Cash Value

Return on Invested Capital and Economic Value Added both measure different aspects of value creation. As a primary investment criterion, however, Private Equity firms are looking for companies with stable and recurring cash flows in order to have sufficient cash to service the entire debt obligation. It comes as no surprise that PE firms are interested in precisely measuring the cash returns on their investment⁵⁵. Acquisitions create value when the cash flows of the combined companies are greater than sum of cash flows of the independent companies.

In this section, we want to measure the breakeven year when the value of the combined company matches the implied price of it. We are looking for the breakeven year as opposed to the somewhat similar payback period method. The payback period is a purely accounting measure which completely ignores the time value of money thus not satisfying our needs.

Ideally, in order to measure the breakeven year of the transaction, we would treat it as a separate project and calculate the increase in value created by the acquisition and compare it with the market value of the target plus the acquisition premium.

55 (Barber and Goold, 2007)

40,000 80,000 120,000 160,000 200,000

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Accumulated EVA

r=5% r=3% r=2% r=1% r=0%

65 𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑌𝑒𝑎𝑟(𝑋): ∆𝑉𝑎𝑙𝑢𝑒 𝑑𝑢𝑒 𝑡𝑜 𝑡ℎ𝑒 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 =

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑇𝑎𝑟𝑔𝑒𝑡 + 𝐴𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

However, since we are not able to separate the value brought in only by the acquisition due to the synergies amongst the two companies, we will have to use the combined company as a whole.

To determine the year when the breakeven ensues we will use the following equation:

𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑌𝑒𝑎𝑟 (𝑋): 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑 𝐶𝑜𝑚𝑝𝑎𝑛𝑦 𝑖𝑛 𝑌𝑒𝑎𝑟 𝑋 =

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑐𝑞𝑢𝑖𝑟𝑒𝑟 𝑏𝑒𝑓𝑜𝑟𝑒 𝐴𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 + 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑇𝑎𝑟𝑔𝑒𝑡 + 𝐴𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

The above equation is inspired from Koller et al. (2010) and adapted to our needs. The goal is to identify the year when the total value of the merged company equals the sum of the market value of the acquirer before announcing the deal plus the market value of the target before the deal was announced plus the premium paid for the acquisition.

In this case, we will work based on the assumption that financial markets were efficient and the Market Value of the Acquirer before Acquisition is correctly priced. A misprice in the Market Value of the Acquirer would disturb our result significantly.

We will start with the end part, market values and premium paid, as it is public information. According to S&P IQ Capital database, the market capitalization of AB InBev the day prior to the announcement of the offer was €160,723 MM (see Appendix – Transaction Details). The EUR/ USD exchange rate used by S&P IQ Capital is 1.19514356, which translates into $192,087MM. The market capitalization of SAB Miller the day before the offer was €69,490 MM, which translates to $83,050 MM. The implied enterprise value meaning the market capitalization plus the premium paid was € 101,946 MM, meaning $121,840 MM. This

translates into a premium for the acquisition of 46%. In consequence the market cap of the acquirer plus the market cap of the target plus the acquisition premium equal to $313,928 MM. This value will be right side of our equation.

To calculate the left side of the equation, we need to compute the value of the merged company by using an NPV formula, similar to the Discounted Cash Flow (DCF) model used for determining the enterprise value. The main difference will be that the DCF model incorporates a calculation for the terminal value of the company. Since we are not interested in valuing the company for an indefinite period, we will not include a terminal value of the company.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒_𝑡 = ∑ ₍₁₊^{𝐹𝐶𝐹𝐹𝑡}

𝑊𝐴𝐶𝐶)^𝑡

𝑥𝑡=1

66 where x=breakeven year,

FCF=Free cash flow to the Firm = Cash Flow from Operating Activities - Cash flow from Investing activities⁵⁶, WACC=weighted average cost of capital.

Our base case scenario assumes a revenue growth rate equal to the implied one of 3% and a WACC of 7.2%, the breakeven year when the value of the future FCFFs equals the market value of AB plus the market value of SAB plus the acquisition premium is 2050. Any future FCFF obtained after 2050 will represent a gain on the transaction for the acquirer.

Also in this particular evaluation, the revenue growth rate and the WACC play a major role. We will construct a sensitivity analysis based on these two measures in order to assess the impact they have upon the breakeven year.

Breakeven Year WACC

6.20% 7.20% 8.20% 9.20%

Revenue Growth Rate

r=3% 2045 2050 2060 >2070

r=4% 2041 2045 2051 2064

r=5% 2039 2042 2046 2052

r=6% 2038 2040 2043 2047

r=7% 2036 2038 2040 2043

r=8% 2035 2037 2038 2041

Exhibit 51: Breakeven Year sensitivity to Revenue Growth Rate (vertical) and WACC (horizontal). Source: Author's elaboration

Higher revenue growth rate implies more value created while a higher WACC implies lower value created.

After careful research, there was no evidence of any study looking at the breakeven period of an acquisition. The reason is that the method is quite unorthodox as most studies look at the valuation of transactions. Consequently, we do not have a term of comparison for our breakeven period. However, we consider the breakeven period of 33 years, 2017-2050, for the merged company to recoup its value too high.

Therefore, the need of a proper valuation arises to collect additional information.

56 (Plenborg and Petersen, 2012)

67 We will construct a DCF valuation to evaluate the enterprise value according to the method of Plenborg and Petersen (2012) based on the formula:

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒₀= ∑ 𝐹𝐶𝐹𝐹_𝑡 (1 + 𝑊𝐴𝐶𝐶)^𝑡

𝑥 𝑡=1

+ 𝐹𝐶𝐹𝐹_𝑛+1

𝑊𝐴𝐶𝐶 − 𝑔+ 1 1 + 𝑊𝐴𝐶𝐶

Year 2017 2018 2019 2020 2021 2022

FCFF 13,991 14,611 15,739 16,454 16,995 17,494

WACC 7.2% 7.2% 7.2% 7.2% 7.2% 107.2%

Present Value, FCFF 13,052 12,714 12,776 12,459 12,005 11,527

Present Value of FCFF in 5-year forecast horizon 63,005

Present Value of FCFF in terminal period 615,804

Estimated Enterprise Value 678,809

Net Interest-Bearing Debt -95,487

Estimated market value of equity 583,322

Exhibit 52: Enterprise Value calculation. Source: Author's elaboration

The assumptions made in the DCF model were g=4.5% as this is the growth rate of the FCF once the debt raised for the acquisition is paid back, Net Interest-Bearing Debt equal to approx. $ 95 BN after the debt related to the merger is paid back and the revenue growth rate, r, is the implied one of 3%.

The DCF model clearly shows that the enterprise value is far bigger than the market value of the AB InBev plus the market value of SAB Miller plus the acquisition premium thus providing an answer to subquestion 5.

68