Glenboden M & A Originations

SABMiller a surer bidder for Mexico's FEMSA than Heineken

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Origination Status management statements on 'exploring opportunities', October 2009
Asset FEMSA Cerveza (Mexico), no.2 domestic beer producer
Buyer candidates are SABMiller and Heineken
Seller FEMSA CV (Mexico), leading domestic soft drinks, retail and beer group
Buyer Rationale leading share in large Mexican market, export brands
Seller Rationale valuation, strategic partner, focus on soft drinks and retail
NBs ABI is no.1 player in Mexico through 50% stake in Grupo Modelo
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FEMSA's management has admitted that strategic talks are ongoing with respect to its beer business, the no.2 player in Mexico. Heineken and SABMiller are tipped as the potential investors, with ABI conflicted out because of its 50% stake in Grupo Modelo. We believe however that the timing isn't right for Heineken, and that both strategically and financially SABMiller is better placed to acquire this business.

Cerveza has seen volume declines but has strong profitability ...FEMSA Cerveza is the owner of iconic Mexican export beer brands, most notably Sol and Dos Equis. With sales of over US$ 1,5 bln in H1 2009, that beer unit represents about 25% of FEMSA's total revenues.

About 70% of sales are in Mexico, with a further 15% in Brazil and the remaining 15% in export markets, mostly the US. However the Mexican business has seen flat volumes recently, and Brazil has seen a decline and is going through a turnaround project.

Nonetheless, Cerveza's EBITDA was up by 7% in H1 2009. It delivers an EBITDA margin of 23%, when FEMSA's group average is only 19%. In addition, the group's net debt ratio is only x0,9 EBITDA. In these circumstances, one wonders why FEMSA might intend to sell its beer unit.

... so FEMSA is not under major pressure to sell ...Perhaps that just demonstrates how strong global consolidation pressures are in brewing, these days. Presumably FEMSA is trying to take advantage of strong acquisition competition between Heineken and SABMiller, at this time.

... and might just want to shift the investment burden to a strategic partner Also FEMSA's other businesses, in particular FEMSA Coca-Cola, which is the largest Coke bottler in Latin America and constitues 50% of the groups revenues, are growing more strongly than the Cerveza unit, and maybe the group sees greater investment opportunities in soft drinks and retail, than in beer. Certainly capex in its beer unit fell by 20% in H1 2009.

It could also be that FEMSA is looking to remain as a significant shareholder in Cerveza, to enjoy the upside that beer presents in Latin America going forward, but wishes to shift the investment and management burden onto a big global beer specialist.

In that case, they could achieve an ownership structure similar to the no.1 player in Mexico, Grupo Modelo (Corona brand), in which Anheuser-Busch InBev has a 50% stake.

Heineken tipped as partner through existing commercial links...So far Heineken is most widely tipped as the strategic partner for Cerveza. Maybe that derives from the long-term distribution agreement between the two groups, in the USA, where sales are growing strongly (up 10% in H1 2009).

However, the US is still a small market for Cerveza, and it's only the 4th largest beer importer into that country. So, we don't think Heineken has any preferential path to gaining a strategic stake in Cerveza.

... fundamentally Heineken isn't ready for another big merger ...Moreover, looking at Heineken's fundamentals right know, it seems that the last thing the group needs is another big acquisition. It's still trying to recover its balance sheet strength, in the aftermath of the € 15 bln acquisition of Scottish & Newcastle (jointly with Carlsberg in 2007).

Heineken's strategic priority, as expressed in its H1 2009 results, is to improve free cashflow and reduce its net debt ratio. Further major investments, as expressed in its forecast capex spend of only € 700 mln for FY 2009, are not a priorty at all.

At the end of H1 2009, the group's net debt had been reduced to x3,1 EBITDA, from x3,3 at y/e 2008. The aim is to bring this down to x2,5. To this end, Heineken is improving free cashflow, through 'robust prices', higher share of premium brand sales and cost reductions.

However, with free cashflow of only € 400 mln in H1 2009, next to operating profit in that period of around € 1 bln, the group still has some way to go to achieve its stated aim of a 'full cash conversion ratio'.

... with the Cerveza valuation likely to be highMeanwhile, the Cerveza business is on target to achieve EBITDA of € 500 mln equivalent in FY 2009. Even with a multiple of x12, that would mean a valuation (assuming a cash -only deal) of € 6 bln. That could increase Heineken's net debt ratio to over x5 EBITDA, when its target is half of that number. Talk about going against the grain of one's strategy.

SAB is better placed in terms of M&A history and consequent leverageSABMiller, the other cited bidder, does not have the same financial hangover of a major acquisition that Heineken has. It's last 'mega-merger' was between SAB and Miller, back in 2002.

In recent years, that group's deals have been much smaller. Notably investments in developing markets, most recently its purchase of the Maheu beverage portfolio in Zambia in September 2009; also single brands with international potential, as exemplified by buying Grolsch in 2007.

As a consequence of this M&A strategy, SABMiller's net debt ratio at y/e FY 2009 was just over x2 EBITDA. In hard numbers terms, if it paid € 6 bln for 100% of Cerveza, then that ratio would remain under x4, significantly lower than in the case of Heineken. (SABMiller + Cerveza est. € 12 bln net debt vs. € 3,5 bln EBITDA).

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THIS LEAD'S VALUATION
Size (€ mln) 6.000
Sector brewing
Asset Quality Mexico no.2 branded
Seller large plc
Buyer large plc
P/S 3,0
P/Ebitda 12,0
Type enterprise value estimate
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