As a rule, we aren’t a big fan of commenting on speculation but the article in the New York Post warrants some clarification if there is any truth to the rumblings it suggests are coming from the Department of Justice regarding potentially “major concessions” it might be seeking from Anheuser-Busch InBev (ABI BB, BUD) as it pursues its acquisition of Grupo Modelo (GMODELOC.MM).
We reference our note published on January 2nd (“Reaching for the Crown”) where we highlighted the DOJ’s response to InBev’s acquisition of Anheuser-Busch as a template for looking at this acquisition.
To review, Anheuser-Busch held an approximate 48.5% share of market at the time it was acquired by InBev. As part of the judgment of the Department of Justice consenting to the transaction, InBev was required to divest the Labatt’s business in the United States – the business was part of Labatt Brewing Co. Ltd., which was a partially owned subsidiary of InBev based in Toronto. While Labatt’s held a less than one percent share of the total market (0.8%) in the United States, more than half its sales were in upstate New York, where the DOJ was concerned that, when combined with Anheuser-Busch’s share of market in that region, the new entity would enjoy a market share over 75%.
The solution was the mirror image of the proposed Crown transaction – InBev was required to grant an exclusive license to brew, market, sell and distribute the brands in the United States. Labatt’s Canada agreed to brew the brand during an interim period (three years). The rights in the United States were eventually sold to North American Breweries.
In the case of Constellation Brands and Crown, STZ will be purchasing the same rights (distribution, marketing, promotion, and, importantly, pricing) as those acquired by North American Breweries with two key differences. The first difference is that ABI will continue to be responsible for continuity of supply (brewing) as well as brand innovation. The second difference is that ABI has the right to exercise a call option on Crown and purchase the business at 13x EBIT every ten years.
Based on the commentary in the Post article, it appears that the first key difference that we highlighted is what the DOJ may be examining – the DOJ is uncomfortable with ABI continuing to control the supply of Corona (and other brands) to Crown. This doesn’t make a whole lot of sense to us, as it is essentially a contract brewing agreement, with Crown controlling all the important aspects of brand management. Regardless, if the DOJ were to insist on such a concession, we strongly suspect that it is a measure that ABI would agree to (the Post article suggests likewise).
Keep in mind that the value of this transaction to ABI should not in any way shape or form be measured with respect to the degree that ABI remains involved in the U.S. market through Corona. The value to ABI is the synergies that it is able to extract from an inefficient, family-owned business in Mexico and the ability of the company to grow the Corona (and other) brands globally.
Note that there is some historical precedent for multiple layers of control over Corona in the United States. At one point, Gambrinus and Barton had east/west geographic control over the distribution and Modelo managed the distribution relationships through a U.S. subsidiary - Procermex Inc. (going to back to 2006). Also, forcing the creation of (or shifting the volume to) another brewer might be what passes for job creation these days, so we wouldn’t be at all surprised to see the DOJ go down that path.
We continue to believe that the ABI would be willing to agree to the concessions that were speculated in the article given the potential value creation associated with the Modelo transaction. We also note that someone else brewing the beer in no way diminishes the potential value creation of the deal to STZ.
Have a good week,
HEDGEYE RISK MANAGEMENT, LLC