Quilmes Industrial (Quinsa), S LQU W
July 12, 2005 - 9:33am EST by
charlie479
2005 2006
Price: 25.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,399 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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  • alcohol
  • Latin America
  • Argentina
  • Brand
  • Low Competition
  • low-cost producer
  • Competitive Advantage
  • Pricing Power
  • High Barriers to Entry, Moat
 

Description

Quilmes Industrial (Quinsa) is a very high quality business with excellent returns on capital. Its stock sells at a cheap price and a change of control is going to occur.

Quinsa is the dominant beer brewer in several South American countries. Its beer brands account for 79% of the market in Argentina, which is the company’s main market (I will tackle Argentina issues in the Q&A). Quinsa also controls 97% of the market in Bolivia, 95% in Paraguay and 98% in Uruguay. One of the hallmarks of a great business is very little competition and as the Nielsen figures indicate, Quinsa’s competitors have not been very successful going up against the company. To make matter worse for the competition, Quinsa acquired the operations of the #2 competitor in its markets two years ago and thereby increased its lead in Argentina, Paraguay and Uruguay. Also as a result of that transaction, AmBev became a large shareholder of Quinsa. AmBev will not be doing business in Quinsa’s markets except through its interest in Quinsa. This removes the threat of a competitor entering from neighboring Brazil.

What are the competitive advantages that allow Quinsa to maintain its monopoly-like position?

Quinsa is the lowest cost producer.

The company produces a greater volume of beer than any other local competitor so it reaps advantages from economies of scale. Its facilities operate at higher capacity utilization rates so fixed costs are spread over large quantities. It purchases more bottles, more crown-tops and other inputs than its competitors so it has an advantage in buying inputs cheaply (interesting note: Quinsa owns the farms that produce much of the barley and its developed barley strains account for nearly all the barley produced in Argentina). Quinsa’s cost of goods sold per liter is among the lowest in the world, let alone the lowest in its markets (Quinsa manages to make a 54%-56% gross margin on net revenue of only $0.345 per liter. For comparison, Anheuser-Busch gets net revenue of $0.94 per liter but its gross margin is only 40%). This discourages foreign competitors from entering the market as they are unlikely to be able to match prices.

Quinsa has strong brands.

The phrase “strong brands” can be an over-applied investment banking sales pitch but in this case Quinsa’s brands are a true source of durable competitive advantage. Beer is a product that consumers choose by brand instead of price (the next time you order a beer at a bar or a restaurant, notice if you even look at the price before you order). Quinsa has ingrained its Quilmes brand in the minds of millions of beer drinkers in Argentina with countless television commercials, billboard displays, radio spots and other advertisements over much of the modern part of its 100+ year history. These advertisements are a Pavlovian bombardment of positive associations for the Quilmes brand: beautiful people, parties, soccer, music, national pride, etc.

Additionally, millions of these beer drinkers have had dozens of positive experiences over their lifetime drinking Quilmes beer. If you add to this mix the chemical reinforcement properties of alcohol, the result is a population with a deep-rooted affinity for Quilmes. This “share of mind” is the same thing that Buffett describes as Coca-Cola’s most valuable intangible asset. It is very difficult for a competitor to replicate this because they’d first have to spend years advertising to build up the necessary number of positive image associations in people’s minds. And they’d have to spend years trying to associate their brand with millions of positive taste experiences. Quinsa has already been “training” its population for decades.

Besides the obstacle of time, the competitors have the obstacle of money. Quinsa’s competitors would have to spend a disproportionately large amount of their budget on advertising to match Quinsa. Quinsa spends over $55 mil per year on advertising. This amount is more than the local beer revenue of many of its competitors. Quinsa has also locked up certain key sponsorships such as the national soccer team and popular club teams.

Quinsa dominates the channels of distribution.

Quinsa’s beer is available at over 440,000 points of sale. Many of these points of sale are either covered by the company directly or serviced through independent distributors. There are 800 of these distributors and Quinsa has exclusive arrangements with nearly all to sell only Quinsa products. Quinsa happens to also be the largest Pepsi bottler in a few of its countries so its negotiating power with distributors is compounded. As a result of its overwhelming market share, Quinsa is able to spread its volume over several geographically-dispersed distribution centers whereas competitors can support only one. This creates a cost advantage in transportation expense.

The comprehensive coverage provided by the numerous points of sale means that Quinsa’s beers are nearly always readily available, a key in developing favorable consumer consumption patterns. Whenever a customer wants a Quilmes, one is available. When I visited Argentina, sometimes a 2nd beer choice was simply not available.


Enough qualitative stuff, numbers please.

Quinsa trades at 5.98x 2005E EBITDA. The multiple of 2004 EBITDA is 6.75x. The 2005 estimate is a forecast from a valuation report commissioned to justify the price offered by InBev to AmBev shareholders, so there was an incentive to skew the value of AmBev’s stake in Quinsa lower. This estimate has EBITDA growing by 12.9% in 2005 despite the fact that EBITDA grew by 48% last year (even with a 32% increase in advertising spending in Argentina). Quinsa is on pace to surpass the forecasted EBITDA, as it grew by 28% in the first quarter of 2005 (Quinsa does not publish quarterly results but you can find it if you dig into the filings for AmBev). Winter here is summer down there so 1Q 05 is one of the 2 key selling periods. The calculations I present here are based on the conservative EBITDA forecast minus certain items I subtract to adjust things to US GAAP.

EBITDA has limitations of course but in this case it may be the most important metric because it is the key variable in a takeover formula that I will explain later. Also, because of the importance of this EBITDA-driven takeover formula I believe the company is currently overspending on capex (i.e. EBITDA-capex may understate the cash flow generation ability of the company). It trades at 9.19x 2004 EBITDA-Capex and 9.18x 2005E. I am using actual capex, not maintenance capex and not making any adjustments for overspend. The EBIT multiples are 9.88x 2004 and 8.07x 2005E.

The company’s blended income tax rate is 34.5%. However the company has $196 million of accumulated tax loss carryforwards so the cash paid for income tax has been materially lower. Even at a full tax rate, the valuation multiples are very reasonable for a company with 60% pretax returns on tangible capital and high double digit cash flow growth rates. Quinsa’s high return on capital is not apparent at first glance because the financials are prepared according to Luxembourg GAAP, which does certain strange things like recording treasury stock as an asset as opposed to a reduction of shareholders’ equity. You have to make some adjustments to get a clear picture of the true economic return on capital.

For those of you who want comps, these are the 2005 EBITDA multiples for some other global brewers. These are Morgan Stanley’s figures.

AmBev $30.02 per share 9.3x
Anheuser-Busch $46.54 10.4x
Fomento Economico Mexicano $57.59 6.5x
Grupo Modelo $31.10 8.6x
Heineken $31.50 7.0x
SABMiller $15.30 7.1x


Change of Control

When AmBev exchanged its operations in Argentina, Paraguay and Uruguay for a stake in Quinsa in 2003, it entered into a put/call agreement with Quinsa’s controlling shareholder. The agreement gives the controlling shareholder the right to sell its stake to AmBev at a price determined by a formula in Schedule 1.04 of the agreement. This put right is exercisable annually. The next exercise date is in April 2006. If the put is not exercised in the next few years then AmBev has a call option to purchase the shares at the formula price. When there is a put and a call struck at the same price it is bound to be exercised by one of the parties.

The formula is not simple enough to include in this write-up but it essentially values LQU at the greater of (1) 8x EBITDA and (2) the trailing EBITDA multiple for AmBev. It then applies some discounts to determine the number of AmBev shares that would be issued for LQU shares. According to my calculations, the formula would have produced a sale price of $48.25 per share of LQU if the put had been exercised in April 2005. Applying the various discount factors would have left a price of $38 realizable in the form of AmBev shares. As I mentioned earlier, EBITDA for 2005 could be substantially higher than last year so if the other variables remain the same then the put price could be higher at the exercise date in April 2006.

Why should we care if 55% of the voting power is put to AmBev? The European Union adopted the Takeover Directive in March 2004 to harmonize takeover laws. It specifies mandatory bid requirements to be adopted by member states for acquisitions of companies in the EU. If an acquirer obtains voting control of a target, the acquirer must follow with an offer for the remaining public shares. The offer must be made at an “equitable price”, which is defined as the highest price paid by the acquirer for any shares within the last 12 months (EU members can make this as short as 6 months). If control of Quinsa transfers to AmBev at $38 per share for example then laws implementing the Takeover Directive would require a mandatory offer to minority shareholders at $38 per share.

