You have got to love takeover rumours.
In the last seven weeks of trading, SABMiller (LSE: SAB) stock has outperformed Diageo’s (LSE: DGE) (NYSE: DEO.US) by roughly five percentage points. Most of the gap is dated June 10 – i.e. the day after the Financial Times had speculated about a possible takeover of SAB by AB InBev.
Diageo’s discount is warranted right now. SABMiller would likely be valued at a 10%-plus premium against Diageo if it merged with the spirits maker. That’s a possibility that has emerged, again, in the last few days. I wouldn’t bank on it.
Focus Is Elsewhere
“Diageo has a market cap of £46bn and an enterprise value of £56bn; SAB has a market cap of £52bn and an enterprise value of £62bn. As unconceivable as it may seem, a merger of equals would make sense,” I argued on May 15.
Diageo and SABMiller have struggled in emerging markets in the last 12 months, and the outlook isn’t great. They are at the crossroads, but there are alternatives to a merger between the two. Both management teams are intent on delivering value by taking action on their companies’ portfolios.
SABMiller announced on Monday to have agreed to sell its 39.6% stake in South Africa’s Tsogo Sun Holdings Limited for about $1.1bn. The gaming, hotel and entertainment group was non-core to SABMiller, so the brewer rightly decided to divest the asset after more than 10 years. Diageo, meanwhile, has finally managed to secure a majority stake in United Spirits, India’s largest liquor company.
The Merger
A merger between SAB and Diageo would give the market a total beverage alcohol player which, according to Diageo’s long-term plan, should be able to deliver value to shareholders in the beverage sector. Diageo wants to be acquirer, however.
Analysts believe the deal would make sense as revenue and cost synergies would allow the combined entity to be more profitable. The problem with such a tie-up, as I have recently argued, is that that the life span of different products, different procurement cycles and different distribution channels may cause problems, preventing a successful integration.
Valuation Hurdles
According to consensus estimates from S&P Capital IQ, Diageo stock trades at 5.4x sales and 15.4x earnings before interest, tax, depreciation and amortisation, based on estimates for 2014 financial figures. These multiples drop to 5x and 14.5x, respectively, in 2015.
Diageo and SABMiller boast very similar prospects for growth, profitability and earnings. SABMiller’s trading multiples, though, are between 5% and 10% higher than Diageo’s for 2014 and 2015, which simply means that if a merger occurred, SABMiller would retain a controlling stake in the combined entity. Yet the spread between the trading multiples of Diageo and SABMiller will narrow if rumours surrounding SABMiller fade away…