Post-merger value creation: the case of AB InBev and SAB Miller

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Post-merger value creation: the case of AB InBev and SAB Miller

Master Thesis

MSc. Finance and Strategic Management

Supervisor: Leonhardt Pihl Author: Razvan Mititelu CPR:

Number of characters: 121,264 Number of pages: 67

Date of submission: 15.05.2017

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Executive Summary

The main objective of the following paper is to determine whether the merger of AB InBev with SAB Miller will create value.

Historically the companies represented the largest and the second largest beer producer in the world. They merged during late 2016 when 3G Capital, the main shareholder of AB InBev and the team behind its management team acquired SAB Miller through a friendly takeover. 3G Capital is a private equity company, known for its big-ticket acquisitions and for their way of slashing costs.

The papers starts with presenting in a descriptive matter the three parties involved. The following section starts the analytical side of the thesis through the restatement of the financial statements for the two companies in order to separate the operating activities from the financing ones. The forecast of the two companies is performed through a pro forma method. A financial model will be designed rather than static financial statements, in order to be able to apply different adjustments on some of the Income Statement and Balance Sheet items. The impact of these adjustments will be able to be measured only through a financial model.

The next section presents both qualitatively and quantitatively how 3G Capital usually applies their

integration plan after the merger in order to obtain synergies. To forecast which synergies will be obtained and what will be their value, we will be looking at two comparisons: firstly against previous 3G deals including AB InBev and Kraft Heinz and secondly against peer companies in the industry such as Heineken and Carlsberg. The main synergies will be in the areas of Cost of Goods Sold, Selling, General and

Administrative expenses and Accounts Payable Management. The value of these synergies will be taken then into account in the financial model in order to obtain the consolidated financial statements of the combined company.

Based on the financial statements of the merged company we will assess and measure the value creation.

Firstly, through Return on Invested Capital and and Economic Value Added. Both measure will indicate that value is created, however not at the full potential. Cost synergies have a limited effect on the value creation and thus revenue growth synergies have to be introduced in order to maximize the potential. Revenue growth has a tremendous impact on value creation and will represent the success factor behind this merger. In the end section, we look at the value creation from a cash perspective and determine that the value of the combined company exceeds the market value of the two companies before the merger plus the acquisition premium. Thus, the thesis concludes that 3G Capital will be able to create value through the merger of AB InBev with SAB Miller.

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Source: Author's elaboration ... 59 Exhibit 45: Economic Value Added for AB&SAB in 2020. Source: Appendix - Return on Invested Capital 2017- 2020. ... 61 Exhibit 46: Economic Value Added for AB&SAB in 2020. Source: Appendix - Return on Invested Capital 2017- 2020. ... 61 Exhibit 47: Economic Value Added calculation. Source: Author’s elaboration. ... 61 Exhibit 48: Achieving EVA = 8,992, at various revenue growth rates. Source: Author's elaboration. ... 63 Exhibit 49: Sensitivity analysis of Revenue Growth Rate and its impact on EVA. Source: Author's elaboration.

... 63 Exhibit 50: Accumulated EVA for various revenue growth rates. Source: Author's elaboration ... 64 Exhibit 51: Breakeven Year sensitivity to Revenue Growth Rate (vertical) and WACC (horizontal). Source:

Author's elaboration ... 66 Exhibit 52: Enterprise Value calculation. Source: Author's elaboration... 67

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1. Introduction

Through the merger of AB InBev and SAB Miller, historically the largest and the second largest beer company in the world, a mammoth company will be formed. According to some sources the merged company will dominate the global supply of beer with a market share of approximately 30%.

The question that is left is whether a company this size will be able to bring any value or quite the opposite destroy value due to its size. The engine behind this merger is a Brazilian private equity company called 3G Capital. Although in general the private equity industry is covered in mystery, the story behind 3G Capital success is out there with several books being written about it. They are well known for cutting costs and improving the efficiency of a company. With several big deals closed already such as Burger King, Heinz, Kraft and AB InBev, they have developed their own way of integrating a company in the post-merger phase, known as the 3G Model.

This paper applies financial methods in order to assess whether they will be able to create value through their usual way of integration. A financial model will be built to assess each cost cutting measure. Several measures of value creation will determine the final answer.

2. Research Questions

The main objective of the paper is to assess whether 3G Capital through its integration process generates value in the AB InBev and SAB Miller merger.

The main research question therefore is:

Will 3G Capital post-merger integration process of SAB Miller into the existing AB InBev organisation generate value?

The following sub-questions are phrased in order to provide a framework for the project and to cover all the aspects related to the subject:

1. How were AB InBev and SAB Miller expected to perform in the future as separate firms?

2. What is 3G Capital model for post-merger integration?

3. What synergies is 3G Capital applying in the case of SAB Miller and what is their value?

4. What will be the performance of the combined company in terms of Return on Invested Capital and Economic Value Added?

5. Does the value of the combined company exceed the market value of the two companies plus the acquisition premium?

The first sub question tries to answer how are the two companies forecasted to perform in the future as separate entities. The second one’s aim is to describe and to qualitatively assess the typical

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8 integration process of a 3G company. The third sub questions will answer which synergies will take place, how will they be implemented and what will be their effects from a financial point of view. By calculating the ROIC and EVA, we will have two financial metrics to measure the value creation. The last sub question will look at the value creation from a cash perspective and will be the decisive measure for evaluating the investment.

3. Methodology

The paper follows three broad methods encompassed in two separate books in order to investigate the subject.

Firstly, the thesis follows the method of Plenborg and Petersen (2012) for the restatement of balance sheet and income statement and the assessment of profitability. The method is an analytical and quantitative process, which separates assets and activities into operating and non-operating.

