautious response from both competitors and the investment community alike.

"In the longer term, this is certainly a very powerful combination - it could be a winner. In the short term, however, there are a lot of loose ends to the deal," said Ian Shackleton, beverage analyst with Credit Suisse First Boston. "It is a very complicated deal."

Essentially, a share swap will see Interbrew take a 57% stake in AmBev. The deal includes the issue of about €3.3 billion of Interbrew shares to the controlling shareholders of Ambev, a cash tender offer to AmBev minority common shareholders for €1.2 billion and AmBev's taking over of Interbrew's North American assets valued at €4.6 billion.

The confusion has not been helped by the rhetoric used over the last week to announce the deal, with Ambev in particular anxious to avoid any reference to a sale or takeover of the company, though a number of analysts are viewing it as exactly that.

Interbrew has been more than happy to play along with this. Brock too has pushed the premise that this is an alliance of equals. InterbrewAmBev's board will be composed of four members appointed by Interbrew, four members appointed by AmBev, and six independent directors. And the two companies will continue to be listed separately.

But the idea that InterbrewAmbev can continue in the long-term as a double-headed beast seems unlikely. "You'll end up with one vision for the company. It can't stay with two heads forever," said one analyst.

That said, post-merger, these two companies remain very separate entities and coming up with a single vision and focused brand strategy will be no easy task. Indeed quite how the group will operate even in the short term remains unclear.

In particular, Interbrew's contentious relationship with its Mexican partner FEMSA represents something of a dark cloud over the new group's potential. Since Interbrew bought a 30% in the Mexican brewer, the relationship between the two has had its rocky moments. The two have ended up in the US courts twice over their tie-up, and Femsa is rumoured to have been left out of talks between Interbrew and AmBev.

As part of the deal, AmBev will in effect take control of Interbrew's share in Femsa. However, the Mexican may argue that this constitutes a change in ownership, giving it first refusal on buying the stake back, as part of its initial agreement with Interbrew.

Most analysts believe Femsa will jump at the opportunity to take control, although AmBev remains hopeful. "We've been friends on a shareholder and management level for some time," Telles is quoted as saying.

The two companies are due to meet later this week to discuss the future. If Femsa chooses to go it alone, this will hurt InterbrewAmBev's drive to gain a foothold in the US beer market. It won't be plain sailing for Femsa either, however, as it will need to secure a distribution agreement elsewhere for the US.

As the world's second-largest bottler of Coca-Cola, Femsa could even look to sell off its beer unit and focus solely on its soft drinks division, presenting the new Interbev - as it is to be called in short - with its first major acquisition target. However, the truth is that nobody, the parties involved included, know how this will pan out.

In broad terms no one can deny that this was a one-time chance for Interbrew and it has grabbed it with both hands. "At one stroke, Interbrew has changed its profile completely, it is now the legitimate number one in Latin America," said an analyst.

It has also suddenly leapt to the world number one position with 215m hl in total volume sales, of which beer contributes 190m hl and soft drinks 25m hl on a pro forma 2003 basis. It will rank number one or number two in more than 20 beer markets.

"This platform, together with the combined group's enhanced financial strength, will enable InterbrewAmBev to leverage three global flagship brands Stella Artois, Beck's, and Brahma, while further strengthening specialty and local brands," Interbrew said in a statement. "The formation of InterbrewAmBev will establish a top-tier performer in the global brewing industry, with the potential for the highest organic EBITDA growth of any major brewer."

In addition to the sheer muscle created by the merger, the two companies have complementary geographical strengths. "Strategically, I think the merger is an excellent fit," Matthew Jordan of ABN Amro told Another analyst described the new group as having a "a great global footprint."

However, both these analysts raised concerns about the price Interbrew was paying, a perennial accusation levelled at the brewer whenever it has made acquisitions in the recent past. "They have paid a tremendous premium for AmBev," said the analyst. "This deal isn't about earnings for the next two to three years."

Matthew Jordan was even more blunt about the price issue. "Interbrew have overpaid quite dramatically," he said. "I assume they've done this to cement their position long-term. Interbrew tends to be seduced by strong positions in attractive markets. In this case, InterbrewAmbev would need 30% compound profit growth per year for the next three years to make the merger worthwhile, on top of the savings they are both going to make. It looks too good to be true, and in my experience, when something looks too good to be true, then it usually is."

It is an accusation levelled at the Ambev board too by its shareholders. AmBev's non-voting preferred shares fell 3.5% on Friday, sliding for the third session in a row since the Interbrew deal was announced, as many believe AmBev will pay too much for Interbrew's North American businesses, which are growing more slowly than AmBev's existing operations in Brazil.

Perhaps this is why, despite initial press reports to the contrary, Anheuser-Busch appears to have few concerns about the new behemoth. The InterbrewAmBev deal "does not have a significant impact on A-B in any of the markets where we have major operations," said Stephen J. Burrows, chief executive and president of Anheuser-Busch, in a written statement

And a number of analysts seem to agree. "This merger is simply the combination of two brewers in two different parts of the world, so it's not really much of a threat to the other big brewers," said Jordan. "If, say, Miller and Coors were to merge, then that would concern Anheuser-Busch - this merger won't. It's not really a direct challenge to anybody."

Meanwhile, beverage analyst at Legg Mason, Mark Swartzberg, wrote last week: "If completed, the proposed Interbrew-AmBev combination relegates the king of beers to being king only of the global profit pool. But all scale is not created equally, and the proposed combination is of limited consequence to the current A-B's future cashflows and the certainty ascribable to realising those cashflows, in our view.

"A-B continues to hold the distant share of the global beer profit pool, and the proposed combination brings little, if any, lasting top-line synergies to either party's US and Mexico business, where A-B makes its money. Nor does the combination represent a material change to the competitive landscape in China, an important cashflow driver for a future generation of A-B shareholders."

That said, the creation of such a giant is not without its repercussions for the industry. The two companies have secured a formidable position in Latin America and the new entity may continue to acquire to secure its position elsewhere in the Americas.

Even if the merger has as little material effect on A-B's operations as has been suggested, the sheer speed and surprise of the move and the fact that no-one, including the industry's pre-dominant force, saw it coming will have unsettled A-B, if only a little. "Anheuser-Busch probably feels slightly stunned by this move. Perhaps the acquisition of AmBev has come earlier than some people thought. It's changed the game for everyone else," said Ian Shackleton.

Indeed so, having been looking over their shoulders at A-B for years, smaller brewers now have another takeover-orientated conglomerate to concern themselves with. As one analyst put it: "Beer mergers and acquisitions will pick up. Small brewers need to be afraid of this brewing giant coming."

Expert Analysis

Company Profile: AmBev

AmBev's Brazilian beer operations witnessed growth of just over 24% in 2001, due mainly to price increases throughout the year, designed to offset the increase in dollar-denominated costs. Prices of AmBev's main brands, Skol, Brahma and Antarctica, rose by an average of 16.3% during fiscal 2001.

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Company Watch: Interbrew

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