I think that this is an attractive situation even without the possibility of a mandatory bid. AmBev and Quinsa’s controlling shareholder have demonstrated an interest in increasing their ownership percentages through share purchases and company buybacks. In August 2004, the company purchased 41% of the float through a tender offer. So far in 2005, the company has purchased another 4% of the float through open-market share repurchases as high as $24.96 per share and as recently as June 15. Also, page 21 of the recently filed Form 20-F mentions that the board has been considering a transaction involving a buyout of the minority shares. The company has been so eager to buy up shares that when it ran into a constraint created by Luxembourg law (a company cannot continue buybacks if it depletes certain treasury stock reserves) it decided to go through the hassle of changing its fiscal year twice, creating two stub periods, and holding several annual/special meetings in order to approve the necessary reserves. It’s worth mentioning that this little technicality, which has been keeping Quinsa out of the stock market for the last few weeks, will end a few days from now. On July 15, 2005 there is a special meeting to get the flexibility to resume the share repurchase program and authorize certain dividend payments.

Incidentally, Luxembourg law does not give acquirers minority squeeze-out rights so the controlling shareholders cannot force a going private transaction (a Luxembourg lawyer explained the rationale to me this way: “if you are the owner of shares then why should anyone have the right to take those shares away from you at a price you don’t want?”).

Other dynamics and catalysts

Quinsa is a great business with rapidly growing cash flow and it is available at a cheap price. These core factors are enough to produce an attractive investment on their own. As a bonus, there are several additional factors converging together that could make this a really great opportunity.

The put option formula creates an incentive for the controlling shareholder to maximize EBITDA and reduce shares outstanding. The controlling shareholder knows that it will be parting with its stake in Quinsa, which it has held for generations, so they are motivated to optimize the inputs in the put option formula.

To maximize EBITDA, the company has recently been raising prices at a healthy pace. Since the execution of the put/call agreement, Quinsa raised beer prices in its primary market by 10% in March 2003, and then another 10% in September 2003. Prices were raised again in 2004, with the most recent increase (8% on a consolidated average in December 2004) not yet fully reflected in the trailing numbers. Run-of-the-mill businesses cannot withstand large price increases like this but with a wide-moat business like Quinsa you can raise prices without losing volume. Quinsa’s volumes have actually been increasing despite the price hikes (2002: 7.619 mil hectoliters of beer, 2003: 9.921 mil hectoliters, 2004: 10.396 mil hectoliters – remember, though that in 2003 Quinsa made an acquisition). As the volumes have gone up, cost of goods sold per hectoliter have fallen (down 10% in 2003, down 2% in 2004). Equally impressive is the decline in administrative and general expense on an absolute basis even though revenues have grown substantially – the controlling shareholder is very serious about maximizing EBITDA. A wide-moat business like Quinsa has enormous latent earnings power that is not reflected in the income statement until management decides to start raising prices. The put option has been a catalyst for Quinsa to flex its pricing muscle.

Because the put option formula does not penalize for capex spending, the company has begun to ramp up capital investments. The capacity of a malting plant in Argentina is being doubled for $27 mil, a new bottle facility in Paraguay is being built for $10 mil and a new soft drinks production line is being added for $10 mil. These investments should facilitate higher revenue, higher EBITDA and ultimately, a higher sale price for shareholders.

The impending change of control has also encouraged the company to continue doing the right things in returning capital to shareholders and deploying excess cash. Last year Quinsa purchased several minority interests in key operating subsidiaries, which will increase the proportionate EBITDA credited in the formula. The company has also done the previously mentioned share buybacks and after July 15, 2005 it will have the power to buy the equivalent of 11%-13% of the current float.

I like the fact that the people piloting the ship have been passing up opportunities to exercise their put option at a price that is much higher than the publicly-traded price today. The put was likely not exercised last year because of the anticipated price increases and other EBITDA-maximization efforts. EBITDA ended up growing 48% in 2004. I believe that the anticipated effect of price increases and EBITDA growth is the main reason that the put was not exercised in April of this year. I do not mind the deferral of the change of control if insiders think that EBITDA is going to increase at a pace sufficient to compensate for passing on a massive premium today.

Catalyst

Investor recognition of a great business.
Resumption of buybacks on July 15th.
Change of control at a large premium, as early as April 2006.
Controlling shareholders may offer to take the company private before then.
Recent price increases and future increases will begin to demonstrate the company’s true earnings power.
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    Description

    Quilmes Industrial (Quinsa) is a very high quality business with excellent returns on capital. Its stock sells at a cheap price and a change of control is going to occur.

    Quinsa is the dominant beer brewer in several South American countries. Its beer brands account for 79% of the market in Argentina, which is the company’s main market (I will tackle Argentina issues in the Q&A). Quinsa also controls 97% of the market in Bolivia, 95% in Paraguay and 98% in Uruguay. One of the hallmarks of a great business is very little competition and as the Nielsen figures indicate, Quinsa’s competitors have not been very successful going up against the company. To make matter worse for the competition, Quinsa acquired the operations of the #2 competitor in its markets two years ago and thereby increased its lead in Argentina, Paraguay and Uruguay. Also as a result of that transaction, AmBev became a large shareholder of Quinsa. AmBev will not be doing business in Quinsa’s markets except through its interest in Quinsa. This removes the threat of a competitor entering from neighboring Brazil.

    What are the competitive advantages that allow Quinsa to maintain its monopoly-like position?

    Quinsa is the lowest cost producer.

    The company produces a greater volume of beer than any other local competitor so it reaps advantages from economies of scale. Its facilities operate at higher capacity utilization rates so fixed costs are spread over large quantities. It purchases more bottles, more crown-tops and other inputs than its competitors so it has an advantage in buying inputs cheaply (interesting note: Quinsa owns the farms that produce much of the barley and its developed barley strains account for nearly all the barley produced in Argentina). Quinsa’s cost of goods sold per liter is among the lowest in the world, let alone the lowest in its markets (Quinsa manages to make a 54%-56% gross margin on net revenue of only $0.345 per liter. For comparison, Anheuser-Busch gets net revenue of $0.94 per liter but its gross margin is only 40%). This discourages foreign competitors from entering the market as they are unlikely to be able to match prices.

    Quinsa has strong brands.

    The phrase “strong brands” can be an over-applied investment banking sales pitch but in this case Quinsa’s brands are a true source of durable competitive advantage. Beer is a product that consumers choose by brand instead of price (the next time you order a beer at a bar or a restaurant, notice if you even look at the price before you order). Quinsa has ingrained its Quilmes brand in the minds of millions of beer drinkers in Argentina with countless television commercials, billboard displays, radio spots and other advertisements over much of the modern part of its 100+ year history. These advertisements are a Pavlovian bombardment of positive associations for the Quilmes brand: beautiful people, parties, soccer, music, national pride, etc.

    Additionally, millions of these beer drinkers have had dozens of positive experiences over their lifetime drinking Quilmes beer. If you add to this mix the chemical reinforcement properties of alcohol, the result is a population with a deep-rooted affinity for Quilmes. This “share of mind” is the same thing that Buffett describes as Coca-Cola’s most valuable intangible asset. It is very difficult for a competitor to replicate this because they’d first have to spend years advertising to build up the necessary number of positive image associations in people’s minds. And they’d have to spend years trying to associate their brand with millions of positive taste experiences. Quinsa has already been “training” its population for decades.

    Besides the obstacle of time, the competitors have the obstacle of money. Quinsa’s competitors would have to spend a disproportionately large amount of their budget on advertising to match Quinsa. Quinsa spends over $55 mil per year on advertising. This amount is more than the local beer revenue of many of its competitors. Quinsa has also locked up certain key sponsorships such as the national soccer team and popular club teams.

    Quinsa dominates the channels of distribution.

    Quinsa’s beer is available at over 440,000 points of sale. Many of these points of sale are either covered by the company directly or serviced through independent distributors. There are 800 of these distributors and Quinsa has exclusive arrangements with nearly all to sell only Quinsa products. Quinsa happens to also be the largest Pepsi bottler in a few of its countries so its negotiating power with distributors is compounded. As a result of its overwhelming market share, Quinsa is able to spread its volume over several geographically-dispersed distribution centers whereas competitors can support only one. This creates a cost advantage in transportation expense.

    The comprehensive coverage provided by the numerous points of sale means that Quinsa’s beers are nearly always readily available, a key in developing favorable consumer consumption patterns. Whenever a customer wants a Quilmes, one is available. When I visited Argentina, sometimes a 2nd beer choice was simply not available.


