The merger between Embotelladoras Arca and Grupo Continental could be positive for both firms

The merger between Embotelladoras Arca and Grupo Continental could be positive for both firms

Shares in Embotelladoras Arca (Arca) and Grupo Continental (Contal) rose sharply on Tuesday (25 January) on the news of a merger between the second and third largest Coca-Cola bottlers in Mexico respectively.

The announcement was welcomed by analysts, who believe the deal will be positive for both entities, producing a structure likely to create great value for the two bottlers. Indeed, the City agreed, as shares in Arca climbed 14.6% to MXN67.05 (US$5.55) and for Contal 12.7% to MXN42.48 on Tuesday.

Estimates show that the combined operations of both companies, which will be integrated under a single company named Arca Continental, will produce sales of around 1.2bn cases, according to Arca, making it the second largest bottler in Latin America, behind Coca-Cola FEMSA. JP Morgan analysts estimate their combined enterprise value to be above $6.6bn.

Only a few months ago, Arca formed a joint-venture with the privately-owned Coca-Cola bottler Ecuador Bottling Company. It appears, then, that the Monterrey-based firm was on the lookout for additional purchases.

According to JP Morgan, Tampico-based Contal has been courted by its neighbours Coca-Cola FEMSA and Arca for some years. Contal includes the franchise of Mexico's second largest city, Guadalajara, so inevitably it was an attractive proposition for Arca. And, its geographic location is arguably a perfect fit for Arca as both territories are contiguous.

Contal is the 13th largest Coca-Cola bottling group worldwide and now serves around 14.5% of Mexico, including Coahuila, Durango, Zacatecas, Aguascalientes, San Luis Potosi, Jalisco, and Colima.

Arca, headquartered in Monterrey, Nuevo Leon, was formed in 2001 through the merger of three of the oldest bottlers in Mexico, making it the second largest bottler in the country. The company serves the northern region of Mexico, as well as Ecuador and northern Argentina.

There is no doubt that the deal, for Arca, opens the door to a wide range of value creation opportunities, strengthening its position as one of the leading beverage companies in the region.

For Contal, chief executive Miguel Angel Rabago believes, the benefits include economies of scale, exchange of best practices, and geographic and product diversification.

In a conference call on Tuesday, the firms said they hope to achieve synergies of around 8% of sales with the merger of the two companies, suggesting the possibility of facility closures. JP Morgan analyst Alan Alanis expects synergies to be around $80m a year.

"These could likely come from closing some production, distribution and administrative facilities post the integration of the two entities," Alanis said.

Indeed, in response to an analyst question as to whether plants will close following the merger, Arca CEO Francisco Garza Egloff noted that Arca and Contal "have some facilities that are close to other ones."

Credit Suisse analysts suggested in a report by Dow Jones that the new company could boost its efficiency by closing plants.

"Mexico could be run with half the bottling capacity currently in place," Credit Suisse said. "Arca has 12 bottling facilities while Contal has ten - average capacity utilisation of the combined entity is below 60%."

Before the merger, the companies plan to propose dividend payments of MXN1.40 per Arca share and MXN2.85 per Contal share. On closure of the transaction, Arca will offer a special dividend either in cash of MXN13.60 per share or 0.341 per share for each share held.

Alanis said he expects most shareholders will choose the shares, increasing the liquidity of the stock.

He upgraded both Arca and Contal to Overweight (OW), adding that he sees an "upside on the story".

"The transaction is subject to regulatory approvals, including antitrust, but we don't anticipate these will be an issue as they are not competitors and they run separate geographic franchises of Coke," Alanis said. "Thus the risks to our rating and price targets remain largely macro, related to Mexico, Argentina and Ecuador."

The transaction is expected to close during the second quarter of this year, but whether this leaves the door open for another bidder is questionable.

"We believe it is [too late]," Alanis says. "But one thing seems clear; consolidation of Coke bottlers in Latin America looks far from over."