SABMiller won’t get Foster’s on the cheap

June 21, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — SABMiller’s A$11.2 billion ($11.8 billion) approach to Foster’s Group is unlikely to be its last. The UK-listed brewing giant will have to dangle more to win a recommendation from its Australian target, whose shares jumped 5 percent above the A$4.90 being offered. But SAB cannot afford to stretch too far.

Foster’s has undeniable charms for a global brewer like SAB, starting with its 50 percent share of a highly profitable market. Foster’s 38 percent operating margins are more than twice SAB’s. There’s even room to improve on that. As half of a cosy duopoly, Foster’s has grown fat. A new, unproven chief executive gives further grist to SAB’s opportunistic mill.

Funding an all-cash offer would be simple enough. Of the global brewers, only SAB and U.S. brewer Anheuser-Busch Inbev can raise the requisite cash without issuing equity, or taking net debt beyond a comfortable 3.5 times EBITDA, say Credit Suisse research. So SAB could conceivably stretch to $13.8 billion — implying a share price 30 percent above its current offer.

Still, while SAB has the firepower, a substantially higher bid isn’t easy to justify. Foster’s may be inefficient, but there is little scope for synergies given SAB’s paltry 1.5 percent share of the Australian beer market. Based on Foster’s forecast operating profits for 2012, the post-tax return on investment a year from now would be a meagre 5.5 percent.

The maths might change if SAB could work some operational magic. Slashing Foster’s marketing budget from 10 percent of sales to SAB’s 8 percent would also help. And repositioning Foster’s towards so-called “new-style” low-carb beers, where AC Nielsen sees Australian volumes growing at 17 percent, would offset the slow decline for traditional beers like Foster’s Victoria Bitter.

Assume SAB can grow Foster’s revenues by 7 percent for the next two years, and widen margins by four percentage points. It could eventually squeeze out a post-tax return somewhere close to Foster’s 8.5 percent cost of capital. However, that might get pushed out by another two years if certain tax credits fall away as a result of the deal.

Foster’s appeal is all too visible to other global brewers. Japanese peers Asahi and Suntory may want to follow rival Kirin, which took over Australian number-two Lion Nathan in 2009. Mexico’s Modelo has might also be interested, though 50 percent shareholder AB Inbev might have other ideas. But with AB Inbev still digesting past deals, SAB looks like the lead cash cash bidder. That just leaves Foster’s board — and the market to win over.

Breakingviews calculator determines how much SABMiller can afford to pay if the deal is to cover its cost of capital.

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