    Enough qualitative stuff, numbers please.

    Quinsa trades at 5.98x 2005E EBITDA. The multiple of 2004 EBITDA is 6.75x. The 2005 estimate is a forecast from a valuation report commissioned to justify the price offered by InBev to AmBev shareholders, so there was an incentive to skew the value of AmBev’s stake in Quinsa lower. This estimate has EBITDA growing by 12.9% in 2005 despite the fact that EBITDA grew by 48% last year (even with a 32% increase in advertising spending in Argentina). Quinsa is on pace to surpass the forecasted EBITDA, as it grew by 28% in the first quarter of 2005 (Quinsa does not publish quarterly results but you can find it if you dig into the filings for AmBev). Winter here is summer down there so 1Q 05 is one of the 2 key selling periods. The calculations I present here are based on the conservative EBITDA forecast minus certain items I subtract to adjust things to US GAAP.

    EBITDA has limitations of course but in this case it may be the most important metric because it is the key variable in a takeover formula that I will explain later. Also, because of the importance of this EBITDA-driven takeover formula I believe the company is currently overspending on capex (i.e. EBITDA-capex may understate the cash flow generation ability of the company). It trades at 9.19x 2004 EBITDA-Capex and 9.18x 2005E. I am using actual capex, not maintenance capex and not making any adjustments for overspend. The EBIT multiples are 9.88x 2004 and 8.07x 2005E.

    The company’s blended income tax rate is 34.5%. However the company has $196 million of accumulated tax loss carryforwards so the cash paid for income tax has been materially lower. Even at a full tax rate, the valuation multiples are very reasonable for a company with 60% pretax returns on tangible capital and high double digit cash flow growth rates. Quinsa’s high return on capital is not apparent at first glance because the financials are prepared according to Luxembourg GAAP, which does certain strange things like recording treasury stock as an asset as opposed to a reduction of shareholders’ equity. You have to make some adjustments to get a clear picture of the true economic return on capital.

    For those of you who want comps, these are the 2005 EBITDA multiples for some other global brewers. These are Morgan Stanley’s figures.

    AmBev $30.02 per share 9.3x
    Anheuser-Busch $46.54 10.4x
    Fomento Economico Mexicano $57.59 6.5x
    Grupo Modelo $31.10 8.6x
    Heineken $31.50 7.0x
    SABMiller $15.30 7.1x


    Change of Control

    When AmBev exchanged its operations in Argentina, Paraguay and Uruguay for a stake in Quinsa in 2003, it entered into a put/call agreement with Quinsa’s controlling shareholder. The agreement gives the controlling shareholder the right to sell its stake to AmBev at a price determined by a formula in Schedule 1.04 of the agreement. This put right is exercisable annually. The next exercise date is in April 2006. If the put is not exercised in the next few years then AmBev has a call option to purchase the shares at the formula price. When there is a put and a call struck at the same price it is bound to be exercised by one of the parties.

    The formula is not simple enough to include in this write-up but it essentially values LQU at the greater of (1) 8x EBITDA and (2) the trailing EBITDA multiple for AmBev. It then applies some discounts to determine the number of AmBev shares that would be issued for LQU shares. According to my calculations, the formula would have produced a sale price of $48.25 per share of LQU if the put had been exercised in April 2005. Applying the various discount factors would have left a price of $38 realizable in the form of AmBev shares. As I mentioned earlier, EBITDA for 2005 could be substantially higher than last year so if the other variables remain the same then the put price could be higher at the exercise date in April 2006.

    Why should we care if 55% of the voting power is put to AmBev? The European Union adopted the Takeover Directive in March 2004 to harmonize takeover laws. It specifies mandatory bid requirements to be adopted by member states for acquisitions of companies in the EU. If an acquirer obtains voting control of a target, the acquirer must follow with an offer for the remaining public shares. The offer must be made at an “equitable price”, which is defined as the highest price paid by the acquirer for any shares within the last 12 months (EU members can make this as short as 6 months). If control of Quinsa transfers to AmBev at $38 per share for example then laws implementing the Takeover Directive would require a mandatory offer to minority shareholders at $38 per share.

    I think that this is an attractive situation even without the possibility of a mandatory bid. AmBev and Quinsa’s controlling shareholder have demonstrated an interest in increasing their ownership percentages through share purchases and company buybacks. In August 2004, the company purchased 41% of the float through a tender offer. So far in 2005, the company has purchased another 4% of the float through open-market share repurchases as high as $24.96 per share and as recently as June 15. Also, page 21 of the recently filed Form 20-F mentions that the board has been considering a transaction involving a buyout of the minority shares. The company has been so eager to buy up shares that when it ran into a constraint created by Luxembourg law (a company cannot continue buybacks if it depletes certain treasury stock reserves) it decided to go through the hassle of changing its fiscal year twice, creating two stub periods, and holding several annual/special meetings in order to approve the necessary reserves. It’s worth mentioning that this little technicality, which has been keeping Quinsa out of the stock market for the last few weeks, will end a few days from now. On July 15, 2005 there is a special meeting to get the flexibility to resume the share repurchase program and authorize certain dividend payments.

    Incidentally, Luxembourg law does not give acquirers minority squeeze-out rights so the controlling shareholders cannot force a going private transaction (a Luxembourg lawyer explained the rationale to me this way: “if you are the owner of shares then why should anyone have the right to take those shares away from you at a price you don’t want?”).

    Other dynamics and catalysts

    Quinsa is a great business with rapidly growing cash flow and it is available at a cheap price. These core factors are enough to produce an attractive investment on their own. As a bonus, there are several additional factors converging together that could make this a really great opportunity.

    The put option formula creates an incentive for the controlling shareholder to maximize EBITDA and reduce shares outstanding. The controlling shareholder knows that it will be parting with its stake in Quinsa, which it has held for generations, so they are motivated to optimize the inputs in the put option formula.

    To maximize EBITDA, the company has recently been raising prices at a healthy pace. Since the execution of the put/call agreement, Quinsa raised beer prices in its primary market by 10% in March 2003, and then another 10% in September 2003. Prices were raised again in 2004, with the most recent increase (8% on a consolidated average in December 2004) not yet fully reflected in the trailing numbers. Run-of-the-mill businesses cannot withstand large price increases like this but with a wide-moat business like Quinsa you can raise prices without losing volume. Quinsa’s volumes have actually been increasing despite the price hikes (2002: 7.619 mil hectoliters of beer, 2003: 9.921 mil hectoliters, 2004: 10.396 mil hectoliters – remember, though that in 2003 Quinsa made an acquisition). As the volumes have gone up, cost of goods sold per hectoliter have fallen (down 10% in 2003, down 2% in 2004). Equally impressive is the decline in administrative and general expense on an absolute basis even though revenues have grown substantially – the controlling shareholder is very serious about maximizing EBITDA. A wide-moat business like Quinsa has enormous latent earnings power that is not reflected in the income statement until management decides to start raising prices. The put option has been a catalyst for Quinsa to flex its pricing muscle.

    Because the put option formula does not penalize for capex spending, the company has begun to ramp up capital investments. The capacity of a malting plant in Argentina is being doubled for $27 mil, a new bottle facility in Paraguay is being built for $10 mil and a new soft drinks production line is being added for $10 mil. These investments should facilitate higher revenue, higher EBITDA and ultimately, a higher sale price for shareholders.

    The impending change of control has also encouraged the company to continue doing the right things in returning capital to shareholders and deploying excess cash. Last year Quinsa purchased several minority interests in key operating subsidiaries, which will increase the proportionate EBITDA credited in the formula. The company has also done the previously mentioned share buybacks and after July 15, 2005 it will have the power to buy the equivalent of 11%-13% of the current float.

    I like the fact that the people piloting the ship have been passing up opportunities to exercise their put option at a price that is much higher than the publicly-traded price today. The put was likely not exercised last year because of the anticipated price increases and other EBITDA-maximization efforts. EBITDA ended up growing 48% in 2004. I believe that the anticipated effect of price increases and EBITDA growth is the main reason that the put was not exercised in April of this year. I do not mind the deferral of the change of control if insiders think that EBITDA is going to increase at a pace sufficient to compensate for passing on a massive premium today.

    Catalyst

    Investor recognition of a great business.
    Resumption of buybacks on July 15th.
    Change of control at a large premium, as early as April 2006.
    Controlling shareholders may offer to take the company private before then.
    Recent price increases and future increases will begin to demonstrate the company’s true earnings power.