Secondly, it follows the steps described by Koller et al. (2010) in order to construct the financial model. The method itself is practical oriented as it represents a “how to…” manual for building financial statements models. The scope of this method is building a financial model that encompasses the income statement, balance sheet and cash flow statement. The three statements need to be linked to each other and assumptions have to be taken in order for the model to be flexible and to forecast as many years into the future as needed. Additionally, for our purpose the model has to be able to take adjustments into some line items both on I/S and B/S and adjust the rest of the statements accordingly. This feature is highly significant as it distinguishes between simply stating financial statements and building a financial model. A financial model has to be able to run “what if” scenarios and show immediately the results.

Thirdly, it applies the framework provided by Koller et al. (2010) to explain how value is created. The framework is highly theoretical as it maps out how we should think about value. It illustrates what are the drivers of value (ROIC, revenue growth), how should we measure it (Cash flows) and what are the external factors influencing it (WACC). In order to decompose the framework into tangible and quantifiable facts we will use the Du Pont analysis.

Since the paper is a case study, any of the findings should not be applied as a generalization to other mergers and acquisitions deals or any other transactions in the brewing industry.

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3.2. Delimitation

Following the transaction close, the new combined company had to get approval from the competition regulators of the main markets: EU, USA and China. In order to receive the approval several brands and business that used to be part of SAB Miller were sold. The Japanese brewer, Asahi, bought the brand Peroni, Grolsch and Meantime. Even more, SAB Miller sold the stake in its US joint venture with the partner Molson Coors agreeing to buy it¹.

In the paper we will disregard the information that some parts of SAB Miller were sold. The rationale behind this assumption is due to the fact that no financial statements were released to the public containing detailed information about the brands i.e. no Income Statement or Balance Sheet for the

specific brands were released. For the analysis to be feasible we will just have to assume the specific brands were performing average, in line with the overall company. If the brands were performing better or worse than the overall company, after selling the brands the company would perform quite the opposite. The same principle has to be applied also for the balance sheet items related to the brands. We will assume the brands were in line with the company i.e. they were not more asset intensive brands or more debt financed than the rest.

4. Companies’ Presentation

4.1. AB InBev

Anheuser-BuschInBevSA/NV is the world's largest brewers based in Belgium involved in the production, distribution and sale of beer and soft drinks. The company has operations in 26 countries across the world and offers a portfolio of over 400 brands of beer and other malt beverage brands. Anheuser-Busch InBev’s soft drinks business consists of both own production and agreements with PepsiCo related to bottling and distribution arrangements between various Anheuser-Busch InBev subsidiaries and PepsiCo. Ambev - subsidiary of Anheuser-Busch InBev is one of PepsiCo’s largest bottlers in the world. The Company has long- term agreements with PepsiCo whereby it was granted the exclusive right to bottle, sell and distribute certain brands of PepsiCo’s portfolio. Major brands that are distributed under these agreements are Pepsi, 7UP and Gatorade. ABInBev’s wide brand portfolio caters to a broad range of customer tastes and incomes, giving it the potential to absorb changes in market conditions that include seven of the ten most valuable beers in the world. The company has operations in the North America, Mexico, Latin America North, Latin America South, Europe and Asia Pacific Zones and has headquarters in Leuven, Belgium. The Company is listed on multiple exchanges with its primary listing on the Euronext Brussels (EN) and secondary listings on

1 (BBC, 2016)

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10 Mexican Stock Exchange (BMV), Johannesburg Stock Exchange (JSE) and New York Stock Exchange (NYSE) with a market cap of €220 billion².

The American regions dominate sales at ABInBev, with North America accounting for 36%, Latin America (mainly Brazil) 21% and Mexico 9% while Asia makes up about 13%. Within American markets, ABInBev tends to have market shares in excess of 40%. However, the company now holds a significant market share of beer across all regions, resulting in an unprecedented 27% of total global volumes. For 2015, beer was responsible for 99% of ABInBev’s volumes. However, the company is working to develop its presence in other categories, including malt-based Ready-to-Drink beverages and cider/perry. The annual sales for the company in 2016 were US$45.5 billion. The Top Brands of AbInBev are as follows:

Global brands:

 Budweiser: Founded in 1876, Budweiser was the first beer launched by the company and is the most popular beer available across more than 85 countries and the most valuable beer brand.

 Stella Artois: Based on a rich Belgian brewing heritage of more than 600 years, Stella Artois caters to the premium tastes and is sold in more than 90 countries. It is also the 4^th most valuable brand in the world.

 Corona: Founded in 1925 at the Cervecería Modelo in Mexico, Corona is the most popular beer brand in Mexico and 6^th most valuable brand globally sold across 120+ countries³

International brands:

 Beck’s: Beck’s is German’s no. 1 Beer founded in 1873 and available in more than 85 countries

 Leffe: Made from only the highest quality ingredients, Leffe's unique brewing heritage is now shared and enjoyed by consumers in more than 70 countries worldwide

 Hoegaarden: Hoegaarden is a true authentic wheat beer dating back to 15^th century and available across over 70 countries

Local champions: Bud Light, Skol, Brahma, Antarctica, Quilmes,Victoria, Modelo Especial, Michelob Ultra, Harbin, Sedrin,Klinskoye, Sibirskaya Korona, Chernigivske, Cass and Jupiler⁴.

2 (AB InBev, 2016)

3 (AB InBev, 2016)

4 (AB InBev, 2016)

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11 Company History:

ABInBev was formed following the acquisition of American brewer Anheuser-Busch by Belgian-Brazilian brewer InBev, which itself is a merger of AmBev and Interbrew. Interbrew was created in 1987 again from a merger of the two largest breweries in Belgium: Artois, based out of Leuven, and Piedboeuf, of Jupille.

While AmBev was formed back in 1999 also with the merger of the two biggest Brazilian brewers,

Antarctica (founded in 1882) and Brahma (founded in 1888). Anheuser-Busch was established in 1860 in St.

