On Sunday, Heineken (HEIA) confirmed a Bloomberg report that it has rejected an acquisition offer from SABMiller (SAB). The terms of the offer were not disclosed, and Heineken reiterated its intention to remain independent. We regard SABMiller's approach as an attempt to strengthen itself against a potential bid from Anheuser-Busch InBev, a strategy that we think is fraught with the risk of overpaying for the asset.
Nevertheless, we think a combined SABMiller-Heineken entity would be a wide economic moat company with very strong competitive advantages, narrowly eclipsing Anheuser-Busch InBev as the global leader. Any future agreement would likely be reached at a premium to our fair value estimate. Until such time, we are reiterating our €54 fair value estimate, which is based upon the future cash flows of the standalone entity.
There is limited geographic overlap between Heineken and SABMiller, and we would expect minimal regulatory challenges in the event of an agreement being reached. The addition of Heineken would strengthen SABMiller's position in Africa, giving it a dominant position in Nigeria, where Heineken holds a 65% share and SABMiller is a minor player.
Its position in Latin America would be bolstered by Heineken's 44% share in Mexico. The combined entity would provide a platform to launch the Heineken brand, the global international premium lager leader, in Asia, where Heineken's presence is low. We regard this as a highly attractive potential opportunity.
Moreover, an SAB-Heineken combination would have sufficient scale to rival that of industry leader Anheuser-Busch InBev (ABI), with total beverage volumes of 502 million hectolitres, even greater than A-B InBev's 2013 volumes of 426 million hectolitres, and revenue of around $47 billion. This vast global scale would significantly increase SABMiller's raw material purchasing power, a cost advantage that is an important source of economic moats for the leading global brewers.
The acquisition of Heineken would probably put SABMiller out of reach of Anheuser-Busch InBev at present. In our report of June 2014, The Case Against Anheuser-Busch InBev Acquiring SABMiller, we stated that at 17.0x EV/EBITDA and at a net debt/EBITDA ceiling of 4.6x, A-B InBev would have to finance 45% of a deal for SABMiller using stock.
We estimate that an A-B InBev acquisition of the SAB-Heineken entity at a similar valuation would require 60% funding in stock. An SAB-Heineken combination would have three large shareholders - the Heineken family, Altria, and the Santo Domingo family - each of which would have tax liabilities so large that it is likely they would require a prohibitive premium to the current market price or a stock deal. The amount of stock used in the potential deal may be too great a dilution risk for A-B InBev shareholders, in our opinion.
Historical multiples in brewing transactions have been quite high, with EV/EBITDA multiples averaging 12x over the last decade, with mid to high-teen multiples paid for emerging market exposure. Following a modest upward move on Monday morning, Heineken is now trading at 11.5x our estimate of 2015 EV/EBITDA, leaving some headroom for SABMiller to pay a premium. Nevertheless, we are concerned that SABMiller, in its desperation to remain independent, may overpay for its target.
Given the limited geographic overlap between the two firms, we expect cost synergies to be limited to the elimination of duplicate back-office functions, some trimming of the 80,000-strong workforce, and a modest amount of leverage of distribution costs. Our initial estimate of cost savings from the deal is around €500 million to €1 billion per year, and we expect any combination to be much more about driving top line growth rather than margin expansion. As a result, we believe a fair takeout valuation for Heineken would be at the low to mid end of the historical range. Heineken is an achievable target for SABMiller, however, and an all-debt acquisition at the current market price, and before adjusting for synergies, would force SAB to lever up to around 4.5x debt/EBITDA.
We think Heineken's lukewarm rejection of SABMiller's offer leaves the door open for another approach. An accept able offer would likely have to include a significant premium to the current market valuation, and a strong presence on the executive board for members of the Heineken family. Given its strategic importance to remaining independent, we expect SABMiller to improve its offer.
If an agreement between the two parties is reached, Anheuser-Busch may find that its hand is forced in its pursuit of SABMiller. Heineken is a better fit with SABMiller than it is with A-B InBev - we believe there would be antitrust issues in Brazil, Mexico, the U.S., and the U.K. for a combination with A-B InBev - but it is possible that ABI may bid for one of the two firms in order to preserve its position as global leader of the brewing industry, and to protect its cost advantage.
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