    Messages


    SubjectCapacity constraints
    Entry07/12/2005 10:14 AM
    Membercharlie479
    In Argentina, the competitors have a limited amount of brewing capacity in place. Warsteiner has one 1.4 mil hectoliter brewery in Argentina. CCU has 3.2 mil hectoliters of installed capacity. These are theoretical max capacity figures. The likely capacity output is lower because of seasonality (you get higher utilization in the summer, lower in winter). The total volume of beer sold in Argentina is a little over 13.1 mil hectoliters per year. So, if magically overnight everyone started to prefer the competing brands to Quilmes, Quinsa's market share would still be 65% (versus 79.1% now). It would still dominate the market.

    SubjectIsn't Argentina risky?
    Entry07/12/2005 01:15 PM
    Membercharlie479
    Q&A is much easier when you get to make up the Qs. “If sovereign bond yields in Argentina have higher yields than US Treasurys then shouldn’t I be applying a higher discount rate to Quinsa?”

    Although I might be going against business school thinking on this one, I don’t think higher sovereign yield necessarily means that the risk of an equity investment with exposure to that country is greater than the risk of a US company. For one, the price of the sovereign debt could be wrong. If you think of the yield on the sovereign debt just as a comp (a la Anheuser Busch), it becomes a little clearer that it doesn’t really provide any absolute truths. It’s just another security whose price is determined by normal people like us. Moreover, sovereigns can actually have greater risk of loss than equity investments (warning: I am definitely straying from business school convention here). Investors have very little recourse if a country decides it does not want to pay. You cannot take them to bankruptcy court and there is usually little in the way of foreign assets that can be seized. Argentina, for example, refused to pay many of its creditors, and par holders have suffered massive losses. Yet in that same time span, Argentine equity owners maintained their property rights and in many cases now have gains instead of the losses that their sovereign creditor friends have.

    The primary protection we have against adverse foreign conditions is the high durability of Quinsa. It has the pricing power and competitive advantages to weather extreme conditions. When Argentina experienced extreme inflation, Quinsa raised prices by 40%. The company has survived currency devaluations, civil war, sovereign debt defaults, and military dictatorships. It has lived through pretty much every worst-case scenario you can dream up. But because of its wide moat, the company has been able to grow from a small little brewery in 1890 to a dominant multinational despite sub-optimal country conditions.



    SubjectUS vs Argentina
    Entry07/12/2005 01:18 PM
    Membercharlie479
    “I still don’t believe you. Tell me more about Argentina.”

    Argentina is not as bad as perhaps most people think. Here is a random assortment of statistics to somewhat give you a picture of Argentina.

    Current account deficit/surplus: USA -6.3%, Argentina +2.8% (trade surplus is +11%)
    Literacy rate (important for reading the beer label): USA 99%, Argentina 97%
    Unemployment rate: USA 5.1%, Argentina 12% (it might be lower now, I have to check this), Germany 11.7%
    GDP growth: USA 3.8%, Argentina 8.0%
    Budget balance: USA -4.1%, Argentina +2.1% (this is not the most recent figure but it’s not far off. I have to find where I put my notes on this.)
    Inflation: USA 2.8%, Argentina 9.0%
    Debt: US 65% of GDP, Argentina 111% of GDP (this number is lower now because of the debt exchange recently completed by Argentina but I have not yet done the math to adjust. Economist says 63% but I think this is too low.)

    Quinsa is incorporated in Luxembourg. If any corporate governance issues arise, shareholders get Luxembourg corporate law. They are neighbors of France but I’ll take it.

    There are no price controls on the beer industry in Argentina. Although there are certain goods and services in Argentina (and in the US as well) that politicians feel everybody should be entitled to regardless of their ability to pay, beer is not one of them. There is no sense of necessity for beer as there is for, say, electricity. So, while there are controversial disputes over utility rates in Argentina, I think it is unlikely that the beer industry will suffer through anything similar.

    SubjectPeso artificially depressed?
    Entry07/12/2005 01:23 PM
    Membercharlie479
    Although the ADRs trade on the NYSE and even though shareholders get to look at a soothing US dollar-denominated price quote every morning, there is still obviously foreign exchange risk. If the Argentine peso falls by 50%, then sales translated back to a US shareholder will also be halved (excluding impact of any corresponding price increases).

    Despite the f/x risk, I do not mind effectively exchanging my dollars to pesos. First, I think the currency fluctuation will be minor relative to the equity appreciation. Secondly, I am not that excited about the ballooning US current account deficit. Lastly, I think the peso may be artificially depressed.

    The peso was pegged at a 1 to 1 rate to the dollar for roughly a decade. This ended in 2001 when economic problems and the devaluation of the Brazilian Real (Argentina’s main trading partner is Brazil) catalyzed the removal of the peg. The exchange rate now floats freely. The currency has averaged 3.07 pesos per dollar in 2002, 2.95 in 2003, 2.94 in 2004 and it is 2.87 today.

    Argentina has had a strong trade surplus since the devaluation of the peso and the government is politically interested in seeing that continue. The government is concerned that if the peso appreciates substantially it will hurt exports from Argentina (and their votes from farmers). As a result, the Central Bank of Argentina has been intervening to sell pesos and buy US dollars to try to support the USD versus the peso. In May the Central Bank tripled its sales of pesos and purchases of dollars to an average of $74 million per day from $23 million the previous month. Foreign currency reserves now stand at $23 billion. The government also just recently imposed new foreign deposit requirements to try to restrict the inflow of foreign currency and prevent a further strengthening of the peso. China is doing similar things with its Yuan and the US government is shouting that the Yuan is artificially depressed.

    SubjectGrowth
    Entry07/12/2005 01:43 PM
    Membermadmax989
    Charlie,

    Thank you for an outstanding write-up and idea. Though I was not familiar with the company before today, I figured I'd post a third-party question rather than force you continue to post your own.

    So...What were the drivers of last year's growth and what will allow the company to continue to grow going forward? While the moat here is clear, the value of the moat serves only as protection for the current earnings power if the company is not able to grow its business at the high marginal rates of return provided by that moat. Will Quilmes be able to do so?

    Thanks again - really terrific write-up.

    'Max

    SubjectGrowth drivers
    Entry07/12/2005 03:39 PM
    Membercharlie479
    The growth in EBITDA last year was driven mainly by price increases. The economic environment in its markets was relatively stable so they were able to raise prices on certain things. Beer prices were up 15% on a consolidated basis in USD terms. Soft drink prices were up 10%. The economies were also strong enough to allow volumes to grow despite the price hikes. Perhaps the increase in advertising helped volumes a little bit too. Beer volume was up 8% and soft drinks up 10%.

    As a result, revenue was up 23% in 2004. COGS per hectoliter fell as volumes increased so gross margins expanded. There was also some operating leverage as management kept a lid on expenses. One thing I like about some foreign companies is that the appetites of their management teams aren't quite as big as their US counterparts. Sometimes you'll find a company in the US growing at 20% in sales but bonuses keep growing bigger and they keep hiring more assistants so you get no operating leverage even with a large growth rate! That's not so for Quinsa. The controlling shareholder I think will continue to make sure of that. Also, no stock option grants here.

    How will they keep this growth going? They will continue raising prices. I mentioned the hikes in December of 04 that will start to be reflected in 2005. I think there is still substantial pricing power left. Net revenue per liter is still low on an absolute basis. And there are still pockets where hikes have not begun, such as Uruguay which hasn't gotten an increase since 2003. Volumes have also continued to grow into the 1st quarter of 2005. Beer up 7% and soft drinks up 21% year over year.

    SubjectPer capita consumption
    Entry07/12/2005 03:51 PM
    Membercharlie479
    Madmax89, I also think that long-term growth will come from increases in per capita consumption. The countries that Quinsa serves currently don't drink that much beer relative to the rest of the world. Through advertising and some inherent advantages of beer over other alternatives (e.g. you can package a consistent quality of beer over and over whereas wine varies tremendously by vintage), Quinsa should be able to increase liters per capita. I think this is essentially the long-term play that global brewers are making in China and India.

    Per capita consumption (liters per capita)
    Country 2003 2004
    Paraguay 28 33
    Argentina 34 35.5
    Uruguay 14 14
    Bolivia 21 24.5

    Per capita consumption in the US is 81. In Brazil it is 47. Mexico is 52. It's 155 in the Czech Republic. Perhaps they can start sponsoring some student exchange program with the Czechs.