Louis, Missouri, USA, as Anheuser & Co. In 2004, Interbrew and AmBev merged, creating the world’s largest Anheuser-

Busch InBev (Formed 2008)

Inbev (Formed 2004)

Interbrew

Brouwerij Artois

Piedboeuf Brewery

Labatt Brewing Company

Lakeport Brewing Company

Ambev

AmBev

Cerveza Quilmes

Cervecería Nacional Dominicana

Anheuser-Busch

Harbin Brewery

Anheuser-Busch

Grupo Modelo (Acquired 2012 -

Mexico)

Exhibit 1: AB InBev company history. Source: AB InBev Annual Reports

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12 brewer, InBev. In 2006, InBev acquired the Fujian Sedrin brewery in China, making InBev the No. 3 brewer in China which is also the world’s largest beer market⁵.

On 18 November 2008, the merger of InBev and Anheuser-Busch was completed, creating Anheuser–Busch InBev, the world’s biggest brewing company in the world. The transaction details reveal Anheuser-Busch shares were acquired for 70 USD per share in cash, for an aggregate of $52 billion.

Key Management:

Carlos Brito, CEO: Born in Rio da Janeiro, Carlos Brito holds a degree in Mechanical Engineering from the Federal University of Rio de Janeiro. In 1987, Carlos Brito met Jorge Paulo Lemann through a friend of a friend. Brito was working for Shell Oil by then and had been accepted to Stanford Business School but was not able to afford it. Lemann together with other people from Banco Garantia ran a scholarship program that backed promising young people in their early careers. Lemann, who would later co-found investment firm 3G Capital, had only a few conditions: that Brito one day help other people if possible, and that he consider coming to work for them (Fortune, 2013). After finishing at Stanford, Brito went to work at

Brahma, a Rio-based brewer that Garantia had just bought. Brito quickly rose the ranks at Brahma where he learned the art of cost cutting,working under Lemann's partner Marcel Telles. In 1999, the company announced plans to merge with São Paulo-based competitor Antarctica to form Cia de Bebidas das Americas, or Ambev and in 2004, only three months after becoming the CEO, Brito announced a merger with Belgian beer giant Interbrew to form InBev.

Claudio Braz Ferrero, Chief Supply officer: Served as Chief Supply Officer at Anheuser-Busch InBev SA/NV from January 1, 2007 to March 2016 and has been a Chief Supply Integration Officer after 2016 looking after global supply chain and integration operations globally.

Miguel Patricio: Has been Chief Marketing Officer of Anheuser-Busch InBev SA/NV since July 2012 and serves as its Member of Executive Board of Management looking after global branding and marketing strategies.

4.2. SAB Miller

Founded in 1895, SABMiller is now a global beverage company involved in Beer and Soft drink market and is the world’s second largest brewer, behind ABInBev, with a 10% share of total volume sales globally. The Company which was the first industrial company to be listed on the Johannesburg Stock Exchange has its

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13 first product- Castle Lager would still the South Africa’s most famous beer, 120 years after its launch. The UK based company has established a global presence and registers annual sales in beer and soft drinks of more than 30 billion liters and $20bn in revenue in EMEA, Americas, APAC and Australasia regions. The company has over 70,000 employees working in more than 80 countries and produces over 200 beers. The company also has a significant presence in China- world’s largest beer market and accounts for almost half of the market share along with its Chinese Joint venture partner, China Resources Enterprise. It also has a growing soft drinks business being one of the world’s largest bottlers of Coca-Cola drinks with 6% volume growth in 2016⁶.

SABMiller has a wide portfolio of local and regional brands, with standard lager accounting for 53% of its total beer volume sales in 2016⁷. The company is further advantaged by the geographical spread that was built over many years which is biased towards developing markets, offering higher long-term growth opportunities in both volume sales and margin expansion. SABMiller’s developing markets exposure is complemented by the scale in well established, extremely profitable, and cash generative businesses in developed markets, primarily in the USA (through its’ joint venture with Molson Coors), Australia, and Europe. The key initiatives taken up by the management include innovation that is scalable and repeatable across multiple markets, from new beer styles, including craft, to flavoured malt beverages to low or zero- alcohol beers⁸.

SABMiller continues to offset volume decline in developed markets by expanding its above-premium lager line, offering high-ABV beers, craft-style beers and a premium positioning. The company is expanding its portfolio and investing in brands with innovations that is aimed to rival the output of the craft industry. The firm’s emphasis on locally focused brands is expected to help the company to obtain provincial monopolies in emerging markets and affordable segments. SABMiller is significantly present in mid-priced and premium lager supported by its top ranking position in various African and American markets. However, the brewer is missing out on growth in other categories and on the brand equity to be gained from developing a wider range of beer alternatives which is why market is likely to see a wider array of innovations in beers via a premium positioning or the creation of beer alternatives. Global beers consist of four core brands which include Miller Genuine Draft, Grolsch, Pilsner Urquell and Peroni Nastro Azzurro which are promoted and distributed via a global platform.

Company History:

6 (SAB Miller, 2016)

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14 In 1999, after listing on the London Stock Exchange to raise capital for acquisitions, the group purchased the Miller Brewing Company in North America from the Altria Group in 2002, and changed its name to SABMiller. Following this, the group's next major acquisition was of a major interest in Bavaria, South America's second largest brewer and owner of the Aguila and Club Colombia brands in 2005.

The company got engaged in the hostile takeover of Fosters in mid-2011 and at the end of 2011, the board of Foster's agreed to a takeover bid valuing the company at A$9.9bn (US$10.2bn). The deal was completed by the end of 2011, although it excluded the Foster's lager brand in the UK and Europe, where it is owned by the rival-Heineken. In May 2015, SABMiller announced it would acquire British brewery company Meantime Brewing for an undisclosed fee⁹. In 2016, ABInbev made an acquisition bid for SABMiller that would unite the world's two biggest beer companies. The deal was finalized at £44 per share valuing the company at $71bn.

