After months of speculation SAB has finally bought Miller Brewing for $5.6 billion, and with it second place in the world brewing rankings. Doubts over price and potential have taken the shine off the deal. However, Chris Brook-Carter argues that a longer-term view should be taken of this industry-transforming merger.

 

Graham Mackay, chief executive, of South African Breweries has been a patient man. Portrayed as the great white hunter when he moved SAB's primary listing from the Johannesburg Stock Exchange to London over three years ago, the industry waited in expectation for the man from the South African Highveld to make his move and acquire or sell SAB to one of its new European neighbours to create a global brewing force.

 

But SAB sat and waited. Despite talks with S&N, rumours of a bid from Interbrew, and a number of possible acquisition targets such as Beck's, Carling Brewers and Bass, Mackay remained unmoved, balking at the prices being asked. Three years down the line many wondered if SAB would indeed close the deal it had been seeking.

 

Doubters needn't have worried, for SAB's move came last week and is bolder than anyone could have imagined and braver than any of the other recent deals. By paying US$5.6 billion for Miller Brewing, it has, in one move, created the world's second largest brewer with a combined profit of US$1.5 billion, 38,000 employees, volumes of approximately 5.6 billion litres a year and major brands such as Pilsner Urquell, Lion, Miller and Miller Lite.

 

But as so often happens in the City, the same analysts who have been calling on Mackay to make his move reacted quickly to news by going on the defensive, worried about the scale of the task ahead as the new brewer takes on Anheuser-Busch in its own back yard. These jitters had the effect of forcing SAB's share price down.

 

Most evident were concerns that SAB had in the end been forced to pay too much for Miller, some US$5.6 billion as opposed to the anticipated US$5 billion. And it is certainly more than is ideal given the somewhat meagre US$50m SAB will receive in annual cost savings by the end of year three. What is more, investment bank ABN Amro estimates that while EPS will be boosted 8% in the first year, the return on capital will be only 6.4% in the third year, as opposed to a US-weighted average cost of capital of 7%.

 


"There is also a perception in the industry that SAB has paid this vast sum for a weak business, that can offer little benefit, particularly in the short term"
There is also a perception in the industry that SAB has paid this vast sum for a weak business, that can offer the fast-growing South African little benefit, particularly in the short term. Miller has around a 20% share of the US market but has been losing ground on its arch-rival Anheuser-Busch, which holds just below 50%. Perhaps more worrying though is that between 1995 and 2000 Miller's volumes fell from 62.5m hectolitres in the US to 53m hls, with only 1.5m hls outside the US.

 

The critical question these figures raise among the deal's critics is whether SAB can change its focus from successful emerging market operator to a mature market operator? The jury is still out over that but it would be unfair to dismiss the many positives Mackay has already achieved for SAB by acquiring Miller.

 

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"The bears will point out that SAB has seemingly over-paid. However these same bears have criticised SAB for its focus on emerging markets - they cannot have it both ways"
The bears will point out that SAB has seemingly over-paid for an under-performing US business. However these same bears have criticised SAB for its focus on emerging markets - they cannot have it both ways," said drinks analyst Stuart Price of WestLB Panmure. Indeed he goes as far as to say that the current weakness in the SAB stock represents a good buying opportunity.

 

SAB has suffered hard from its reliance on emerging markets and in particular on South Africa where the weak Rand has eaten into profits. On the same day SAB announced its Miller deal it also unveiled profit before tax (PBT) down from US$638m to US$601m. However trading was in general excellent and Price believes the volumes growth "confirms that the erosion in PBT had more to do with 24% erosion in the Rand-US$ exchange rate than anything to do with the management's operational skills." He went on: "The exchange rate issue is now behind SAB, thanks to the acquisition of Miller."

 

The deal, in fact, gives SABMiller an excellent geographical spread and balance between emerging and mature markets. Based on 2002 pro forma figures, North America will now account for 35% of the expanded company's EBITA, South Africa 33%, Europe 16% Africa and Asia 14% and Central America 2%.

 

SAB also gets an important foothold in the US, the world's most profitable beer market, which unlike many developed markets is experiencing growth, particularly at the premium and import end of the scale, a category SAB is ideally placed to exploit, with brands such as Pilsner Urquell. Furthermore, Miller has a string of RTDs, the country's fastest growing drinks category, recently launched or about to launch.

 

And neither is Miller the expensive failure critics believe. Firstly theUS$5.6bn translates into a historic EV/EBITDA multiple of 9.4 and according to WestLB Panmure the industry average over the last two years has been a multiple of about ten.

 

"The deal itself is structured on attractive terms," said Mackay on Thursday (May 30th).  "It's a nil or low premium transaction and it allows us access to the biggest profit pool in the world. The scale aspect is a tremendous advantage in a consolidating industry. Miller is a stable business, has been around a long time and has some very good brands. It has been through some tough times but we believe that it is performing better now than it has been, and we believe that it has the potential to continue to perform better and better."

 

Mackay went on to defend Miller's recent record. "


"I think it is very misleading to compare Miller to Anheuser-Busch. Anheuser-Busch has been a significant success story "
I think it is very misleading to compare Miller to Anheuser-Busch. Anheuser-Busch has been a significant success story and has gained share. Miller has not done that. Nor has it been declining or falling off the edge in any sense at all. Added to which the management team, which went in three years ago, we think is a very strong management."

 

In fact, SAB would have to do very little to improve Miller to reap significant rewards. "The profit/market share dynamics in the USA is such that a one point move in market share yields US$70m of incremental EBITDA," said Price.

 

And Mackay concluded: "We think, in summary, they've [the Miller management] done a lot of good things and that results will start to show over the next few years."

 

This is the crux of the problem SAB and Miller have faced in convincing sceptics of the logic of their deal. The acquisition is not about short-term gain. It needs to be seen in the broader picture and part of an on-going metamorphosis of SAB from South African local to global power. And SAB has already hinted that this is not the end of the hunt.

 

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"SABMiller's global network will provide an attractive platform for growth, both organically as well as through further synergistic acquisitions"
SABMiller's global network will provide an attractive platform for growth, both organically as well as through further synergistic acquisitions or partnerships of preference," said SAB when announcing the deal.

 

"We think another acquisition could be likely," said Price. "Targets could be Scottish & Newcastle or Fosters or a joint venture with Carlsberg." Market fillers in China and Russia could also be possibilities.

 

Above all, Miller gives SAB a stable base with a significant cash flow to pursue these goals, which of course is what it does best. And there are plans to raise further equity through the addition of some 170m shares. Seen in this light the deal takes on a new dynamic as a merger between two of the world's most efficient brewers. SAB may yet retain the same spots that have made it the industry's most successful emerging market operator.