    I am not 100% certain but I think last year was a milestone in that Argentine beer consumption surpassed wine consumption.

    SubjectWorries?
    Entry07/12/2005 04:50 PM
    Membermadmax989
    I like that one can purchase the core business at an attractive price and get the Czech student exchange catalyst essentially for free. Though I wonder what would happen to your sovereign risk profile if the country were invaded by drunken Bohemians?

    So what if anything would concern you in this investment?

    Thanks again,

    'Max

    SubjectPut Option Calculation
    Entry07/12/2005 06:21 PM
    Membercarb886
    Great writeup and interesting idea! Could you walk us through the mechanics of the put option implied price and the associated discounts (i.e. - how do you arrive at the $38 figure based on 2004 results)

    Thx

    Carb886

    Subjectluxemborg law
    Entry07/13/2005 12:11 PM
    Memberthistle933
    Have you gotten specific advice from Luxemborg counsel regarding minority class B rights as the class A shares are transferred by BAC?

    The EU Takeover harmonisation you cite is no more than a set of guidelines. Luxemborg law will govern, and public minorities don't do well in that jurisdiction.

    One clear issue - the ADRs represent ownership of class B shares, and obligations may not apply across different classes. Have you raised this with counsel?

    SubjectPut option calculation
    Entry07/13/2005 01:17 PM
    Membercharlie479
    Carb886 and someone else asked me to post my calculation behind the $38 price I mentioned in the write-up.

    Start with AmBev's trailing multiple. To calculate AmBev's multiple you first need to pro forma their 2004 numbers because AmBev engaged in a transaction with Interbrew last year and obtained Labatt Canada. The formula gives credit to AmBev for Labatt Canada as if it had always been with the business whereas the actual AmBev 2004 EBITDA only included Labatt Canada for a few months. Use the AmBev preferred to calculate the multiple (that is what the formula specifies). I used $31.40 per ADR equivalent. This is 12.5x pro forma 2004 EBITDA.

    Take the greater of the AmBev multiple and 8.0x. Apply the multiple to LQU's proportionate EBITDA. To calculate LQU's proportionate EBITDA it's easiest to start with the Luxembourg GAAP numbers and first adjust them to US GAAP. Luxembourg EBITDA in their financial statements was about $309 million. From this I subtracted $40 mil of other expenses that are likely to be included as operating items under US GAAP and I added $3 mil of items in other income that should also be reclassified. This leaves approximately $272 million of EBITDA.

    Quinsa does not own all of this EBITDA so you have to make some further adjustments. It owns 87.63% of a holding company called called QI(B). And then there are also some minority owners of various operating subsidiaries. There are various ways to allocate value to these minority holders at the operating subsidiaries but if you assume QI(B) owns 94.7% of the operating subs you won't be far off. So this gives me proportionate EBITDA of $225 mil.

    The enterprise value of LQU is then $2.822 billion. Subtract net debt and you have $2.7 bil of equity value. Divide by 55.97 mil ADR equivalents to produce $48.25.

    The number of shares of AmBev preferred to be issued is determined by an equation. Take $48.25 and multiply by a discount factor of 0.9207 and multiply by 59.96%, then divide by the price of the preferred. I get 0.85 shares of AmBev preferred ADR equivalent.

    The number of shares of AmBev ordinary to be issued is determined by a different equation. Take $48.25 and multiply by 0.9207 discount factor and multiply by 40.04%. Now take this and multiply by an 80% discount factor if the AmBev multiple you used above was NOT 8.0 (if it is 8.0 then do not multiply by any discount factor). Divide by the price of AmBev ordinary share. I get the equivalent of 0.45 AmBev common ADR equivalents.

    Multiply the respective shares by the respective prices and get $38.

    Subjectqwer22
    Entry07/13/2005 01:24 PM
    Membercharlie479
    Please see the post I just made in reply to carb886 for some detail about the put option mechanics.

    I am not sure what your friend is referring to. The ADR for the ordinary shares are listed on the New York stock exchange. The ticker is ABV/C. He is right that they coudl be 40% of the consideration but I am not sure what he meant by "not marketable"

    I do not have any great tips for you on how to find blocks of stock. I have had a hard time buying it myself and I've been at this one a long time. Liquidity is worsening because the company keeps reducing the float. I suppose you could do what the company is considering to overcome its problems in finding liquidity: launch a tender offer :)

    Subjectabra399
    Entry07/13/2005 01:46 PM
    Membercharlie479
    I may have covered your first paragraph of questions in my put option calculation post. If I didn't please feel free to ask me again. Net debt I am using is $122 mil. I believe a decent amount of the debt resides at the operating subsidiaries but I am not sure how much exactly so I am assuming net debt is at QI(B) level. The formulas for first stage and second stage are basically the same. My calculations assume that both stages assume they close at the same time. In reality, they'll do the second stage calculation a bit later. If EBITDA is going up I think my way should be wrong ont he conservative side.

    I'd rather not show my upside calculations because it could be embarrassing if I'm wrong :). I think the calculation behind the $38 and the observations I made about EBITDA growth in 2005 gives people enough that they can craft their own scenarios.

    Yes I think the put will be exercised first. I actually think that they'll tender again for the minority before this even happens.

    The reason the company wants to take out the minority is because it improves the formula price that they receive for their controlling shares. If you can buy out the minority at even a slight discount to the multiple in the formula then you accretively reduce shares outstanding. The formula would then produce a higher number for the controlling family. AmBev also doesnt mind because they increase their relative stake in the company. Also as the ultimate owners, AmBev says money on taking out the minority at anything lower than the formula multiple.

    I'll save your Luxembourg question for another post. I see a bunch of Luxembourg topics in some other questions.

    There are a few things different now than they were in 2000. One is the devaluation of the peso. So the pre-devaluation figures you are looking at are somewhat inflated as they are translated into US dollars at an exchange rate that was not freely floating. It's easier to think of everything in pesos to understand some of the margin improvement. Revenues in pesos are actually up dramatically versus 2000. There is some natural operating leverage when revenues grow.
    Also, at the beginning of 2003 they bought AmBev's operations in Argentina, Paraguay and Uruguay. If you read through the materials during and following that period you can see the cost savings that management was able to produce. There was consolidation of distribution, G&A efficiencies, production savings, etc.

    Subjectthistle933
    Entry07/13/2005 02:24 PM
    Membercharlie479
    Arrg, my browser ate my last post so let me try again.

    I have gotten advice from Luxembourg counsel. As you may know, a lot of the specifics will depend on Luxembourg law implementation of the EU Takeover Directive. It is hard to pin down Luxembourg counsel on what minority holders exact rights will be when control transfers to AmBev.

    However, I think there are some certainties that can be confirmed by talking to any Luxembourg counsel. Minority holders currently get no special rights. Luxembourg law has no existing sell-out rights or mandatory bid requirements. The EU Takeover directive has already been approved. The deadline for implementation by each member state is May 20, 2006. I'm afraid the certainties end there.

    I think nearly all lawyers would agree that a law conforming to the Directive would require a mandatory bid if the controlling shareholders A shares are transferred to AmBev. AmBev would end up owning well over 50% of the votes. It's likely this will pass any definition of change of control.

    The specifics for determining "equitable price" are not as clear. The A shares are essentially the economic equivalent of the B but with 10x the vote. But will Lux law say that the price paid for the A shares is not the minimum equitable price for the B shares in the mandatory bid? We shall see. No matter what happens with the implementation of the directive, you'll retain your right to say no and wait for a better offer.

    I encourage anyone that gets involved here to read the directive themselves and to speak to Luxembourg counsel about the various scenarios. The link to the takeover directive is http://europa.eu.int/eur-lex/pri/en/oj/dat/2004/l_142/l_14220040430en00120023.pdf

    Subjectworries
    Entry07/13/2005 03:01 PM
    Membercharlie479
    Heh, I think I should have framed this investment the way you did.

    I don't think I've ever not had worries about any investment. I've also never not used at least one double negative in Q&A. Here are some of the main things I worry about in this one:

    Inflation. Inflation was quiet in 03 and 04 but it has crept up recently in 2005. As I mentioned, it is now 9% for the last 12 months. Real GDP growth is still good and I think pricing power will help them get through any rough patch but I'm certainly not eager to have another case of hyperinflation test my theory. The government has been selling so many pesos and buying so many dollars to keep this exchange rate from appreciating that the popular thinking is that it is having inflationary effects. I would love to see the government give up its f/x intervention.

