What the DOJ did…
After reading through the complaint filed by the DOJ, it seems clear to us that the DOJ was more interested in appearing to do SOMETHING rather than examine the facts of the case. The DOJ has a long history of wanting to appear sympathetic to the little guy that buys beer and baby food.
The DOJ gave ABI/Modelo/STZ virtually no credit for the indirect nature of the control that ABI would have had subseqent to the transaction closing. Instead, the focus was placed on the supply agreement, and how that might allow ABI to influence Corona pricing.
So, the deal has become contentious, with the potential to drag out beyond Q1. If this moves to trial, we won't likely see a start for 2-4 months. However, both sides can and likely will continue to talk. We fall back on our initial assessment based on the following factors:
- Modelo is an asset that ABI has long coveted (multi-year owner/partner)
- If not now, when does ABI act? Waiting for changes in the regulatory winds doesn't seem like a sound business strategy on the part of ABI
- Modelo is a multi-billion global opportunity for ABI
Walking away seems unlikely, if you accept our fact pattern. Therefore, what has to be done. First off, the call option on the business has to go -- the DOJ mentioned it about a half dozen times in the complaint. The DOJ was focused on premium and premium plus pricing, so ABI might have to give up a brand in that segment - we have suggested Michelob. Finally, we fall back to our analysis of the InBev/Budweiser deal where InBev sold and then brewed Labatt's for a period of three years for North American Breweries. In short, the DOJ's concerns regarding supply have to be met in some fashion (selling a brewery or searching for an alternate supply for Crown).
What the DOJ said...
We read the complaint so you don’t have to, and we have selected some comments that we believe highlight how the DOJ has attempted to shoehorn a conclusion into a fact pattern that is several sizes too small. To begin:
“As the two largest brewers, ABI and MillerCoors often find it more profitable to follow each other’s prices than to compete aggressively for market share by cutting price. Among other things, ABI typically initiates annual price increases in various markets with the expectation that MillerCoors’ prices will follow. And they frequently do. In contrast, Modelo has resisted ABI-led price hikes.”
The DOJ has embraced a temporary market share vs. price strategy as a structural imperative of the US beer industry. It is just as likely that Modelo, satisfied with recent share gains, seeks to improve profitability through pricing for a period of time.
“The loss of this head-to-head competition would enhance the ability of ABI to unilaterally raise the prices of the brands that it would own post-acquisition, and diminish ABI’s incentive to innovate with respect to new brands, products, and packaging.”
ABI competes in a global market place with shifting demographics and consumer taste preferences. Further, consumers across all staples categories are demanding different varieties and taste profiles. Finally, the growth of the craft brewing segment has been a driver of innovation across the industry, not the competition between ABI and MillerCoors. In this case, the DOJ has mistakenly viewed a structural imperative of virtually all staples sectors (innovation), as a temporary market condition.
“For no substantial business reason other than to avoid liability under the antitrust laws, ABI has entered into an additional transaction contingent on the approval of its acquisition of the remainder of Modelo. Specifically, ABI has agreed to sell Modelo’s existing 50% interest in Crown Imports LLC (“Crown”)”
This one is a real head-scratcher – of course there was no business reason. Any incremental concessions won’t have any substantial business reason either.
“Constellation has already shown through its participation in the Crown joint venture that it does not share Modelo’s incentive to thwart ABI’s price leadership. In fact, Constellation consistently has urged following ABI’s price leadership.”
This is simply a difference of opinion between JV partners, neither position is permanent (see earlier point) nor is one necessarily the correct or incorrect course of action at any point in time.
“The acquisition gives complete control of Modelo to ABI, and gives ABI full access to competitively sensitive information about the sale of the Modelo brands in the United States – access that ABI does not currently enjoy.”
Really? I have access to pricing information on Modelo brands. Not real time, nor in advance, but does the DOJ believe that the largest brewer in the U.S., with a network of distributors across the country, is unaware of the actions of its competitors, whether it owns a portion of them or not?
“Beer is a relevant product market and line of commerce under Section 7 of the Clayton Act. Other alcoholic beverages, such as wine and distilled spirits, are not sufficiently substitutable (emphasis added) to discipline at least a small but significant and nontransitory increase in the price of beer, and relatively few consumers would substantially reduce their beer purchases in the event of such a price increase.”
Again, really? I have to assume that the DOJ just missed the spirits companies talking about targeting beer occasions. Someone needs to tell Brown-Forman that no one who drinks beer is a potential consumer of any of their products. It would save the company a lot of time, money and effort. Someone should also point out the consistent and multi-year loss of share of liver on the part of beer to wines and spirits.
“Brewers are able to price differently in different locations, in part, because arbitrage across local markets is unlikely to occur.”
I’m confused – is beer pricing local, or is it uniform across the country?
“Crown executives have recognized the differing incentives, as it relates to pricing, of their two owners. As one Crown executive observed in a March 2011 email, “Modelo has a higher interest in building volume so that they can cover manufacturing costs, gain manufacturing profits and build share as the brand owners.” Constellation, however, “is interested primarily in the financial return on a short-term or at the most on a mid-term basis.”
Of course STZ was short-term focused; it wasn’t clear what the status of the Crown JV was much beyond the next couple of years. The nature of the transaction changes the incentives and durations of the parties involved.
Where does that leave us?
In summary, it appears that the DOJ is focused on pricing (naturally), the fact that there is no brewing facility associated with the transaction (ABI controls supply) and the 10 year call option (mentioned several times, that thing really has to go). We think that there is a middle ground to be had here that preserves the illusion that the DOJ actually accomplished something and that allows for ABI/Modelo/STZ to realize significant value from the transaction.
Call with questions, please.
HEDGEYE RISK MANAGEMENT, LLC