This Buds For You - And By You, I Mean InBev

Posted by Bull Bear Trader | 7/05/2008 08:19:00 AM | | 0 comments »

As a former Missouri native growing up in the suburbs of the St. Louis area, I had come to think of Anheuser-Busch and the Clydesdale's as part of my identity, even before I was old enough to drink. Along with McDonnell-Douglas (now gone and replaced by Boeing), AB was part of the fabric of St. Louis. Just about every person you knew either worked for Mac or AB, or at least had a family member or friend who did. When McDonnell-Douglas was finally taken over by Boeing, it felt like the city was losing its security blanket, even though most of the employees and operations stayed. Now that Anheuser-Busch may fall victim to a takeover attempt by InBev, it feels more like potentially losing a friend.

Of course, this friend was the one that hung out with the cool kids, and only the best cliques. To get a job at Busch, well, you seem to have to know someone, someone deep in the clique. Yet, we all tried. I mean how great would it be to work for a beer company, especially one as dominate as AB? As they say, people drink in good times and bad, so job security was a given. Plus, they owned (or did own) the baseball Cardinals, another St. Louis tradition. And of course, they made really cool commercials. All was good.

But then the city got punched in the gut with news that InBev was making a play for Bud. InBev? Who the heck is InBev? Coors, sure. We have all heard of Coors, but they were no threat. Miller? Sure. They were big competitors, but let's be real. We did not really worry about Miller. The great taste - less filling commercials were amusing, but again, not to worry. We had Bud Light. And then a little thing happened while everyone slept. Smaller beer companies started becoming larger ones, and before you knew it, once mighty AB was a target. Instead of being the one acquiring, AB became the acquired - maybe.

So there it is. As AB's stock languished in the high $40's and low $50's, InBev offered $65 a share ($46.4 billion total), and mouths in St. Louis and across the country collectively gaped open. As expected, Bud rejected the offer, and went on the offensive. As a starting point, the company began running countless commercials of the CEO August Busch IV talking about company heritage. Notably, the commercials also included other spots with father and former CEO August Busch III, who did not always agree with his son's stewardship. InBev quickly replied by running an advertisement discussing what it would not change, including the headquarters in St. Louis, the U.S. breweries, Grant's Farm, and of course, the Clydesdale's. In addition to commercials, AB has begun crafting a $1 billion cost cutting plan that they hope will bring value back to the shares. In other words, we don't need your $65 a share bid. We can do it ourselves.

The cost cutting plan will include cutting 10% of the workforce over two years through attrition, cuts in benefits, price hikes for its top beer brands, and the repurchase of $7 billion in shares. This is all good, unless of course you are a big beer drinker, or an employee seeing your benefits reduced. Yet, while possibility too little, too late, does this really help AB? If InBev does acquire AB, wouldn't you expect InBev to do exactly the same thing? It would seem that such a move by AB does not really strengthen their case with existing shareholders, as far as maintaining control, but actually makes it more likely that InBev will proceed with their takeover attempt. AB may be doing nothing more than speeding up the process for InBev, both from a cost-cutting perspective, and also from a takeover perspective. AB may simply be forcing their hand, causing them to raise their bid, or go hostile, beyond just threats to remove the board.

While seemingly late, and possibly counterproductive to halting a deal, AB may have no other choice than pursue the approach it is taking. AB currently does not have a poison pill in place, but does have the means of adopting one. Nonetheless, given their recent talk of increasing shareholder value internally, it is difficult to see them putting one in place. The other much talked about option of buying out the remaining half of Mexican brewer Groupo Modelo also seems unlikely given that all six families that control the remaining 50% would have to sign off on the deal.

If the deal does go through, it is unclear at what price. Some analysts are predicting that InBev may have to go as high as $73 per share to close the deal, while others are predicting that even if the InBev offer goes as high as $80 a share, AB would still say no. Of course, if $73 per share could make the deal happen, there is no guarantee that InBev could come up with the financing. InBev has written to AB stating that it has the necessary financing in place for the $65 per share deal, yet if the deal goes higher, or becomes hostile, it is unclear if banks will want to step out on a limb in the current credit environment. InBev also recently announced that it plans a stock sale to fund the AB bid (see Jackson Business Journal article), but did not disclose how much capital they hope to raise, causing some concern regarding their ability to obtain enough money from the credit markets to get the deal done.

So what is an investor or trader to do? If the deal does get done, it is likely to be at a higher price, possibility in the $70s. Given the closing price of $61.67 on July 3rd, that gives around a 5.4% return for a price of $65, a 13.5% return for a offer of $70 a share, and a return of 21.6% for a deal going out at $75 per share. If InBev were to pull a Microsoft and simply walk away instead of going hostile, the price will surely fall back near the before-take-over value (near $48 per share), representing around a 22.2% decrease in price, unless of course you assume that investors believe the internal turn-around story advertised by AB and reward the company with a higher valuation. Given how Yahoo! fell, even with the Google news, this is unlikely. Yet, if investors do believe the story, the downside of taking a position may not be as painful. Nonetheless, any position now, given either optimistic or pessimistic scenarios, should produce a roughly one-to-one risk-reward relationship.

For those who trade options, buying calls may be a safer, and a potentially more profitable move. Currently, the December $60 calls are going for about $5, essentially eliminating gain at a $65 per share takeover, but allowing you to double your money if the offer rises to $70 per share. Of course, traders will need faith that the offer will be increased. If expecting a $70 per share price, another investment might be the December $65 strike calls, which are going for about $2. At $70 you are getting over $5 for your $2 investment, and of course limiting your downside. To help pay your premium, traders could also sell December $50 strike puts, currently going for about $1.30, or December $45 strike puts, going for about $0.70, depending on whether you believe the turn-around story by AB, and how much you think the price might fall if the deal does not go through. September calls are a little cheaper, and give a slightly better reward if you think any deal will either be done or fall apart quickly. But this is only one trade, and probably not the best. Things may change tomorrow. There are countless possibilities.

As for me, I will probably have a hard time pulling the trigger. No only is the risk-reward outside my comfort zone, with too many possibilities, there is also added danger since this would be an emotional trade. As any trader knows, once emotions sets into your trading, you are dead. Furthermore, I would probably be rooting against myself. It would kind of like be betting on the Tigers over my beloved Cardinals in the 2006 World Series, simply because all year the Tigers appeared to be the better team. What is the point? I both lose and win no matter what happens. It's a wash. I guess I could buy some puts, but again, I would be trading with emotion, and not my head.

It is worth noting that I have closely followed and commented on the Microsoft-Yahoo! talks for the last six months, arguing that Jerry Yang should just look out for shareholder interest and get the deal done. Now as I find myself hoping AB can stay a St. Louis tradition, calls of hypocrisy are understandable. Yet, this one is slightly different, at least to me - AB has leading brands in its markets, and seems to have some idea how to create shareholder value. But, their are similarities too. Without a deal, shareholders will certainly have to wait and hope that management can delivery the same value for them, something that I am still not convinced Yahoo! could do by themselves. I believe that AB can. If they don't, AB has no one to blame but themselves. In general, the founders or the family members of founders will need to realize that they are vulnerable. This is not just their company, it is the shareholder's company. If they cannot bring value, then the shareholders will find someone who can. If you sit on your hands long enough, competitors and/or shareholders may take your company away from you. Just ask Steve Jobs. He ended-up getting control of his company back. AB may not be as fortunate.