    Decline in AmBev multiple. You can come up with a scenario where even if Quinsa's EBITDA appreciates at a fast pace the formula could produce a lower price than $38. All you need is a big decline in the AmBev multiple. The percentage decline in the multiple would have to be big enough to offset the expected increase in Quinsa EBITDA. I take comfort in the fact that the formula still produces a large premium if Quinsa and AmBev achieve its forecasts even if AmBev stock stays right where it is today. Incidentally, I am not sure whether I am rooting for AmBev to make its forecasts or not. It's possible that if their 2005 results are bad but people expect 2006 to normalize then the trailing multiple for AmBev by April 2006 could be even better.

    There is risk in the exact implementation of the takeover directive in Luxembourg. Although I am convinced that the law will require AmBev to make a mandatory bid, it is not 100% certain that the minimum equitable price specified by the law will be equal to the put price. Besides the wording, there is risk in timing. The deadline for implementation is 20 days after the next exercise period so what happens if the change of control happens right before mandatory bid law is implemented? I wish I had a definitive answer but I do not. The last few times the controlling shareholder has had the option it has taken a long time for it to decide. At least once the exercise period was tolled because numbers were not quite ready or there was some negotiation between the two parties. I'd love to see another small delay come April if Lux law is not already implemented. As I say in the writeup, I do not think that any of this is necessary to get a premium offer for minority holders, but it certainly would not hurt.

    Subjectjim211
    Entry07/14/2005 09:21 AM
    Membercharlie479
    The put agreement is here http://www.sec.gov/Archives/edgar/data/1010246/000095015702000348/ex2-2.txt

    If have $29 for the 8x scenario on the 2005E EBITDA figure. I cannot fault you for focusing on the possibility of the 8x number. Remember though, this case assumes a more than 33% decline in AmBev's multiple in just 9 months and we've also been assuming that Quinsa's 2005 EBITDA comes in well under the pace that it has been growing at last year and in the first quarter of this year. Also, if the controlling shareholder and AmBev are indeed considering an offer before next April then they will be making their decision on how much to offer on what AmBev is trading at too. Of course, this will give us little comfort if all breaks loose.

    I suppose one could try to build an imperfect hedge by shorting AmBev. There are also puts. The hedge might just end up costing you money if the multiple declines because of a rapid expansion in AmBev results but I throw the idea out there anyway who wants to explore ways to minimize the downside.

    SubjectQuestion
    Entry07/14/2005 02:23 PM
    Membertdylan409
    Excellent idea.

    Curious if you have a long term (3-5 years) investment view on Quinsa or if this is more of a short term value arb play?

    If you do have a long term view, curious what your view of the management team is with respect to strategy, operating expertise and capital allocation?

    Thanks again for the great writeup.

    Subjecttdylan409
    Entry07/14/2005 11:31 PM
    Membercharlie479
    I think that they controlling shareholders will try to buy out the minority shareholders before any of us gets to see our 3-5 year views played out. I am fairly bullish on how good the operational performance could be 5 years from now. I don't think it'd do any good to share them here. It could easily be misinterpreted and this situation stands on its own without it.

    The management has proven itself in regards to capital allocation in my opinion. I wish some of my US positions had managements with skills as good in this area. They successfully managed through a 70% devaluation. Then about a year later they moved to buy out the #2 player in 3 of its countries during the depths of the Argentine crisis. They also began buying back stock when investors didn't want anything to do with Argentina and they have been steady buyers ever since. I seriously doubt that my capital allocation would have been anywhere near as good during this period.

    There are fewer data points on their operational report card. I have been pleased with how opex has been kept under control even though the good times have returned. Also, nearly all of the operational synergies that were outlined during the acquisition of the #2 were eventually met or exceeded. Go back through some of the annual reports and public statements and compare to the subsequent actuals.


    Subject2nd quarter volumes
    Entry07/14/2005 11:36 PM
    Membercharlie479
    Quinsa released volumes for the 2nd quarter after the close. Beer volume was up 9.4% and soft drinks were up 24%. This is a greater increase than was achieved in the 1st quarter (7.1% and 21.3%). Growth in second quarter EBITDA is likely to be at least on pace with good growth achieved in the first quarter, especially so because operating leverage is higher in the 2nd quarter.

    Subjectmgmt
    Entry07/15/2005 02:43 PM
    Membertdylan409
    Thanks Charlie, that is quite helpful.

    And thanks for sharing a great idea.

    SubjectSAB and Colombia
    Entry07/18/2005 01:07 PM
    Memberruby831
    What are your thoughts on the reported deal between SAB and Grupo Empresarial Bavaria. It is on WSJ Online.

    SubjectBavaria
    Entry07/18/2005 03:38 PM
    Membercharlie479
    I have nothing insightful to say about the Bavaria acquisition. They seem to be getting a decent price. There aren't many South American brewers left that haven't been claimed by one of the global brewers. Perhaps it gives SABMiller a platform to begin competing in some of the southern cone markets? I am not sure though that Bavaria's brands would necessarily be any better for this purpose than Miller's, though. Also, it seems that neighboring Brazil would be a larger and easier market to try to export into first.

    See? Nothing insightful.

    Subjectcorrection
    Entry08/03/2005 12:44 PM
    Membercharlie479
    I noticed something in reading the annual report that came out today that didn't quite mesh with the sample put option calculation I posted here. It's minor but in footnote 7 of the deconsolidated Quinsa financials, there is described an intercompany loan from QI(B) to Quinsa. The effect on consolidated debt is of course zero but since minority holders own 12.37% of QI(B) it increases the net debt applicable to LQU shareholders in my calculations. Roughly, the impact is about a tenth of an EBITDA multiple point.

    AmBev's stock has risen slightly since I did my sample put option calculation. Factoring the current price and this intercompany loan adjustment results in a slightly higher price, from $38 to $38.85.

    Subjecttake out value change???
    Entry08/05/2005 12:55 PM
    Memberluke0903
    what impact does today's news have on your calculation of the take out value? thanks.

    Subjectluke0903
    Entry08/08/2005 01:34 AM
    Membercharlie479
    Hi Luke,

    It actually increases the put option price a little bit. The company increased its stake in QIB. It bought that stake from BAC at 6x EBITDA, which is slightly lower than the multiple implied by the stock price of LQU. If you think of it as a repurchase of approximately ~5% of the outstanding at a discount then it's easier to understand why the formula produces something slighltly higher now (>$39.50 by my calculations).

    When the put option gets exercised, AmBev has now also agreed to pay to BAC additional consideration in cash equal to QIB’s 2005 EBITDA multiplied by 0.0638544. I have not included this amount in my put option price.

    Subjectimplied EBITDA
    Entry08/08/2005 01:39 AM
    Membercharlie479
    Also, if you do the math to calculate the estimate of 2005 EBITDA the company based its calculations on in the press release, you get a number that is about 10% higher than than the 2005 EBITDA figure that I used to determine the multiples in my writeup. It seems the company's base case for 2005 is moving higher.

    SubjectUpdated implied put price
    Entry03/01/2006 03:04 PM
    Membercharlie479
    Hi Pat110, the results looked decent to me, too. I'll tell you what my updated calculation produces but I'll preface it by saying that I had to approximate certain things and not all of the necessary detail is available yet. I might not get all of the detail until the 20F is out. For example, the formula begins with EBITDA calculated according to US GAAP. Last time (in post 13) I took their reported Luxembourg GAAP figures and put it through my GAAP transformer and got the approximate US GAAP numbers. This year the company reported under IFRS (more conservative, and now required by the European Commission) instead of Luxembourg GAAP so the numbers in the press release are IFRS but I don't have the financial statement footnotes to figure out how to transform that into US GAAP.

    Quinsa reported $375 mil of EBITDA (they normalize this to $385) in 2005 compared to $269 mil in 2004 EBITDA, both under IFRS. 2004 EBITDA under Lux GAAP was $309 and I estimated the US GAAP figure was $272. Without going into the details, I'm using $357 mil for my 2005 US GAAP estimate. It's possible the right number is higher and closer to the IFRS figure of $375 mil (but I could be wrong and it could even be lower than my $357 mil).

    So, if I start with $357 mil in EBITDA, I end up with a $57 put price. If you're trying this at home, don't forget to use the new share count after repurchases and don't forget that Quinsa increased its percentage ownership of its principal QIB subsidiary. I used AmBev's closing prices from yesterday to get the multiple so if you're doing it today you'd get a higher number.

    The $57 put price is quite a bit higher than the $38 put price I had in post 13 but it's worth re-reading all the risks and uncertainties of this situation so you don't get carried away.

