Should UK investors stick with the FTSE 100 firm or look overseas to alternative heavyweight brewers Heineken (NASDAQOTH: HINKF.US), and Budweiser and Stella Artois group Anheuser Busch Inbev (NYSE: BUD.US)?

Last week, SABMiller announced that finance chief Jamie Wilson had “tendered his resignation for personal reasons” and “steps down from the Board with immediate effect”.

The news came as a shock to industry watchers, although, with hindsight, there was perhaps a whiff of something in the air three weeks ago when Wilson exercised an option to purchase company shares and immediately sold the lot for a net profit of £390,318. His previous practice on such occasions had been to sell only enough shares to cover tax liabilities and suchlike.

SABMiller chief executive Alan Clark said: “I am saddened by Jamie’s departure. He has been a huge support to me over many years, first in Europe and then over the past several years as CFO”. Indeed, Wilson has been a key figure in the success of the world’s number two beer group, which today trades on a rich valuation: 21.6 times forward 12-month earnings at a share price of £36.

The principal executive directors at Heineken and Anheuser Busch Inbev (AB Inbev) have been with their respective firms for 35-plus years, and carrying out their chief exec and finance boss roles for a decade or more.

Heineken, the world’s number three beer company, trades on a forward 12-month P/E of 19.7 at a current share price of €67.22 (in Amsterdam) and $38.63 (in New York, where two Heineken US “ADRs” represent one ordinary Heineken share).

World number one AB Inbev — whose turnover exceeds that of Heineken and SABMiller combined — trades on a P/E of 22.4 at a current share price of €107.95 (in Brussels) and $123.57 (in New York).

It’s clear, then, that while there’s some variation in the P/Es, all three companies are very highly rated (the long-term average P/E of the FTSE 100, for example, is just 14). To put the current ratings into further context, when I looked at the brewers back in October 2011, the P/Es were: SABMiller 15.3, AB Inbev 13.3 and Heineken 11.9.

So, we’ve seen a hefty re-rating of the whole sector, with SABMiller benefiting a little less than its rivals.

Why are the shares of these companies currently so in demand with investors? Well, the 10% or so annual earnings growth expected from them in the next couple of years looks very attractive at a time when a lot of industries are finding growth hard to come by. Also, it appears prices have been bid up on the potential for M&A activity in the sector.

Last September, SABMiller made a takeover approach for Heineken, which was rebuffed in no uncertain terms, with the controlling Heineken family making clear its intention to “preserve the heritage and identity of Heineken as an independent company”. Heineken’s stance rekindled what has long been mooted as the obvious megadeal in the sector: namely, for AB Inbev to swallow SABMiller.

Putting it all together, I’m not convinced UK investors have much to gain from deserting the FTSE 100 brewer for one of its overseas-listed rivals at this stage. All three companies are highly rated, and there appears little prospect of their share prices appreciating much beyond the rate of earnings growth, because their P/Es surely can’t go a great deal higher.

SABMiller looks the one company that could give its shareholders an exceptional return from here, purely on the basis of a takeover bid. Boardroom upheavals often provide a fertile environment for an approach, and the shock exit of SABMiller’s finance chief might just be a catalyst for AB Inbev to swoop.

I’m not going to be buying SABMiller shares on the hope of a bid, but if I were already a shareholder, I think would be happy to stick with my investment.

Diageo

Shareholder advisory group PIRC had awarded a ‘red top’ rating to Diageo’s remuneration policies, joined in its protest by shareholder Royal London Asset Management. “Rewards made to the Executive Directors for the year are considered excessive in comparison with their base salaries,” PIRC said in a statement. But around 97% of voters backed the report of both last year’s pay and the company’s pay policy for future years.

At last year’s AGM Diageo fared worse, with 12% of shareholders voting against its pay policy, but the board consulted with shareholders and made changes, including simplifying long-term incentive policy and selecting more focused performance metrics for its annual bonus plan.

So performance was not as good as the company expected, but this had a significant effect on executive pay, with annual bonuses paying out at less than 10% of the maximum, only just over half of performance shares vested, and just over two-thirds of stock options became exercisable through missing targets. This is how executive pay is supposed to work: performance is poor, pay goes down, performance is good, pay goes up. It’s how it’s supposed to work… and it did.  

Diageo chief executive Ivan Menezes earned less in the year to September 2014 than he did as chief operating officer (COO) in the prior year — £5 million compared to £8.3 million in 2013 — although he also received £2.7 million in share awards related to his COO role.

In fact, one of Diageo’s key competitors has a more generous pay policy. Anheuser-Busch InBev NV chief executive Carlos Brito could earn up to 360% of salary as cash bonus compared to 200% at Diageo, and received around 640% in stock options compared to a maximum 500% of salary for Diageo’s chief executive. Last year, Brito earned a base salary of €1.24 million, €2.48 million in cash bonus, plus matching shares, and received stock options worth around €8 million. Of course, AB InBev did much better than Diageo. Annual performance measured against EBITDA, cash flow, operating costs and market share showed year-on-year improvements. But again, this looks like executive remuneration working as it is supposed to do.

After all the investor angst this year, shareholders recognise that when a company performs poorly and the CEO gets a pay cut, at least management is sharing some of their pain. That’s why Diageo shareholders chose not to punish directors by voting against their pay packages. Had pay gone up, the result would have been very different.

Is value up for grabs right now? Is this enough to get rid of SAB stock? There are few other things you should consider. 

Takeover Premium = Zero? 

