Main Question: How much is AB InBev worth according to you? Explain. Suggested Questions: Which valuation technique is best suited for the case’s issue? Explain Using the different valuation technique

Main Question: How much is AB InBev worth according to you? Explain. Suggested Questions: Which valuation technique is best suited for the case’s issue? Explain Using the different valuation technique
F-958 -E October 2020 HBP# IES795 AB InBev, Valuation Jan Simon “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Benjamin Graham Introduction It was August 30, 2019 and Maddox Marcus had delivered a presentation on AB InBev’s cost of capital, as well as its Enterprise Value Added at different levels of debt. Within 24 hours, his boss had come to him with a new request. Luis Felipe Pedreira, CFO & CTO of AB InBev, had asked him to prepare a presentation on AB InBev’s market valuation. More specifically, “let us know if you think our stock is overvalued or undervalued and whether we should issue more stock or buy stock back,” he said. Starting in the ‘80s, AB InBev’s management had built the world’s number No. 1 beer brewer through a series of small, large and very large acquisitions. While this strategy had created handsome returns for its shareholders up until 2014, its stock had underperformed since then. So far, 2019 had seen some recovery. Sell -side analysts had given myriad causes for the lull in stock performance: integration problems, excessive debt and regulatory conditions. AB InBev had stemmed the negative tide by deleveraging its balance shee t through asset sales and by focusing on innovation and growth. This had been done despite being in a market that had stopped growing since 2011. This case was prepared by Professor Jan Simon. October 2020. IESE cases are designed to promote class discussion rather than to illustrate effective or ineffective management of a given situation. Copyright © 2020 IESE. To order copies contact IESE Publishing via www.iesepublishing.com . Alternatively, write to [email protected] or call +34 932 536 558. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise – without the permission of IESE. Last edited: 6/10/20 F-958 -E AB InBev, Valuation Maddox’s Thoughts and Notes On AB InBev’s Stock Performance Before addressing the task at hand, Maddox decided he wanted to get a feel of how the stock had performed, in absolute and relative terms, over the last 10 years before zooming in on the last five. He therefore pulled up the following Bloomberg screens: Figure 1 AB InBev Stock Perfo rmance, Aug ust 200 9-Aug ust 2019 Source: Bloomberg, September 2019. Figu re 2 AB InBev AB InBe v (white) Sto ck Perfo rm ance vs. SP5 00 (yellow), Augus t 200 9-Au gust 2019 Source: Bloomberg, September 2019. 2 I ynedllow AB InBev, Valuation F-958 -E Figure 3 AB InBev ( ) Sto ck Perform ance vs. Carls berg (gr een), Heineken ( ) a Di ageo (magenta) Aug ust 200 9- Au gust 2019 Source: Bloomberg, September 2019. Figure 4 AB InBev Stock Perfo rmance, Aug ust 201 4- Aug ust 2019 Source: Bloomberg, September 2019. I 3 F-958 -E AB InBev, Valuation Figure 5 AB InBev InBev (white) Sto ck Perfo rmance vs. SP500 (yellow), Augus t 201 4-Aug ust 2019 Source: Bloomberg, September 2019. Figure 6 AB InBev (white) Sto ck Perform ance vs. Heineken (green), Carlsb erg (yellow) and Diageo (magenta) Augus t 201 4- Augus t 2019 Source: Bloomberg, September 2019. 4 I AB InBev, Valuation F-958 -E Staring at the graphs, Maddox couldn’t help but wonder if the SAB Miller acquisition had created the hoped -for value yet and, if not, if expected future growth would. On October 13, 2015, AB InBev had bid over $100 billion for its rival. This bid was accepted after four previous bids had been turned down. After fulfilling several regulatory requirements, the deal had closed on October 10, 2016. Maddox was beginning to understand why his boss questioned the market’s valuation of AB InBev, as well as his motivation for potentially taking advantage of the market’s present judgment. On AB InBev’s Valuation − General Though valuing a business was not an exact science, it was time to come up with some well – reasoned and reasonable valuations. Maddox recalled the three