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Unlocking value through mergers, acquisitions

If it’s bedded down, the Anheuser-Busch InBev SA (AB) $90 billion takeover bid for SABMiller would be the largest global deal year-to-date for mergers and acquisitions (M&A) in a wobbly global economy.

Nesbert Ruwo and Jotham Makarudze

AB, the world’s largest brewer, has approached the world’s second largest brewer, SABMiller Plc, about a takeover that would create a global beer giant, producing a third of the world’s beer. The merged group would have a market capitalisation of around $275 billion at current prices. SABMiller was founded in 1895 in South Africa as The South African Breweries (SAB) and grew to the current market capitalisation of approximately $90 billion through organic and an aggressive acquisitive strategy. It has bedded down over three dozens of acquisitions throughout the world over the past two decades. The acquisition of the US brewer, Miller Brewing in 2002 resulted in the name change from SAB to SABMiller.

AB has a current market capitalisation of approximately $185 billion and annual sales of $47 billion (2014). The brewer is a very acquisitive company which has built its business to the current size through a flurry of corporate finance activities — mergers and acquisitions, disposals, and restructurings. Now AB has launched its biggest deal to date in a bold move to take over SABMiller. If this deal is successfully sealed, it would combine the world’s two largest brewers with annual sales of at least $80 billion — at least five times the closest rival, Heineken NV and a multiples more than Carlsberg Group.

SABMiller shares were up as much as 24% in London trade on the announcement of the AB’s intention to make an offer last Wednesday. AB shares rose by as much as 12% on the day. It is estimated that the merger could be earnings accretive by at least 20%.

A merger is a business combination in which the acquiring firm absorbs a second firm and the acquiring firm remains in business as a combination of the two merged firms. The acquiring firm usually maintains its name and identity. The shareholders of each of the merging firms involved are required to vote to approve the merger. Depending on the intent of the combination, there are three common ways in which businesses can combine. These are vertical, horizontal and conglomerate mergers. A vertical merger occurs when a company combines with another firm in the up or downstream of its value chain, that is either a supplier or customer. In a horizontal merger, two companies in a similar business combine. The merger of AB and SABMiller would be a horizontal merger. In the case of a conglomerate merger, two companies in unrelated industries combine.

Mergers and acquisitions are seen as a quick way for companies to upscale their operations, diversify and broaden their product or services portfolio, and enter into new markets.  Almost without exception, management promise shareholders that a merger and acquisition will increase stakeholder value. The success of M&A depend on how the merger or acquisition was planned and executed. This is normally judged on whether the merger or acquisition was earnings enhancing or value destructive. Typically, the acquiring company pays a high premium over the current price to the target company’s shareholders to incentivise them to accept the merger or acquisition offer. It appears the market expected that AB would potentially pay a premium of at least 25% on SABMiller price before the announcement.

M&A generally seeks to create shareholder value through revenue enhancement while maintaining the existing cost base or through cost reduction and/or improved efficiencies while maintaining the existing revenue level. However, M&A do not always deliver the value promised to stockholders, especially if they are pursued without a clear plan or at too high a price. As evidenced by a 2011 M&A study by KPMG, 37% of deals do not increase shareholder value, that is, they are value neutral. The same study indicated that 32% of deals actually destroy shareholder value. The report shows that only 32% deals enhanced shareholder value.

A review of the value-creating performance of acquisitions show that while shareholders of target companies are better off with abnormal returns in the order of 20% to 40%, shareholders of acquirers experience value losses on average, or at best, break even. Since the odds of positive and significant value creation may be less than 50%, mergers and acquisitions are clearly high-risk transactions for acquirer shareholders. Bringing two companies together is an enormous task that needs to be approached with caution and rationality. This points to a need for careful planning, comprehensive due diligence and execution. In analysing a potential merger or acquisition, many considerations must be taken into account, such as the intent of the M&A, new group’s strategy, combined business’ ethos, administrative, and systems integration. Will the merger be earnings enhancing and how? Even mundane questions like where should the primary listing or headquarters of the combined operation be located? Are there any deal breakers?

Done right, M&A can be a tool to unlock significant shareholder value. Unless the hard and soft questions surrounding the M&A can be satisfactorily answered, and a comprehensive due diligence is done, the intended benefits of a business combination may not be achieved in full.

Nesbert Ruwo (CFA) and Jotham Makarudze (CFA) are investment professionals based in South Africa. They can be contacted on media@opportunvest.co.za

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