OREANDA-NEWS. Fitch Ratings has placed Anheuser-Busch InBev's (ABI) and SABMiller plc's (SABM) Long-term Issuer Default Ratings (IDR) and senior unsecured ratings on Rating Watch Negative (RWN) following today's announcement by ABI that it has made an offer to take over SABMiller plc. A full list of rating actions is shown at the end of this commentary.

The rating action reflects likely higher leverage for both ABI and SABM, should ABI's offer be successful at the terms published today. The transaction would create a strong global player with annual pre-dividend consolidated free cash flow (FCF) of up to around USD10bn. Fitch calculates that a combined ABI-SABM group would have consolidated debt of between USD120bn and USD160bn (end June 2015: USD51.4bn) depending on whether the two key shareholders Altria and BevCo exercise the option to swap their shares into new restricted ABI shares. The offer is subject to acceptance by the SABM board and completion of the transaction remains subject to further conditions.

With respect to SABM's ratings, we expect to equalise them with ABI's, subject to SABM's debt ranking equally with ABI's debt and to the issuing entities being able to access group cash flow.

SABMiller's board has yet to respond to the takeover offer. The ratings are likely to be downgraded upon a successful completion of the merger, or affirmed if the takeover fails to complete.


Leverage Increase
Based on the current terms of the offer, which besides a cash offer, also includes an option for the two key shareholders Altria (27% approximately) and BevCo (14% approximately) to swap their SABM shares into ABI shares and receive a cash payment of USD2.15 per share (equal to a total cash disbursement of up to USD2.4bn), we calculate that ABI's consolidated funds from operations FFO adjusted gross leverage could rise to 6.6x (equating to total debt/consolidated EBITDA of 5.5x, up from 2014's 2.6x) if the 41% equity option is fully taken up. However, in the other, albeit less likely event of a fully debt-funded transaction, FFO adjusted gross leverage could reach 8.5x (total debt/ consolidated EBITDA of around 7.0x).

Scope for Subsequent De-leveraging
Based on our estimation of annual pre-dividends consolidated FCF of approximately USD10bn, the merged entity could reduce consolidated FFO adjusted leverage to approximately 5.8x over a two-year period. We believe that the merger would also require divestments due to market overlaps in the US and China, that could raise up to approximately USD15bn-USD20bn.

Overall we estimate that under these assumptions and in the event of a major reduction of dividends over the initial two-year period, debt reduction should enable consolidated FFO adjusted leverage to reach 4.8x by 2017. However, this would still be high relative to the 4.0x seen for 'BBB'-rated alcoholic beverages companies in Fitch's universe.

Potential Multi-notch Downgrade
In the event of a fully debt-funded transaction, ABI's ratings would struggle to retain their investment-grade status. However, a combined ABI/SABM could limit the downgrade to the mid- to high- 'BBB' rating category in a transaction including the major equity component offered. This would reflect the moderately high leverage being balanced by the large, stable and predictable cash flow of the new entity as well as its exceptional global reach, market positions and portfolio of brands.

Structural Considerations
We expect that ABI's 62%-owned subsidiary AmBev would continue to generate an important portion of the enlarged group's cash flow (pro forma over 30% of FCF pre-dividends). The majority of ABI's debt is currently incurred outside AmBev's perimeter, with ABI only accessing its cash flows via dividends. If all the acquisition debt is placed outside AmBev, this would exacerbate a mismatch between the debt-free and highly cash generative AmBev and ABI's highly leveraged capital structure (pro-forma for SABMiller and taking into account only dividends received from AmBev) putting additional pressure on the ratings.

Transaction Uncertainties and Execution Risks
If the merger goes ahead as planned, the transaction will still require the agreement of different stakeholders and involve integration processes in multiple jurisdictions, as well as potential anti-trust approvals and divestments. ABI management have been reluctant to share detailed strategic and integration plans or hurdles they may have identified.

Further uncertainty stems from SABM's previous rejections of two informal offers for ABI and therefore an increase of the offer price cannot be excluded. Mitigating integration risks are ABI's and SABM's successful track records of managing major M&A in the international beer sector.

Currency Mismatch
A merger would only partly reduce the current currency mismatch of SABM, which funds mostly in euros, US and Australian dollars but generates less than 30% of operating profit in these currencies. Due to the important contribution to cash flow from South America, Asia and Africa (over 60%), a combined ABI-SABM with acquisition debt raised in US dollars or euros would maintain a large hard/soft currency mismatch.

More Challenging Industry Environment
Compared with a year ago, the global beer industry suffers from a weaker trading environment, with volumes having contracted in many markets and currency depreciation impacting, in particular, ABI's FCF. While both ABI and SABM have reported in their most recent results (1H15) sound organic profit growth in Latin America, it was eroded by currency headwinds.

Also, in the core US beer market both brewers are losing market shares to new independent players offering craft beer and are under pressure to respond with new launches. As a result ABI's 1H15 profit margin contracted by nearly 200 basis points on an organic basis in North America.

One Global Leader
The beer industry remains local in terms of brand preferences. Consolidation has created global companies with strong cash generation, but no player operates in all continents. A tie-up between the two leaders ABI and SABM would now create a global player, with presence in many duopoly and oligopoly markets with high profit margins and in several others with medium-term growth prospects, even though volume growth is currently at a historical low point.

Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Although subject to shareholder approval, key Fitch forecast assumptions for the merged group include:

-Successful completion of the merger in January 2016 at the terms of the offer submitted by ABI today
-ABI's and SABM's reported revenues contracting in the low single digits in 2015 and subsequently recovering
-Cost of new acquisition debt of around 3.5%
-Dividend payout by ABI at around 25% to 30% in 2016 and 2017
-Potential divestment proceeds

Upon completion of the transaction, we would likely downgrade the ratings of ABI by one or more notches. The final ratings will depend on pro-forma leverage on completion and on the degree of visibility and credibility of a sustainable de-leveraging path using cash flow and potential divestment proceeds over the first two years post-completion

A positive rating action is currently not envisaged. If the transaction does not proceed this will likely translate into ABI's ratings being affirmed.

We may downgrade SABM ratings to the same level of ABI's upon completion of the transaction. However, should SABM's current debt be structurally subordinated to ABI's existing or acquisition debt, its ratings would be further notched down from ABI's IDR

A positive rating action is currently not envisaged. If the transaction does not proceed this will likely translate into SABMiller's ratings being affirmed.


Anheuser Busch InBev NV/SA
Long-term IDR: 'A' on RWN
Short-term IDR: 'F1' on RWN
Senior unsecured rating: 'A' on RWN

Anheuser Busch InBev Worldwide Inc
Senior unsecured rating: 'A' on RWN

Anheuser-Busch Companies Inc
Senior unsecured rating: 'A' on RWN

Anheuser-Busch InBev Finance Inc
Senior unsecured rating: 'A' on RWN

SABMiller plc
Long-term IDR: 'A-' on RWN
Short-term IDR: 'F2' on RWN
Senior unsecured debt: 'A-' on RWN

SABMiller Holdings Inc.
Senior unsecured debt: 'A-' on RWN