Key management:

Alan Clark, CEO: Born in South Africa, Clark holds a master's degree in clinical psychology from University of Port Elizabeth and a doctorate in literature and philosophy from University of South Africa. Before joining SABMiller, he worked as a clerk in South Africa Prison services and later worked as a lecturer at Vista University. He joined SABMiller in 1990 as a trainee and quickly rose up the ranks where he was promoted as a General Manager and later the CEO of SABMiller’s South African soft drinks operations. In 2003, Clark was promoted to managing director of their European operations. He was in this role until July 2012, when he became chief operating officer (COO), and then in 2013, CEO of SABMiller, succeeding Graham

Mackay¹⁰.

Domenic De Lorenzo, CFO: Lorenzo is a Chartered Accountant (SA), completing his articles at Arthur Young and was educated at the University of Cape Town. Lorenzo joined the firm 19 years ago and he served as a Director of Corporate Finance & development at SABMiller plc since 2000 and served as its Director of The Global Team since 2010 before he became the CFO in 2015.

Now since ABInbev acquired SABMiller on October 10 2016, the parent company announced that Mauricio Leyva, former CEO of SAB South Africa, will be the only SABMiller executive to remain within the new AB Inbev 18-member permanent board and served as Middle East’s zone president. A couple of more people

10 (Bloomberg, 2017a)

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15 such as Johann Nell, Human Resources head and Mark Bowman, Africa MD were staying on a transitional basis¹¹.

4.3. 3G Capital

3G Capital, Inc. is a private equity firm specializing in investments in brands and businesses in retail and consumer sectors. It was founded in late 2004 by Jorge Lemann, Carlos Sicupira, Marcel Telles and Roberto Thompson Motta. The firm is known for its investments in special situations and has been hailed as a pioneer in the lean and mean approach of its acquired companies. The big ticket conquests for the firm include the likes of iconic global brands Anheuser-Busch, Heinz, Kraft and Burger King.

Lemann, who also represented Brazil in the Davis Cup tennis tournament, created his first venture

Garantia. He purchased a little-known broker-dealer based out of Rio De Janerio and made it a full-fledged Investment bank, inspired by Goldman Sachs. The firm worked as private partnerships where executives were invited annually to increase or decrease their holdings based on their performance. In 1982, after a number of small time investments in listed stocks, Garantia undertook the first hostile takeover, purchasing a controlling stake in Lojas Americanas, the Brazilian variety retailer for 20 million US dollars. The trio found great opportunities in companies that lacked clear future and perceived agent-conflict interests¹².

The company became well known for its game changing big ticket acquisition of Brahma, a Rio De Janerio- based brewer, for $60 million without proper legal and financial due diligence. It was also timed so

inappropriately which was only months before the historic election of Fernando Collar De Mello against the union leader back then, Luiz Da Silva “Lula”, who scared the businessmen with his harsh left-wing

statements. Days after closing the deal, a huge pension deal resurfaced, but that did not deter Lemann and his team. Marcell Telles, one of the three partners, became the CEO of the company and implemented a management revolution with methods and experiences from Garantia and Lojas Americanas. He started to expand the business into different regions of South America such as Argentina, Venezuela, Uruguay and also improved the company’s manufacturing practices. Marcel also orchestrated the acquisition of Brahma’s arch-rival, Antarctica and formed a new business, AmBev, which captured almost 70% of the Brazilian market share¹³.

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16 From 1999 to 2004, the Antartica integration was the sole responsibility and goal of the company to lead and expand well in the newer markets. During the time, AmBev was still looking for an expansion and looking for possible Merger & Acquisition opportunities. In 2004, Ambev and its controlling shareholders announced a complex transaction where in the holding company which had Interbrew shares merged itself with a number of Belgium-based family stakes in Interbrew which made the trio retain control in the resulting company which was later called InBev. Moreover, in 2008, it started acquisition talks of Anheuser- Busch, the American brewing company with the most iconic brands Budweiser and Bud Light, led by none other than, Carlos Brito. This deal was heavily criticized by the Anheuser-Busch management and also the American media.

3G also started rolling out and trading in liquid markets with concentrated efforts on Private investment in public companies (PIPE). The first large bet was made in CSX, an American rail road company. After CSX, 3G raised a new funding to enable its takeover of Burger King in 2010 which was in some serious doldrums after 2008 recession. 3G Capital paid just $1.56 billion in cash to take control of Burger King in 2010, financing the burger joint’s remaining acquisition amount with debt. Burger King's earnings before interest, taxes, depreciation and amortization (EBITDA) minus capital expenditures increased more than 60% in the first year under 3G control, allowing the company to pay its new owners a $393.4 million special dividend.

In 2012, 3G Capital returned Burger King to public markets by selling 29% of the company to a public investment vehicle for $1.4 billion. Two years later Lemann joined hands with Warren Buffett’s Berkshire Hathaway when Burger King struck an about $11 billion takeover of Canadian restaurant chain Tim

Horton’s. Berkshire provided $3 billion in preferred equity financing to fund the acquisition and was offered 8.4 million shares for a price of $0.01 apiece. After the deal Burger King was renamed Restaurant Brands International and shares continued to soar and the money train kept rolling forward. Also, Restaurant Brands struck a deal to buy stock market darling Popeye’s Louisiana Kitchen for $1.8 billion, pushing its shares up 7% to new record highs¹⁴.

3G and Berkshire Hathaway joined forces in 2013 to buy Heinz for $23.3 billion in what was the fourth- biggest food and beverage acquisition of all time. The deal was significantly larger than the previous ones but followed the same framework: overtaking a large US based company using significant amounts of debt.

The company follows the same strategy in all of its companies that have proven to be a huge success globally:

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17 1. Find a business with poor management and bloated costs, but strong underlying economics and

sustainable growth trends.

2. Inject a results-oriented culture, lean and mean strategy into the business with hard-charging managers in the most senior roles.

