Interbrew plays at empire building

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Interbrew's announcement yesterday that it may seal a significant deal with Latin America's number one brewer Ambev has raised fears that the Belgian beer group is over spending. But the thought of toppling Anheuser-Busch as the world's largest brewer may be too tempting a target for the company to ignore. Chris Brook-Carter reports.

Interbrew's announcement early this week that it is in talks that could lead to a "significant transaction" with Brazil's biggest beer maker, Companhia de Bebidas das Americas SA (AmBev), will certainly have caused excitement amongst analysts and competitors alike.

Speculation yesterday surrounded an out and out merger.However the rhetoric used in a statement today seems to suggest that particular outcome is now unlikely. In today's follow-up statement, Interbrew declared that if discussions are successful, a transaction could involve the exchange of substantial equity interests between the two companies and or their subsidiaries.

Interbrew said that such an outcome would see Interbrew "own, directly or indirectly, an equity interest in AmBev." However, it added, dowsing speculation that a complete takeover is on the cards, that "under the current discussions, it is intended that AmBev would continue to be a separately listed company."

That said, and although Interbrew is keen to point out that talks may lead to nothing at all, the company has a history of blockbuster transactions, and the prospect of a significant acquisition is without doubt a possibility.

Details of the deal remain hazy, but as one analyst told "Interbrew might be interested in divesting its stake in FEMSA, as relations have not been excellent." Such a deal could see Interbrew sell its 30% stake in the Mexican brewer in return for a stake in AmBev, therefore shifting its South American focus from the troublesome FEMSA to the Brazilian giant.

Certainly Interbrew's relations with FEMSA have experienced happier times than the last 12 months. Last August, the Belgian owner of Beck's and Stella Artois was prevented from integrating its Beck's beer brand into its US distribution operation, Labatt USA. A US Circuit Court of Appeals judgment upheld a suit in a lower court brought by Femsa after the Mexican company contended that the arrival of Beck's would reduce the attention paid to its own brands in the portfolio.

But simply swapping its stake in FEMSA for a stake in AmBev would probably not amount to the "substantial equity interests" Interbrew has referred to and the investment community still believes that an altogether bigger transaction is on the cards.

"I think it is a merger; I am about 70% sure it's a merger," said one analyst yesterday. Though it now seems unlikely it will go that far, the advantages of a larger deal between the two companies are obvious.

Any significant tie-up could create a brewing powerhouse with the volume to knock Anheuser-Busch off the global top spot. In terms of market capitalisation, an Interbrew/ Ambev super-group would be the world's number two, behind Anheuser-Busch but ahead of SABMiller and Heineken, who would fall to three and four respectively.

Ambev and Interbrew also make a good geographical fit. Bank Degroof said on Monday it had raised its rating on the Belgian brewing giant to "hold" from "reduce". "A merger between the two entities is not to be excluded since the companies' geographical activities perfectly fit together," Degroof said in a note.

"The powerful argument [for a large deal] is that these two getting together would be the second largest brewer by market capitalisation and first by volume," said an analyst just-drinks spoke to. "They would have the firepower to expand in Latin America and make inroads into the US by developing distribution there."

He continued: "This is mainly about becoming a major player ahead of SABMiller and behind A-B. The family that controls Interbrew have done these deals in the past that have not made much financial sense, but have been about empire building."

The attraction of empire building may well be driving Ambev too. Had shareholders in the Latin American number one been looking to cash out, its major stakeholders could have sold sometime ago. The prospect of "stepping onto the board of the world's number two," as the analyst put it, may now be what's tempting the Brazilians.

The reaction from the City so far has been mixed and Interbrew's stock fell slightly yesterday on the news. However, the lack of detail makes it tough to call whether this will be earnings enhancing or not for the Belgian group. "It isn't clear enough as to what the deal could be," said the analyst.

Opponents of a merger point out that there will be no cost synergies for Interbrew from the deal. There could be some revenue synergies as the enlarged group begins to sell the likes of Beck's and Stella Artois into Brazil but from such a small base this would be a long-term bet.

However, as has been the case with Interbrew in the past, the main concerns revolve around the issue of price. "If [Ambev's] owners are looking for a premium it could be disastrous for the EPS of Interbrew and its image. It would go back to the image which has weighed on the share price, that Interbrew overspends," the analyst warned.

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This concern is not helped by the feeling that the talks may spark a bidding war for Ambev, with the US giant Anheuser-Busch the obvious opponent.

Mark Swartzberg of the equity analyst Legg Mason said: "Clearly it [Anheuser-Busch] thinks Latin America is an attractive market and one of the most obvious candidates is Ambev. Ambev has long shown an interest in a link-up and Anhueser-Busch could fit the bill very well."

That said, Interbrew is well placed to see off any rivals. Anheuser has always said that it would prefer to walk away from a deal than to overpay, while Interbrew's track record is a little more adventurous, so a bidding war may suit the Belgian brewer's mentality better.

Furthermore, Interbrew's ambitions may suit Ambev better than Anheuser-Busch. "Anheuser-Busch will be interested in Ambev," said the analyst. "But I will guess the (AmBev) owners are not looking to cash out, but rather at some greater strategic ambition."

A deal with Anheuser-Busch would almost certainly see the role of the Ambev management limited to second fiddle to the directions and wishes emanating from St Louis (A-B's HQ). By contrast, any significant share swap with Interbrew could result in Ambev's ambitious management taking a substantial stake in, as well as seats on the board of, a beer empire to rival Budweiser's world dominance.

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