In spite of looking good on paper for both companies, the proposed merger of the North American brewers, Molson and Coors, has received a distinctly cool reception from both investors and analysts. Chris Brook-Carter reports.

"Two drunks propping each other up at the bar" was one description of the proposed Molson/Adolph Coors merger doing the rounds over the weekend. Unkind as it is, it does reflect the lack of enthusiasm with which the deal to create the world's fifth largest brewer by volume has been greeted.

Late last week, after mounting speculation in the press, Canada's Molson and the US's third largest player Adolph Coors said they had agreed a "merger of equals". The transaction is structured as a share exchange whereby shareholders can either convert their shares to shares of the new entity or can elect to receive exchangeable shares on a tax deferred basis. The new entity is to be called Molson Coors Brewing Company and will be listed on the New York Stock Exchange and the Toronto Stock Exchange.

Together, Molson and Coors have sales exceeding US$6 billion with total volume of 51m barrels. In the context of a global brewing environment that is continually demanding greater size and corresponding economies of scale, this larger operator will certainly be able to make a better fist of competing with the likes of SABMiller (US$8 billion in sales) and Anheuser-Busch (US$14 billion in sales).

On top of this, the combination is expected to generate approximately C$175m in annualized synergies by 2007, with half of these benefits achieved within 18 months following completion of the merger. The transaction is also expected to be earnings accretive to the shareholders of both companies within the first full year of combined operations.

Strategically speaking too there are positives to the deal, including good geographic expansion - the two brewers have few overlapping markets - and a good working relationship. Both sides already have agreements in place to sell each other's brands. In fact, Coors accounted for 25% of Molson's net income last year. So why the cool reaction from investors and analysts alike?

"We don't think [the merger] provides a substantial benefit to either companies' existing operations, given a lack of scale in each other's key markets, and limited opportunities to introduce brands in new markets or boost existing brands' presence," JP Morgan, the New York investment house, said in a note to clients.

It is a view echoed by Legg Mason's beverage analyst Mark Swartzberg: "We see little synergistic about the combination, although the company [Coors] says it sees pro forma EBITDA before synergies of US$1.0 billion increasing approximately 9%, or approximately US$90m, for synergies 18 months out. With the limited exception of Canada, the combination of the businesses in a given market involves one company's meaningful market position pairing up with the other company's small to nonexistent position."

The investment rating group DBRS, meanwhile, placed the long-term ratings of the Molson group of companies "Under Review with Negative Implications", as speculation of the deal mounted. "The merger is viewed as negative for Molson's credit rating, as the consolidation of Coors' relatively weaker US and UK operations would increase business risks," it said.

Although DBRS did add that: "The proposed merger should provide some benefits to the company (Molson). Synergies from the merger are expected to be reasonable and should not be difficult to obtain, coming from SG&A, brewery optimisation, and procurement. Molson will also benefit from stronger geographic diversification due to a significant revenue contribution from three separate regions (the US, Canada, and the UK), which would help diminish the impact of the struggling operations in Brazil."

And this tough line on the merger has not been confined to outside investors. Indeed the deal will not go through at all if Ian Molson - a 10% shareholder in his namesake business and distant cousin of Molson chairman Eric Molson - has his way.

In a letter late on Wednesday, he told board members he plans to present a competing bid backed by a group of investors. "I'm confident that once the board has an opportunity to review the details of an offer," he wrote, "the directors will agree that it represents superior value."

Some reports suggest Ian Molson's bid will be an all-cash deal in the range of C$4 billion, representing a premium to Molson shareholders, which is not available under the present all-share offer. However, analysts seem to be giving it only a 50% chance at best of succeeding, primarily because Eric Molson effectively has a blocking stake in the group through his voting shares.

Nevertheless it is stark illustration of how hard a sell this might be for Molson and Coor's CEOs. And it is clearly not a message that has been lost on either man as they both embark today on a multi-city tour of the US and Canada to sell their plans to investors.

A number of those investors may hope this proposed deal will draw other interested parties out of the woodwork who would be keen to launch a bid for either Coors of Molson. On paper this looks a distinct possibility as there are few targets of either Coors or Molson's size left in a rapidly consolidating market.

But a more detailed study reveals few realistic contenders. Anheuser and SABMiller are both out of the question for Coors on competitive grounds, and there is little strategic imperative for either to launch a bid for Molson. Carlsberg and S&N would struggle to finance a bid for either at present and Interbrew is far too caught up in its own merger with Ambev. That leaves Heineken as the only suitable option.

"Heineken and others are reasonable candidates, but it is far from clear that Coors US, about two-thirds of company profits, is an appealing asset to a foreign brewer such as Heineken. Coors US certainly provides scale that cannot be acquired otherwise, but the quality of the scale has substantial issues including reliance upon a single brand, Coors Light, facing increasing challenges," said Swartzberg.

The truth is that although a Molson/Coors merger seems to offer few reasons to get excited, it may well be the best option for both brewers. Coors released soft second quarter results last week that illustrate the kind of pressure it is under to gain scale quickly and although Molson's figures were more positive, it too has hardly set the brewing world alight over the last two to three years, particularly in Brazil, where its business is struggling.

"The combination gives us the critical mass to be a real player in a rapidly consolidating industry," said Coors chief executive officer Leo Kiely last week.

The companies have not identified acquisition targets, but have said they will use their increased financial strength to build operations in the US, Canada, the UK and Brazil - all markets where the combined operations would rank in the top three in market share.

Though clearly a defensive move, this merger will increase the flexibility of both players and at the very least build a more attractive takeover target for a potential bidder in the future.