3. Set four big targets for senior executives each year: market share, expenses, EBITDA, and cash.

4. Implement Zero Based Budget – requiring every expense to be justified each year rather than build off last year’s budget. Be ruthless about trimming any expense that doesn’t generate revenue.

5. Don’t spread yourself too thin and focus on only one or two opportunities at a time¹⁵.

5. Building the Financial Model

5.1. Reformulating the Financial Statements

All firms consist of operating, investing and financing activities. For the purpose of our paper, it was

critically important to separate operating items from financing ones. The reason is that “operating activities are the primary driving force behind value creation”¹⁶.

The historical financial statements for AB InBev and SAB Miller were retrieved from Bloomberg and can be observed under Appendix – AB InBev Historical Financial Statements and Appendix – SAB Miller Historical Financial Statements. However, some of the lines items were extracted from the actual annual reports of the company. Notes on specific line items that needed consideration were read and interpreted from the annual reports.

In the following sections we will describe the line items that required special attention or a judgement call in the reformulating process.

5.1.1. Analytical Income Statement

The analytical income statement requires every line item to be classified to either operations or finance.

Operating profit is considered to be the primary source of value creation from the investors perspective.

From the lenders perspective, operating profit is the primary source to support the debt obligations.¹⁷ The structure of the analytical income statement was taken from Plenborg and Petersen (2012).

Depreciation and amortisation. In AB and SAB Miller’s I/S, depreciation and amortisation are recognised under the function to which they belong. In the annual reports notes of each company, depreciation and

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18 amortisation are fully disclosed. In order to calculate earnings before interests, taxes, depreciation and amortisation (EBITDA) the depreciation and amortization for Cost of Goods Sold (CoGS) , Selling, General and Administrative(SG&A), Other operating expenses and Non-recurring items had to be extracted from their respective costs and restated as a single line item after EBITDA.

Taxes: on the I/S of the two companies cover both operating and financing items. They had to be separated into Income tax on EBIT and Tax on Net Financial Expenses.

Net Operating Profit After Tax (NOPAT) represents the total income generated by the operations. As it represents the main component of the analytical I/S, later on used in calculating the ROIC, it was double- checked in order to ensure it was calculated properly. The verification step included calculating it top-down (from the operations) and bottom-up (from financing items). The formula was the following:

𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥 − 𝑇𝑎𝑥 𝑠ℎ𝑖𝑒𝑙𝑑 + 𝑅𝑒𝑠𝑢𝑙𝑡𝑠 𝑜𝑓 𝑎𝑠𝑠𝑜𝑐𝑖𝑎𝑡𝑒𝑠 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 + 𝑁𝑒𝑡 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝑁𝑂𝑃𝐴𝑇

5.1.2. Analytical Balance Sheet

While constructing the analytical B/S, the same principle as before has to be kept: separating operating and financing line items.

Invested Capital or Net Operating Assets represent the combined investment in a company’s operating activities¹⁸ and is the sum of operating assets minus operating liabilities.

The relations that govern the analytical B/S are the following:

𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 + 𝑁𝑜𝑛 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝑁𝑜𝑛 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐵𝑒𝑎𝑟𝑖𝑛𝑔 𝐷𝑒𝑏𝑡 − 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑤𝑖𝑡ℎ 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

Cash and Cash Equivalents: companies need a certain amount of operating cash in order to finance the day- to-day activities. How much of the total cash represents operating cash is not specified in neither cases.

Both companies however have significant amounts of cash on their balance sheet, which have been increasing at a higher rate than operations suggesting they have been building on cash. As a consequence, all cash will be re-classified as excess cash under Financial Assets.

Other ST Assets (incl. Derivatives and Hedging, Tax Receivables, etc) are not part of the core operating activities but are related to the financial situation of the company were re-classified under Financial Assets.

LT Investments & Receivables (incl. LT Investments and LT Marketable Securities) are financial assets and were treated as such; reclassified under Financial Assets

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19 LT Derivative & Hedging Assets and LT Prepaid Pension Costs. Similar to the ST derivatives and hedging assets, were re-classified under Financial Assets. LT Prepaid Pension Costs are usually costs associated with the management of the company pension fund as some companies manage their own small pension fund for employees. They are not part of the operating activities and were moved under Financial Assets.

The rest of the assets were treated as Operating Assets.

Payables & Accruals (incl. Accounts Payable, Accrued Taxed, Interest & Dividends Payable) - part of operating liabilities, Payables reduce the need for (interest-bearing) debt and as such are part of Non- interest Bearing debt, being deducted from operating assets¹⁹.

ST Provisions are amounts put aside to cover a future liability usually related to a contract term. As they are a measure of risk management related to operations, are re-classified as Non-interest Bearing Debt.

Deferred Revenue, Deferred Tax Liabilities, Other Provisions & Creditors. They all represent liabilities but since they do not bear interest are treated accordingly and moved under Non-interest Bearing Debt.

The restated Income Statements and Balance Sheets can be found under Appendix – AB InBev Restated Financial Statements and Appendix – SAB Miller Restated Financial Statements

5.2. Pro forma Financial Statements

The starting point of the forecasted financial statements is the restated financial statements. The forecasting method is a sales-driven one where different line items are driven by the level of activity i.e.

revenue growth²⁰. The forecast period will cover 2017-2020, considered the first phase after the merger.