    Subjectreply to Charlie
    Entry03/01/2006 06:58 PM
    Memberpat110
    understood, and thanks much for your latest figures.

    pat

    Subjecthack731
    Entry03/03/2006 03:09 AM
    Membercharlie479
    Under your scenario:

    8x --> $43 per share
    9x --> $45
    10x -> $51

    The formula is a discontinuous function at the 8x multiple so that's why results look funny approaching 8x. Also, remember that the formula provides for a minimum multiple of 8x.

    Subjectroc924
    Entry03/07/2006 04:20 AM
    Membercharlie479
    >What am I missing?

    Hack731 wanted me to compute scenarios using $410 mil in 2006 EBITDA. I think he was envisioning a situation next year where EBITDA grows but the AmBev multiple declines.

    >What EBITDA multiple to you calculate for Ambev
    now?

    12.8x but I am using AmBev prices a little lower than today's close.

    >Do you think they will authorize another
    buyback?

    I don't think they're done with their current one. It looks like their share count went down by a little more than 1 mil ADR equivalents. This probably leaves $10-$15 mil in the current authorization. If I had to guess, I'd say yes they probably would authorize another one. I think AmBev ultimately wants to own 100% of Quinsa. It has been the shining star within the InBev complex. One of the cogs at AmBev has remarked that elimination of the public company costs might be enough justification by itself to take out the sliver of float that would result after the Bembergs exercise their put. I'm not sure if this was exaggeration but I can see where he was coming from. Even at today's higher price, the float is < $200 mil.

    Subjectluxembourg takeover law
    Entry03/27/2006 12:13 PM
    Memberroc924
    Does anyone have an opinion on current events with Luxembourg takeover law as they relate to LQU? I read that Luxembourg lawmakers approved last Wednesday draft changes to the country’s takeover rules.

    SubjectReply to roc924 and followup t
    Entry04/14/2006 03:31 AM
    Membercharlie479
    I have received the english translation of the luxembourg bill. It is different in certain parts from the notes of my conversation with Luxembourg counsel that I posted in post 41. Rather than posting new notes from my reading of the english translation, I will try to reconcile the differences first. I am not sure if this is a translation of an earlier bill or if counsel was incorrect or if I misunderstood. I don't want to get in a loop of corrections of corrections so let me hold off until I have cleared things up. As I mentioned in that post 41, don't rely on that as gospel.

    With that confidence-inspiring preface, here are my replies to roc924's questions:

    >Given the BAC/Ambev agreement isn't a public offer, do the majority/minority squeeze out rights come into play?

    If there is no offer then no it would not come into play. If I was an acquirer and I wanted to be really diabolical though, I would try to meet the offer requirement by making a below-market or unattractive offer and then attempt a squeeze out. Who knows if this would actually work, though.


    >I am missing something, or did Ambev agree to pay $64 / LQU ADR equivalent?

    I don't think you're missing anything. Although, I would note that it's not clear how much rounding was involved in the $1.2 billion price. If it's really $1.151 billion then it would be $61 and some change. I knew that class in high school on significant digits would pay off someday.

    Subjectupdates
    Entry04/28/2006 10:31 PM
    Membercharlie479
    This is a quick update on the new laws after reconciling earlier discrepancies and having several exchanges with Luxembourg counsel. Im not in the office so I dont have my notes. Im also working on a crazy French AZERTY keyboard so I apologize in advance for misspellings.

    An acquirer will get squeeze out rights if it meets at least the following 3 conditions:
    1. Conducts a tender offer for public shares
    2. After the tender, it owns 95 pct of the votes
    3. After the tender, it owns 95 pct of the capital carrying voting rights

    Squeeze out rights can be applied separately to each class.

    If the tender offer is part of a mandatory bid requirement then the default fair price is the highest price paid by the acquirer in the last 12 months. If the tender offer is a voluntary bid (would be applicable here) then the squeeze out price would default to the tender price PROVIDED the offer gets 90pct acceptance (eg tender for 1 mil shares, get at least 900k). What does the squeeze out price default to if the tender gets less than 90 pct acceptance? It appears this is unclear. At the least the supervisory authority will have to deem it a fair price.

    The logistics aside, I think the current situation simplifies to this: AmBev is purchasing a stake to bring its share of capital to 91 pct. It is willing to pay 65 dollars per share for that stake. There have been various signs they would like to own the remaining 9 pct. In addition there is the advantage of saving the public company costs and eliminating the sharing of competitive info. When AmBev comes to purchase the remaining shares it will have few options besides making a tender offer at a premium to persuade the remaining public holders to give up their holdings. With the squeeze out threshholds at 95 pct, the public shareholders should be able to refuse all inadequate offers and continue to hold out until a price is offered that is in line with the 65 dollar price. For a megacap like Ambev, the purchase of the remaining float is small potatoes; each dollar of premium is roughly 5 mil to Ambev.

    Subjectthanks charlie, any updates?
    Entry06/06/2006 11:38 AM
    Membermax318
    Charlie-
    Thanks so much for sharing your excellent research on LQU and for your past work).

    What is your reaction to UBS's rather weak downgrade today? They are pessimistic on LQU 1) because there are no tag-along rights 2) because of the small premium Brahma paid to the market values of Antarctica subsidiaries to form AmBev (although this situation should have better minority rights protection)

    They argue that the listing costs are so small to AmBev that AmBev may rather wait it out to get a lower price (ignoring the loss of competitive information).

    Questions:
    1) Does this even make sense? It sounds like you are confident the fair price is set by the BAC transaction and there is no benefit to waiting.
    2) Do you have a timetable for when AmBev would likely act?

    UBS acknowledges that Quinsa is cheap (seems to ignore the price of the BAC transaction) but says there is macroenomic risk in the region and risk from 18% EBITDA exposure to Bolivia.

    Really just wondering if you have updated thoughts. I'm aware of UBS's poor record on LQU.

    Subjectmax318
    Entry06/09/2006 05:19 PM
    Membercharlie479
    Yes, I read that UBS report. Here are my reactions to his assorted points:

    The transaction price is not $64.25 per share. The 13D filed on April 17 mentions in one of the exhibits that the target transaction price is $1,223,915,000. That works out to $65.53. The Bembergs will get to keep the dividend to be declared with respect to 2005. Also, the purchase price has been growing since the execution of the agreement to account for the time value until closing. The current interest rate is 200 bp + 6 month Libor. The two parties can agree to reduce the price by up to $60 mil. The agreement does not specify why they would do this.

    I disagree that listing costs and other associated public company costs are insignificant. I also disagree that AmBev will be happy to wait indefinitely to buy out the minority shares. Moreover, I believe that the longer AmBev waits, the more expensive it could be to tender for the remaining shares. If Quinsa’s EBITDA continues to increase as AmBev believes it will (and as UBS projects it will) then public shareholders will gradually prefer to keep their shares instead of selling their shares to AmBev. To take an exaggerated example, if Quinsa cash flow doubles in the next year then AmBev will have to offer significantly more than $65.53 per share to convince anyone to sell. I think AmBev realizes this potentially expensive aspect of waiting.

    If you talk to AmBev you will hear the outlines of some potential hassles of keeping 2 separate companies. Besides the actual costs of listing, there are public filings and SOX certifications, additional layers of executives including CEO & CFO & directors to pay and delegate orders through, there are the headaches of ensuring that all intercompany transactions are fair, necessitating services agreements and pricing agreements, independent committees, and other meetings and such. There is also the incentive to not give public information about its operations with competitor CCU. I think when you add it all up, there are enough money/headache factors to motivate AmBev management to clean up the last little piece of float, and this is all without getting into any potential aggravation from activist shareholders or unhappy litigants. Who wants to deal with all that when you have a $25 bil company to run? If you were management, would you really want to pursue a contentious avenue that would be widely perceived as shareholder-unfriendly just to try to save $50 mil or so?

    AmBev says that they will evaluate these Quinsa matters after the transaction closes. UBS tries to contort that statement into something negative. I think that, more likely, AmBev is just trying to keep its cards close until they actually have operating control (even though they have the economic majority, currently they are passive in day-to-day operations). It's natural for AmBev to not want to discuss what's going to happen to Quinsa management or other expenses until after they take control. It’s not an ominous sign that AmBev doesn’t want to discuss tendering for shares before they have formally closed on the acquisition and guaranteed themselves control.