principle ways to value a business: cost approach, market approach (relative value) and discounted cash flow approach (intrinsic value). Figure 7 Source: Corporate Finance Institute. He decided to discard the cost approach, which valuated a business based on its replacement value (i.e. the cost to build a similar business). This method was used when valuing companies that were being discontinued (bankruptcy). It was not a good way for valuing ongoing businesses like AB InBev, since its value went beyond the sum of its parts. Comparables A better way of valuing a going concern was by deducing its value from comparable companies. Maddox remembered that this was done by choosing a relevant metric (such as EV/EBITDA, P/E or EV/Sales). The metric of a comparable company (typically its most direct competitor) or the average metric of a basket of similar companies was used to help determine the intrinsic value IESE Business School -University of Navarra 5 F-958 -E AB InBev, Valuation of the company in question 1. Maddox knew that since no two companies were the same, he would have to assess what discount or premium to apply. “I will have to make some judgment calls,” thought Maddox, “particularly, which metric to use, which company or companies to include in the comparison and what discount or premium to apply.” He would start by deciding on the metric and company/basket. Wondering which companies and metrics Bloomberg used as comparatives, he pulled up the following screen: Figure 8 AB InBev Valuation Metrics vs. Heineken, Carlsb erg and Di ageo, Aug ust 2019 Source: Bloomberg, September 2019. Maddox was questioning if he should make AB InBev’s valuation using all metrics (P/E, EV/EBITDA, EV/EBIT, EV/Rev, P/BV) or if one or two would suffice and, if so, which ones to take? He was also questioning if Bloomberg’s basket was an adequate one or if he should make his own. Alternatively, he could use one company. Again, if he decided to deviate, which ones should he use (see Exhibit 1 for a short description of the companies)? Maddox decided to consult the data shown in Exhibits 2 and 3. 1 Comparable companies can be either publicly quoted or private. One only has comparable metrics for private companies if a recent transaction has taken place. 6 IESE Business School -University of Navarra AB InBev, Valuation F-958 -E Discounted Cash Flows After having valued AB InBev using multiples (market approach), Maddox moved on to the alternative: Discounted Cash Flow -analysis (DCF). By discounting and then adding these forecasted cash flows, he could calculate AB InBev’s intrinsic value. Comparing this intrinsic value with its market value would be instructive to decide whether it was over or undervalued. Three types of cash flows (and corresponding discount factors) could be used: • Dividends (required return, Ke) • Free Cash Flow to the Firm (WACC) • Free Cash Flow to Equity (Ke) “The first one, Discount Dividend Model (DDM), is the least used of the three,” thought Maddox. “Since it only assesses one part of profit (dividends, not retained earnings), it is of limited use for growth stocks or stocks that retain much of their earnings. For mature stocks with a high payout ratio and little volatility, it can be useful.” Looking at his MBA notes, he recalled a special formula: the Gordon -Shapiro Growth Model, which could be used as a short -cut, as well as to calculate a firm’s Terminal Value: V0= D 1/(r-g) V0= Value at t 0 D1= Dividend at t1 r= Required return g= Growth rate He wondered: should he use this formula to value AB InBev or only when calculating Terminal Value? The remaining two cash flow models were more frequently used. FCFF (Free Cash Flow to the Firm) is EBIT * (1-Tax) + Depreciation + Amortization – Capex – δ Net Working Capital + Disposal. These cash flows are discounted using the WACC to calculate the enterprise value (EV). Deducting the net debt from EV provides the equity value. FCFE (Free Cash Flow to Equity) is Net Income + Depreciation + Amortization – Capex – δ Net Working Capital + δ Debt + Disposal. The sum of these cash flows discounted at the cost of equity (Ke) gives the equity value. Maddox did not have data on when portions of the debt