This section is corresponding to the first sub questions as to how the two companies were expected to perform in the future

Exhibit 2: Forecast drivers for the Income Statement. Source: Koller et al. (2010)

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20 For the Income Statement we followed the approach shown by Koller et al. (2010) stated below:

AB InBev I/S Forecast Driver 2011 2012 2013 2014 2015 5Y

Average 2016 2017 2018 2019 2020

Revenue Growth% 8% 2% 9% 9% -7% 4% 4% 4% 4% 4% 4%

CoGS % Revenue 38% 36% 36% 35% 34% 36% 36% 36% 36% 36% 36%

Distribution % Revenue 8% 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%

Sales/Mkting/Ad % Revenue 12% 12% 13% 14% 15% 13% 13% 13% 13% 13% 13%

General and Admin % Revenue 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%

Other Op Income % Revenue 2% 2% 3% 3% 2% 2% 2% 2% 2% 2% 2%

Non-recurring items %Revenue -1% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Depreciation(t) %PPE net (t-1) 13% 13% 13% 11% 11% 12% 12% 12% 12% 12% 12%

Amortization (t) %Intangibles (t-1) 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%

Income tax % EBIT 15% 13% 10% 17% 19% 15% 15% 15% 15% 15% 15%

Financial Expense(t) % (ST Debt + LT

Debt)(t-1) 7% 6% 7% 6% 5% 6% 6% 6% 6% 6% 6%

Financial Income (t) % Cash & Cash

Equivalents (t-1) 9% 6% 4% 10% 14% 8% 8% 8% 8% 8% 8%

Share of P.A.T. for Non-controlling

interest 26% 23% 13% 18% 16% 19% 19% 19% 19% 19% 19%

Tax % 20% 16% 11% 18% 21% 17% 17% 17% 17% 17% 17%

Payout Ratio - total sum paid out -

constantly increasing 32% 33% 39% 38% 38% 65% 81% 81% 81% 81% 81%

Exhibit 3: AB InBev Income Statement forecast drivers. Source: Bloomberg, Author's elaboration

All of the line items from the Income Statement were forecasted based on the last 5 years average.

For the Balance Sheet items the guide provided by Koller et al. (2010) was used:

Exhibit 4: Forecast drivers for the Balance Sheet. Source: Koller et al. (2010)

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21

AB InBev B/S Forecast Driver 2011 2012 2013 2014 2015 5Y

Average 2016 2017 2018 2019 2020

Inventories %CoGS 17% 17% 19% 18% 19% 18% 18% 18% 18% 18% 18%

Account Receivables % Revenue 7% 7% 7% 7% 7% 7% 7% 7% 7% 7% 7%

Prepaid Expenses %Revenue 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1%

Tax Receivable %Revenue 2% 1% 2% 2% 2% 2% 2% 2% 2% 2% 2%

Intangible Assets %Revenue 192% 192% 230% 214% 217% 209% 209% 209% 209% 209% 209%

PPE %Revenue 41% 41% 48% 43% 43% 43% 43% 43% 43% 43% 43%

Deferred Tax Assets %Revenue 2% 2% 3% 3% 3% 3% 3% 3% 3% 3% 3%

Other LT Receivables %Revenue 1% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%

Payables %CoGS 84% 95% 104% 102% 112% 100% 100% 100% 100% 100% 100%

Deferred Revenue %Revenue 0% 0% 2% 4% 3% 2% 2% 2% 2% 2% 2%

Deferred Tax Liabilities %Revenue 29% 28% 30% 27% 27% 28% 28% 28% 28% 28% 28%

Other Provisions & Creditors %Revenue 5% 7% 8% 3% 4% 6% 6% 6% 6% 6% 6%

ST Provisions %Revenue 1% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0%

Common stock - constant

Additional Paid in Capital - constant

Retained Earnings (t)= Retained Earnings (t-1)+ Profit After Tax (t) - Dividends (t)

Non-controlling interest - constant

ST Debt growth 40% 23% -3% 42% -5% 15% 15% 15% 15% 15% 15%

LT Debt - constant

Derivatives & Hedging %Revenue 5% 3% 2% 2% 10% 4% 4% 4% 4% 4% 4%

Cash from Cash Flow Statement

Other ST Assets % Revenue 3% 2% 1% 3% 4% 8% 4% 4% 4% 5% 5%

LT Inv & Receivables %Revenue 1% 1% 1% 0% 0% 0% 0% 0% 0% 0% 0%

Derivative & Hedging Assets %Revenue 2% 2% 1% 0% 1% 1% 1% 1% 1% 1% 1%

Prepaid Pension Costs constant

Exhibit 5: AB InBev Balance Sheet forecast drivers. Source: Bloomberg, Author's elaboration

The above table shows all how all the Balance Sheet Items were forecasted.

Retained Earnings line is linking the Balance Sheet with the Income Statement as it is calculated as the previous year Retained Earning plus Profit After Tax minus Dividends.

The Cash line item is linking the Balance Sheet to the Cash Flow Statement as current year Cash on the B/S is Cash Ending Balance from Cash Flow Statement.

A similar exercise of forecasting was perfomed for SAB Miller also (see Appendix – SAB Miller Forecast Drivers)

Now that the three financial statements are linked between them and are also linked from one year to another via Profit After Tax –> Retained Earnings -> Cash Balance, the financial model is in place and it can be used to forecast an indefinite period automatically adjusting itself for any scenarios that we might encounter.

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22 Any scenarios runs on the Income Statement items will affect Profit After Tax which in turn will affect the Cash Flow from Operations and the Cash Balance, which is picked up by the Balance Sheet. Any scenario runs on the Balance Sheet items will get picked up by the Cash Flow Statement, changing the Cash Balance ending balance and thus changing next year’s Cash Balance starting point.

A flexible financial model was needed to support the analysis in order to see immediately the impact on the long-term of a change in a line item. A static representation of the financial statements could not have done that.

6. The 3G Model

3G Capital have developed over the years a rather repeatable model for the integration process of new acquisitions. There have been slight differences in the integration process depending on the business and the industry of the acquisition. The typical target for acquisition has been companies with great brands and part of an old established industry, somehow neglected by the capital markets²¹.

Additionally, what has characterised most of the 3G acquisitions has been also the 3-phase process:

Phase 1: right after the acquisition, the acquired company enters a severe cost cutting process in order to be optimized in terms of organisation - people and production – processes. This phase last a few years, typically 3-4 years.