    Subjectmax318 continued
    Entry06/09/2006 05:20 PM
    Membercharlie479
    AmBev believes there are still substantial synergies to be had between the 2 companies. They say these synergies have not been realized because the 2 companies are separate and LQU is managed by the Bemberg’s guys. If there are indeed easy savings that will improve EBITDA then it’s likely an acquirer would want to buy out the minority shareholders shortly after closing, before those shareholders can start to see the improved performance in the financials. Again, why would AmBev want to wait? If waiting will only make it more expensive to buy out the minorities then UBS’s arguments don’t make sense.

    I think the Bolivia nationalization risk is a nice one to keep in mind but I don’t think this is likely at all. Morales seems focused on the energy sector and running a beer company isn’t in his ideological Top 10. AmBev does not view this as a risk at all.

    UBS reads a lot into the Bemberg family selling for cash. What apparently happened was that the Bembergs exercised their put option to exchange their stake for shares in AmBev. AmBev wanted instead to pay cash and they negotiated to do so. The result was a final transaction price higher than what the put option formula price would have dictated. The logic that UBS neglects to ponder is: why did AmBev pay a premium to buy the LQU stake in cash? Couldn’t this imply a view of future EBITDA performance that is bullish?

    UBS focuses on the tag along aspects but fails to discuss the strong position that minority holders have. Without any practical way to squeeze-out minorities or force acceptance of an unattractive offer, I don’t think AmBev has any good options besides offering a meaningful premium for the LQU shares. If they wait too long then it could develop into one of these expensive NXTL/NXTP dynamics where target shareholders bid up the shares expecting a takeout premium, which forces the eventual offer price to be adjusted higher to provide an acceptable premium-to-market, which causes the shares to be bid up more, etc. It sounds silly but it happens.

    I think there are many signs that suggest AmBev wants our LQU shares. They can’t get it from us unless we let them have it. Until they pay up, I’m happy to continue owning a piece of a monopoly business with growing cash flow.

    P.S. It is peculiar to me that UBS has gotten progressively more bearish as they keep raising their price target. The target has gone from $33 to $40 to now $47. If that deserves a Reduce rating then I am going to load up when they actually like something!

    SubjectVarious updates
    Entry07/06/2006 08:06 PM
    Membercharlie479
    There was a new statement in the company's 20-F filing that indicates a going-private tender offer is a real possibility:

    "Our Board has in the past discussed the possibility of making repurchases of stock that exceed the authorization for the latest repurchase program, whether through expanded market repurchase programs, a tender offer or another transaction. Our Board also has discussed the possibility of engaging in a transaction that could result in Quinsa becoming a company owned solely by BAC and AmBev (or by AmBev after BAC completes the agreed sale of its remaining shares to AmBev)."

    The company has also announced a dividend of $0.70 per ADS to holders as of July 28. Note that BAC receives this dividend and the $65.50 from AmBev for each ADS. This compares to a price of $48.94 today.

    In the accounts distributed at the annual meeting in Luxembourg a couple weeks ago, footnote 11 details a few of the expenses at the holding company. If you add up the board fees and other items, there are at least $4.3 mil of what I would classify as public company costs. I believe AmBev could get these savings by becoming a 100% owner of Quinsa. This $4.3 mil does not include any executive salaries or facilities costs that could be reduced or eliminated as a private company. I think these other savings are more significant than the $4.3 mil.

    Subjectdman976
    Entry09/03/2006 03:40 AM
    Membercharlie479
    Yes, I saw it. If I were AmBev, I would rather purchase the remaining public sliver than deal with shareholders who are raising corporate governance issues and increasing public scrutiny. If they wait and other shareholders start to join the fray, it would really be a pain in the neck.

    You should also read the company's response to Punch Card Capital's letter, which was filed in a 6-K last week. The company basically rejects all of the claims. There is, however, a mysterious last paragraph that says the company will "reflect further on possible opportunities". On AmBev's last conference call they said they have not figured out yet what they will be doing with the remaining public LQU shares.

    I think the AmBev/InBev history here is pretty good. A couple years ago, InBev bought out Suntrade's interests in Sun Interbrew at a large premium to the market price. There were few protections for Sun Interbrew minorities where it was incorporated but after InBev closed on the transaction with Suntrade, it then made an offer to public shareholders at the same price that it paid for Suntrade's shares.

    Also, back in July 1999, AmBev acquired controlling stakes in Brahma and Antarctica. In September 1999, AmBev then acquired the remaining minority shares in Antartica in exchange for AmBev shares. They did the same thing the following year with Brahma, acquiring the remaining minority shares. I think the InBev/AmBev corporate family has demonstrated a preference for not leaving a sliver of public shares outstanding.

    I don't believe it is a question of whether InBev/AmBev will buy out the LQU shares, but rather what price they will pay and when, and whether or not they will try to bluff a lack of interest, or try anything else tricky first. I like the protection that Luxembourg affords for minorities here, and I think we can say no and hold on to our shares until a fair offer is made. I also think that an acquisitive company like InBev is not going to want to drag this out into an ugly thing over a little bit of money (a tiny tiny fraction of their mkt cap), especially if it is going to portray them as poor governors or shortchangers of minority shareholders. As InBev, tries to buy more companies in China, India, and other emerging countries, they don't need future prospects or governments inquiring about their governance history with LQU.

    Subjectlouisc738
    Entry09/04/2006 02:47 AM
    Membercharlie479
    >Besides that, InBev subsidiary in Brazil continues to be a listed company at Bovespa Stock Exchange with NON-Voting shares. I think that they can test minority investor patience, by doing nothing.

    Do you mean InBev's subsidiary AmBev? Yes, AmBev continues to be a listed company but they have left it outstanding because they view it as a different type of ownership situation. InBev owns 49% of the capital of AmBev and there is almost $10 bil in free float at AmBev (incidentally, there are both voting and non-voting shares listed). They don't see that as a situation where they can cash out the minorities and eliminate a set of listing requirements. In contrast, they own 91% of the capital of Quinsa and it would take roughly $0.3 bil to cash out the minorities.

    I don't think anyone likes to leave money on the table but it's not clear that they will save money by waiting and testing shareholders' patience. For one, EBITDA has been growing at a very high rate in recent years and AmBev's projections for Quinsa in 06 and beyond show continued growth. Secondly, AmBev thinks they have near-term synergies they can achieve now that they have control of Quinsa. I think they prefer to buy it in before these synergies become reflected in the financials.

    But let's say they do decide to test shareholders' patience and they wait until 2008 before trying to buy out the 9% they don't own. If EBITDA grows as projected to $479 mil by 2008, minorities probably would not be interested in selling their shares at the price that AmBev paid to LQU's founding family last month. I think that the longer AmBev waits, the higher the price expectations become as EBITDA grows.

    Also, this patient waiting strategy is inconsistent with AmBev's recent actions. The BAC family shareholders seemed to be ready to hold on to their LQU shares for a few more years under the previous put/call agreement. They never exercised their put right. AmBev could have waited until 2009, when their call rights would have kicked in, and they would have been able to issue shares in exchange for BAC's interest. This April, it was AmBev that approached the BAC family shareholders to acquire their LQU shares ahead of schedule and they were willing to pay cash and offer a premium to the formula price to gain control early. BAC shareholders reluctantly agreed and the Argentine press reported that the internal vote within BAC was close. Does AmBev really have the patience to wait a few years to try to save some money on 9% of LQU when very recently they've demonstrated a lack of patience to wait a few years to buy 35% of LQU form BAC, in a situation that would have been much more likely to save money?

    SubjectCharlie
    Entry02/06/2007 02:17 PM
    Memberroc924
    Charlie,

    Any idea why LQU is trading above the tender price?

    Thanks.

    Subjectroc924
    Entry02/20/2007 12:44 PM
    Membercharlie479
    Hi roc924, I had not logged in awhile so I missed your question. You have since probably seen the letters from several of the large shareholders announcing their intention not to tender. There was also an announcement by AmBev on 2/15 that they had zero class A shares tendered so far and 15k class B shares. It seems extremely unlikely that AmBev will get the 4 mil class B shares necessary to squeeze out the public holders at $67.07 per ADR. The operating results have been very good, and the impact of integration savings has yet to be realized, so I think that if AmBev wants to take Quinsa fully private they would have to offer more than $67.07.

    Subjectmax318
    Entry04/20/2007 12:30 AM
    Membercharlie479
    Hi Max, Thank you for your message but I'm sorry I don't have anything for you. I know I have been mute for awhile but that is because I have not had any ideas good enough to post. I don't get them that often so there's a lot of silence in between.
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