As you may know, SAB stock already prices in a significant M&A premium. Its unaffected share price isn’t easy to estimate, but should be in the region of £31.10, or about 15% below SAB’s current stock price, and 17% below its closing price on Monday. 

The implied enterprise value (EV) of SAB divided by its forward earnings before interest, taxes, depreciation and amortisation (EBITDA) stands at about 14x and 13x for 2015 and 2016, respectively. This assumes a normalised EBITDA growth of 8% annually into 2016, which is a base-case scenario.

If EBITDA grows at a faster clip — say at about 15% annually — those trading multiples will drop to 13.3x and 11.6x in 2015 and 2016, respectively. Under a worst-case scenario, with EBITDA growth at 4% annually, SAB’s EV/EBITDA multiple goes up to 14.7x and 14.2 in the next could of years.

Now, based on historical take-out multiples for M&A in the beer space, a properly priced acquisition of SAB should be executed at no premium to SAB’s current stock price — whether the acquirer assumes that SAB will manage to beat growth estimates or not.

It’s hard to envisage why AB Inbev — whose management team have a strong track record in M&A and are known for their powerful negotiating skills — should offer much more than SAB’s current enterprise value to clinch a deal. 

The takeover of Mexico’s Modelo was a particularly difficult deal to pull off a couple of years ago, but back then AB InBev management proved they were willing to wait for the right moment to acquire the half of the Mexican brewer they didn’t own.

So, What’s Next?

SAB is a truly unique beast in the industry for its emerging market exposure, so it may be able to fetch a multiple higher than 14x EBITDA if AB InBev makes a firm offer. Investors are taking profits on Tuesday, though. 

Questions remain not only with regard to the size of the possible offer, but also with regard to the structure of the deal, i.e. the financing mix, which will determine how much AB InBev is willing to pay. I think that the interests of SAB shareholders would be preserved if AB InBev were willing to offer a mix of cash and stock to secure an acquisition that may cost in the region of $110bn, including net debt.

Based on its relative valuation, AB InBev stock trades at a 30% discount to SAB stock, which means that negotiations would probably favour SAB shareholders if the deal was financed by a large stock component. In this scenario, SAB will likely receive a low-ball bid. SAB has no intention to become part of a larger company, but in this scenario it may retain up to 25% of the combined entity. That’s not bad. 

The real problem here is that AB InBev has de-levered its balance sheet and sold assets over the years, and its stock trades at a discount to SAB, so AB InBev must strike an all-cash deal that will unlikely entice SAB shareholders — although an all-cash deal would likely value SAB at a higher take-out multiple.

Either way, downside is apparent for investors betting that SAB will be taken over — as well as for those who wish that SAB would remain independent. 

“Punters order up another round of takeover talk,” is the headline from The Times on Thursday. “Yesterday, in a new spin on the tale, dealers were hearing strong suggestions that SAB has been taking steps to bolster its defences in the event of a move by the purveyor of Budweiser and Stella Artois,” the newspaper added.

Consolidation

If consolidation speeds up in the beer industry, how likely is a takeover of SABMiller?

The answer is very simple: SAB is the most obvious takeover target in the sector, while AB InBev is the most obvious acquirer. SAB would cost more than $115bn, including net debt, yet AB Inbev could certainly pull the trigger. The world’s largest brewer would just have to repeat what it did in the past when InBev merged with Anheuser-Bush: it would load the combined entity’s balance sheet with debt, and would de-lever by selling assets and pursuing efficiencies.

It’s hard to suggest other combinations for AB InBev. Heinken still presents a complex shareholding structure, which prevents a change of ownership, in my view. Furthermore, the Dutch brewer’s assets aren’t particularly appealing, and there is no reason why a suitor would spend £40bn or so to secure a company that offers poor growth prospects and lower profitability than SAB.

In the light of Heineken’s geographical reach, synergies will also be more difficult to achieve. Heineken operates in mature markets where trends for volumes and prices aren’t encouraging, to put it mildly.

Elsewhere, Carlsberg is the smallest brewer in the top four. It may be acquired at some point, but its brands portfolio is much less enticing than that of its larger rivals. Foster’s, which was bought by SAB at the end of 2011, was the last public asset available on the market. What’s next depends on AB InBev, whose management may soon need to act to deliver value to shareholders.

SAB Standalone                                                                   

And if SAB remains independent, what does the future hold for its shareholders?

SAB stock still offers long-term value at this price, although it trades at a significant premium compared the shares of most rivals. Revenue are unlikely to surprise on the upside for some time, but even if growth sputters, operating profitability will be in region of 30%. SAB is cutting costs to become a leaner entity, so growth in earnings per share (EPS) won’t be a problem. According to market estimates, EPS will grow by 18%, 10.4% and 7.2% in 2015, 2016 and 2017, respectively.

The brewer is also expected to grow dividend payments by 12%, 10% and 9.2% in the next three years. I think these estimates are reasonable, although some pressure may build up towards the end of 2015. Then, SAB will likely implement another round of cost cuts to please investors if it doesn’t find valid alternatives (reads: acquisitions).

Incidentally, its balance sheet is sound.

Market Reaction

Investors don’t seem willing to buy into the rumours surrounding SAB. The only alternative to a takeover by AB InBev would be a merger with Diageo, but I struggle to find merits in such a tie-up. The stock was down 0.8% in early trade on Thursday. SAB’s valuation has been boosted by takeover talk for years, so it’s easy to dismiss such speculations right now. But if consolidation accelerates, and if the beer sector follows the same long-term pattern of the tobacco industry, SAB will certainly receive an offer sooner rather than later.