The beer business got a little smaller January 11 when Dutch brewer Heineken announced it was buying the beer operations of Mexican conglomerate Femsa (NYSE: FMX) for $7.8 billion. Paying for the deal with $5.7 billion in stock and assuming $2.1 billion in debt, Heineken gains access to one of the world's fastest-growing beer markets at 11.2 times EBITDA, which most suggest is reasonable given previous deal multiples. In return, Femsa becomes a 20% shareholder in the world's third-largest brewer of beer, gaining a welcome partner in its domestic battle with Grupo Modelo, the largest beer company in Mexico. Investors panned the deal, sending Femsa shares down 13.6% by the end of the day's trading, although Heineken shares were up a modest 3.26%. The question remains whether the shares will stay down. I doubt it. (Beer is a complex beverage shaped by supply and demand, production and distribution, with regulation thrown in for that extra kick. To learn more, read Beeronomics: Factors Affecting Your Pint.)
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A Small Piece Of A Big Pie
Overnight, Femsa has gone from being a big fish in a small pond to the other way around. Investors' initial reaction seems to be that this was a mistake to give up a quarter of its total revenue and the associated operating profits. Let's set the record straight: Femsa's beer business generated $412.1 million in operating income in 2008 from $3.24 billion in revenue. That's an operating margin of 12.7%. If you back out the beer business from Femsa's 2008 annual report, the remaining Coca-Cola (NYSE: KO) and OXXO convenience store businesses would have achieved an operating margin of 12.9%, identical to its margin including Femsa Cerveza. In the worst-case scenario its margin stays the same, albeit on lower revenues, but its debt level drops to zero. Further, Heineken believes that the addition of Femsa will up its operating margin from 32% to 40% in its fastest-growing markets, adding profits to Heineken's bottom line and greater dividends for Femsa down the road. What's not to like?
In my opinion, this deal works for both companies. Heineken gets one of the few large beer companies available in a growing market, and Femsa gains a passive investment in a very difficult industry. It's only a matter of time before Anheuser-Busch InBev (NYSE: BUD) starts sniffing around for the other 50% of Grupo Modelo that it doesn't already own. With 43% market share in Mexico after the acquisition, you can be sure Heineken will make the country a top priority. Furthermore, Heineken will now have a respectable exposure to the Brazilian markets. That's bad news for its bigger competitor. If there wasn't a beer war before, there is now.
Generally, I'm skeptical about large acquisitions. They often don't work, and the projected cost savings - $218 million a year in three years for this deal - often don't materialize. Beer companies, however, seem to be different. Although Molson Coors (NYSE: TAP) is having problems growing revenues right now, it has had little difficulty cutting costs and improving profitability. As for Boston Beer (NYSE: SAM), this deal could be an unexpected gift. With the two largest beer companies locked in a battle south of the Rio Grande, Sam Adams might have more room to maneuver right here in the U.S. As for Femsa shareholders, take a deep breath and be thankful that you have assets other people want and are willing to pay for. In my book, this is a win/win situation. (To learn more about the merger and acquisition business, refer to The Wonderful World Of Mergers.)
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