Phase 2: once the company has been optimized, the management focuses on the long-term organic strategy of increasing the revenue. By first decreasing costs and then increasing revenue, the companies manage to achieve a tremendous operating margin.

Phase 3: inorganic growth. All of the well known 3G transactions in the past have been followed by further consolidation in the market: Burger King and Tim Hortons, InBev with Anheuser-Busch and now SAB Miller and Heinz and Kraft.

After several big-ticket transactions highly covered by the media, 3G Capital have become well known for their excruciating cost-cutting measures as part of the integration process. The methods of cost

optimisation were not developed by 3G people but rather borrowed from some of the successful businesses out there and adapted to their needs. The companies from which 3G Capital borrowed and adapted ideas include General Electric, Wal-Mart, Goldman Sachs, Berkshire Hathaway and Toyota²². Despite their success, 3G has faced some harsh criticism from the media, partners and even political persons. Most often in the media, 3G has been criticism for the massive firings happening after a take-over.

After acquiring Tim Hortons in 2014 and integrating it into the existing Burger King organisation, rumours started emerging about Burger King headquarter being moved for tax purposes to Canada, Tim Hortons’

home country²³. However, they have still kept Burger King’s headquarter in the US. Their suppliers have

21 (de Mello, 2014)

22 (de Mello, 2014)

23 (Rushton, 2014)

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23 also criticised them due to their harsh contract terms regarding delayed payments towards suppliers in order to increase their short-term liquidity basically with interest-free debt.

In the next several sections in order to provide evidence for my analysis and to forecast better, I will be using two different benchmarks: one, against previous 3G deals and second, against the main competitors in brewing sector. While the second approach to benchmarking is a typical one, benchmarking against companies from different industries might be challenging and misleading. As a result, I chose to compare this brewing sector transaction with the ones of Heinz and Kraft from the packaging industry. A justification is needed why the two transactions and the industries they are part of are similar, in order to make the comparison valid.

1. Both industries are characterised by high volumes and low margins. This translated into Return on Invested Capital terms means high Turnover Rate of Invested Capital and low Profit Margin.

2. The main business in both cases is about transforming raw materials into products that are ready to be consumed

3. Automation in the manufacturing process. Lately there has been an increase in the technological advancement making the production process faster, more flexible and less labour intensive.

4. The companies in both industries are situated in the center of the supply chain. They receive raw materials from suppliers and after the manufacturing process they sell their product to the wholesale businesses like supermarkets. This has two implications: one, they can never set the price paid by the end consumer and two, they are pressured by the supermarkets in terms of business deals and can further on down the line pressure their suppliers.

5. The products sold by both industries are highly regulated markets. In most of the countries there are limits on content of alcohol while packaged food needs approval from the respective regulators such as the FDA (Food and Drug Administration) in the US.

6. Tax duties on both alcohol content and sugar content.

7. The market structure in both industries is similar to an oligopoly where few major firms have the majority of the market share. In the packaged foods industry the dominant player are: Nestle, Kraft, Pepsico, Coca-cola and Unilever. In the brewing sector there are four major companies, two of which are the subject of this paper: AB InBev, SAB Miller, Heineken and Carlsberg.

The following sections will represent the qualitative solution to the second sub question referring to the 3G Capital model.

6.1. Improving Cost of Goods Sold

The costs of goods sold are the direct costs related to the production of the goods sold by the company.

They comprise of raw materials, direct labour costs used to produce the good, storing inventory and depreciation of plant and equipment. However, it excludes distribution costs and sales force costs.

6.1.1. Cost of Goods Sold in previous 3G deals

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24 The companies that were bought by 3G Capital and have gone through their process of cost cutting

experienced significant reductions in Cost of Goods Sold. The method for cost optimization has been detailed focus on general cost redundancies, productivity enhancement, incentivized performance and zero-based budgeting method.

Heinz in April 2013, when it was acquired, owned 63 factories and leased 6 factories²⁴. By the end of 2014, the company was owning just 54 factories and leasing 4 factories²⁵. In a little over a year and a half, 3G Capital shut down 9 factories and terminated the lease agreement on another two. The number of jobs that were cut due to factory closures totalled 1,800.

The figure above tracks the development of Cost of Goods Sold. The values for 2013, 2014 and 2015 were adjusted by $168 MM²⁶, $513 MM²⁷ and $404 MM²⁸ respectively, for severance and employee benefits related to job reductions. These charges qualify as exit and disposal costs according to US GAAP and fall under CoGS.

The cost cutting measures deployed by 3G in the period right after acquisition can be observed in two cases: in 2013 the year 3G acquired Heinz and in 2016 the year after Heinz merged with Kraft to form Kraft

24 (Heinz, 2013)

25 (Heinz, 2014)

26 (Heinz, 2013)

27 (Heinz, 2014)

28 (Heinz, 2015)

6,442 6,701 6,754 7,513 7,165 7,132

17,416

16,184

64% 64% 63% 65%

62% 65% 63%

61%

0%

20%

40%

60%

0 4,000 8,000 12,000 16,000 20,000

2009 2010 2011 2012 2013 2014 2015 2016

Kraft Heinz: CoGS

CoGS CoGS %Revenue

0.35 B

1.2 B

Exhibit 6: Kraft Heinz CoGS. Source: Kraft Heinz 10-K reports

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25 Heinz. By 2014 the measures implemented reduced the CoGS with approximately $0.35 BN from one year to another while in 2016 the effect was a cost reduction of $1.2 BN²⁹. The results come as proof that: one, 3G is capable of drastic cost-cutting measures regarding CoGS and two, this is done in the period right after the acquisition, impacting the first year results.

