Beer and cigarettes are not the healthiest combination, but for Altria, the maker of Marlboro, owning 27 per cent of brewer SABMiller has proven lucrative.
The stake has contributed 10-19 per cent of Altria’s annual pre-tax profits over recent years, so the prospect of a bid for SAB by Anheuser-Busch InBev, its larger rival, has left investors watching keenly to see what Altria opts to do with its holding.
The size of the stake also means that the tobacco group could be an important influence over SAB’s discussions on whether to accept an offer, and how the deal should be structured.
Most analysts say that the best outcome for Altria, the biggest tobacco company in the US, is to push for terms that allow it to keep a stake in an AB InBev-SABMiller combination.
Vivien Azer, an analyst at Cowen & Company, expects Altria to use its three board members to lobby for a 50-50 stock and cash deal that would allow it to maintain a “meaningful” position in the merged company. One reason being that selling Altria’s stake for cash would incur significant tax costs, analysts noted.
“They would have a tremendous tax bill if they were to sell,” says Michael Zbinovec, an analyst at Fitch, the rating agency. “They have repeatedly said they are happy with earnings from the business.”
Morningstar’s Adam Fleck estimates that its stake in SAB could be worth roughly $24bn in a takeover, with the research company estimating a fair value for the brewer of £36 per share. Others suggest the price could be higher.
This is close to where SAB trades now, standing at £37.22 in morning trade on Wednesday. It is difficult to determine the company’s undisturbed share price, however. It has rallied nearly 20 per cent since an approach was confirmed on September 16, but speculation about an offer was rife even before this, bolstering the stock.
Regardless, any final price would be far higher than the $6.2bn book value of the asset as recorded on Altria’s balance sheet at the moment.
And the tax rate on its gains would be 35 per cent, analysts say.
Altria, then Philip Morris, gained a 36 per cent share in SAB worth $3.4bn, after it sold Miller Brewing to SAB in 2002. This was gradually diluted to 27.3 per cent by 2009, according to its annual reports.
But tax is not the only reason that holding on to a stake would be in Altria’s interest, according to analysts. SAB’s substantial contribution to Altria’s earnings provides steady cash flow for the company as it seeks to bolster shareholder returns amid a secular decline in its core tobacco business.
It has also been a form of diversification for Altria, given a most of the group’s profit still comes from cigarettes, despite expanding its “smokeless” offerings and wine business. The group’s geographic spread has also narrowed since it spun off Philip Morris International to focus on the US market.
By securing a stake in a combined AB InBev-SABMiller, Altria could share in the gains that analysts expect from a deal backed by 3G Capital, the cost-cutting Brazilian private equity group that owns 22.7 per cent of AB InBev.
Fitch’s Mr Zbinovec also notes that AB InBev’s dividend yield exceeds SAB’s at 3.17 per cent and 2.07 per cent respectively, suggesting a continued stake could increase its dividend income.
Altria’s long-term goal of earnings per share growth of 7-9 per cent “seems to imply growing equity contributions from SABMiller”, Morningstar’s Mr Fleck points out.
“If management wants to continue to hit those targets without increasing equity contributions, it would need to boost pricing and likely accelerate volume declines in its tobacco products,” he says.
Altria’s Marlboro brand, which accounts for almost all of its “smokable” cigarette sales, has nearly 44 per cent of the US market — more than the next 10 brands combined. The segment, which also includes cigars, enjoys generous margins of 44 per cent. Its smokeless offerings, while a much smaller contributor to profit, are growing and have margins of 63 per cent.
But with limited ability to advertise and regulation only likely to get stiffer, tobacco is a difficult industry.
Domestic competition is intensifying at a time of significant consolidation. Reynolds American recently completed its acquisition of Lorillard, with some brands from those two companies sold to Imperial Tobacco’s US subsidiary, while Japan Tobacco this week announced plans to buy $5bn of assets from Reynolds.
More consolidation could come though. There has been market speculation that Imperial itself could be a target either for BAT or Japan Tobacco.
One key focus for investors and analysts if Altria maintains an investment in brewing through an AB InBev-SAB deal, is how big its holding will be.
At the moment, its 27.3 per cent stake and three board members gives it “significant influence” in accounting terms, allowing it to use so-called equity method accounting and consolidate its share of SAB’s profit on its income statement.
While letting its stake fall below 20 per cent could force it to change the way it accounts for its holding and only count dividends, there is no hard and fast rule, analysts say, adding that it could prove in other ways that it continues to exert “significant influence”.
As the Marlboro Man said of his smokes back in 1954 “You get a lot to like”. For Altria, when it comes to maintaining a stake in a newly formed AB InBev-SAB, the same probably applies.