6.1.2. Cost of Goods Sold in the Industry Raw Materials

Malt is the source of sugars that become the alcohol that makes beer. The size of the production has significant influences over the price and the process that involves malt. Macro-breweries, as opposed to microbreweries, have higher bargaining power which enables them to demand lower prices from malt suppliers. According to a person inside the industry, a macro-brewer in the US will pay close to 22 cents per pound of malt while a medium-size beer producer can pay 40-50 cents per pound of malt³⁰. This example shows how a global beer manufacturer can pressure suppliers into lowering their price.

Hops are the plants that give a distinctive flavour usually bitterness to beers, especially to the craft ones.

Yeast is usually cultivated within the company and not bought when it comes to the large beer producers.

Brewing, Aging and Packaging

The brewing process does involve to a certain extent human labour. However, in the recent years, the possibility of automation has made possible the increase in productivity. The packaging costs include cans, bottles and barrels. Often it represents the single biggest expense a brewery is incurring. Packaging can add as much as 25 cents for a bottle. When selling beer in barrels, the packaging cost drops significantly³¹

29 (Heinz, 2016)

30 (Satran, 2014)

31 (Satran, 2014)

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26 The most recent data found on the brewing industry cost structure was a study done in 2011 by IBIS World.

The largest costs to breweries are purchases of raw materials which include packaging:

glass, aluminium, cardboard and raw materials: barley, sugar, malt, corn, rice wheat, hops and preservatives.

Labour is the next largest cost to the industry at 7.7%. It is safe to assume that from 2011, when the study was made, up to 2017, the labour costs for the whole industry have decreased due to the consolidation in the market among the big players which resulted in layoffs and due to the technological advance which increased the efficiency of the operations. In 2011, the depreciation was estimated to be 2.6% of revenue. Brewing is a capital-intensive business where the depreciation of plants and equipment is significant. Other major costs are the rent at 2.3% and utilities at 1.5%.

Based on the above findings it can be concluded that the cost of raw materials is lower for the large breweries due to their increase bargaining power over suppliers. Besides raw materials, the packaging is another significant cost which can be lowered due to economies of scale and increase automatization.

Cost of Goods Sold – Industry Benchmarking

By definition Cost of Goods Sold implies that is a cost dependent on the revenue, therefore, the most useful measure to compare CoGS amongst different companies and to track its development across time is to look at CoGS as a percentage of revenue.

The higher the percentage of CoGS out of revenue the less a company retains from each dollar of sales.

To put into perspective the current situation of AB InBev and SAB Miller, the figure below shows the

58.30%

7.70%

16.50%

2.60% 2.30% 1.50%

11.10%

0%

20%

40%

60%

80%

100%

120%

Brewing Industry Cost Structure

Profit Rent Utilities Depreciation Others Wages Purchases

Exhibit 7: Brewing industry cost structure. Source: IBIS World report (2011)

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27 development of Gross margin across the main players in the beer industry: AB InBev, SAB Miller, Heineken, Carlsberg and an industry average compiled by Bloomberg and composed of 75 firms.

In Exhibit 8Exhibit 8 it can be seen how the CoGS as a percentage of revenue varied across the brewing industry for the period 2006-2015. The values include the depreciation and amortization expenses for all of the companies for a like to like comparison. The above values of AB InBev and SAB Miller do not match the ones from the restated financial statements as depreciation and amortization had been reclassified.

For 2015 the percentage of CoGS from revenue for AB InBev and SAB Miller accounted for 39,30% and 45,96% respectively, meaning this cost category represents a big proportion of the overall expenditure of the two companies. Observing the above figure, it can be concluded that the measures taken by 3G since the 2008 merger of InBev with Anheuser-Busch, which has formed the current AB InBev, has taken the company from being an average one in terms of managing its CoGS to the leading company in the industry.

It is expected, therefore, that the AB InBev entity within the new firm will not be able to cut CoGS further more. However, synergies will appear in various areas.

Increased productivity and production efficiency will be the first area to be improved. In the 1990s, Carlos Brito, the current CEO of the merged company was working at Brahma, one of the first companies that through successive mergers became what is today AB InBev. One of its factories was reaching less than 60%

of its productive potential. Carlos Brito put together Projeto Manufactura (“Manufacturing Project”) a “set of production standards, best practices and standardized process and routines that became the framework

30%

40%

50%

60%

70%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Brewing Industry CoGS % Revenue

AB InBev SAB Miller Carlsberg

Heineken Boston Beer Co Industry average

Exhibit 8: Brewing industry CoGS % Revenue. Source: Bloomberg

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28 for every AmBev factory and was afterwards rolled out to InBev and AB InBev”³².The project improved factory productivity and reduced fixed costs.

By measuring the productivity at AB InBev, the above figure shows the volumes sold expressed in million hectolitres and the volumes sold per employee. Showing just the volumes sold could be misleading since the company can increase the productivity together with the number of employees. In the period 2013- 2015 the volume per employee increased by 9% while from 2008 to 2015 the increase was about 50%. The increases in productivity show the practices used by 3G do work and the results are significant.

The second portion of Cost of Goods Sold to be improved will be raw materials and packaging. By consolidating the two biggest beer companies in the world, they will be able to increase their bargaining power and pressure their suppliers for a better price. Hop growers are usually small and numerous which weakens their supplier power. Barley growers however, have alternatives; barley can be sold for animal feed and malted barley for spirits distillation thus reducing their dependency on the beer industry.

However, raw material quality is highly important for brewers as the taste of the beer is strongly influenced by the nature of the ingredients. Additionally, the switching costs for the end user are low; the companies

32 (de Mello, 2014) 285

391 399 399 403 426 459 457

2,086

3,357 3,490 3,431 3,426

2,756

2,980

3,000

0 1,000 2,000 3,000 4,000

0 200 400 600 800

2008 2009 2010 2011 2012 2013 2014 2015

Million Hectolitres

AB InBev : Productivity measures

Volumes sold Volume sold/employee

9% 9%

Exhibit 9: AB InBev volumes sold. Source: AB InBev Annual Reports

Post-merger value creation: the case of AB InBev and SAB Miller