were due, nor what plans management had around disposals. Luis Felipe had mentioned to Maddox that for the calculations he could assume that AB InBev would not have meaningful disposals in the future and that debt payments (bar interest) would roll over; that is, whenever principal had to be paid back, new debt for a similar amount would be issued. He also knew that the company had very little excess cash (about €7 billion) and about €125.7 billion in long -term debt. The book value of equity was €71.9 billion and its weighted average cost of capital was around 6%. IESE Business School -University of Navarra 7 F-958 -E AB InBev, Valuation In anticipation of his valuation task, Maddox had organized a conference call with bearish sell – side analyst Gerald Overmars (transcript in Exhibit 4). He had also asked the assistant to the CEO, Jennifer Spring (Exhibit 5), for her input. The former could serve as a downside valuation while the latter represented the company’s view and baseline. Looking at some analyst recommendations (Figure 9), he could see why Luis Felipe was eager for AB InBev to make its own valuation and, if necessary, act. Figure 9 An alyst Recommendations, Au gust 2019 Source: Bloomberg, September 2019. “Overvalued or not, the presentation and my advice is due in just a couple of days,” Maddox thought. “It is nearly 7 p.m. – time to go home and have my favorite beer: a Westvleteren 12, established in 1838.” 2,3 2 “Abdij Home.” Sint -Sixtusabdij Westvleteren. Accessed September 16, 2020. https://sintsixtus.be/trial /. 3 Westvleteren is brewed at the Saint Sixtus Trappist Abbey (est. 1831 ) in Vleteren, Belgium. This beer is not sold commercially but sold in small quantities at the door of the monastery to individual buyers. Order in advance and bring your passport or identity card along. Westvleteren 12 is rated to be the best beer in the world by many experts. The case writer, not an expert, concurs. 8 I AB InBev, Valuation F-958 -E Exhibit 1 Comparable Companies • HEINEKEN HOLDING NV is a public company listed on the NYSE Euronext Amsterdam. Its single investment is 50.005% of Heineken NV. It is majority owned by the Heineken and Hoyer families through L’Arche Green. • HEINEKEN NV 4 was founded in 1864 by Gerard Adriaan Heineken in Amsterdam. It has over 165 breweries in more than 70 countries, employing over 70,000 people. It has been the second biggest brewery in the world since Anheuser -Busch merged with SABMiller in October 2016. In 2018, its sales were $26.5 billion (AB InBev: $54.6 billion) • CARLSBERG A/S 5 was established in 1847 by J.C. Jacobson. Headquartered in Copenhagen, its majority is owned by the Carlsberg Foundation. With sales in 2018 of $9.9 billion, it is the world’s sixth biggest brewer. It employs over 40,000 people and sells mainly in Europe (West and East), as well as in Asia. • DIAGEO PLC 6 is the world’s second largest distiller after Kweichow Moutai. Its 2018 sales were over £12 billion. Its brands include Smirnoff, Moët & Chandon, Johnnie Walker, Guinness and Baileys. It sells its products in more than 180 countries. It was formed in 1997 when Guinness Brewery merged with Grand Metropolitan. 4 Welcome to the World of Heineken® | Heineken.com . Accessed September 16, 2020. https://www.heineken.com . 5 “Probably the Best Beer in the World.” Probably The Best Beer In The World – Carlsberg. Accessed September 16, 2020. https://www.carlsberg.com/en /. 6 Diageo. “Annual Report 2018.” Discover Diageo | Producer Of Beer And Spirits | Diageo. Last modified 2018. https://www.diageo.com/PR1346/aws/media/6212/b0000391_diageo_ar -2018_interactive.pdf . IESE Business School -University of Navarra 9 F-958 -E AB InBev, Valuation Ex hibit 2 AB InB ev Ge neral Descri ption , Augu st 2019 Source: Bloomberg, September 2019. 10 I AB InBev, Valuation F-958 -E Exhibit 3 AB InBev Financial Statements (Selected) ($ M) 2017 2018 Actual Actual Revenues 56444 54619 CoGS 18529 17451 Gross Profit 37915 37168 Opex 17238 16264 EBITDA 20677 20904 Dep. & Amrt. 2857 2908 EBIT 17820 17996 Fin. Cost 6625 9401 EBT 11195 8595 Tax 2013 2922 Net Income 9182 5673 Current Assets 23960 18281 Current Liabilities 36211 34103 Total Assets 246126 232103 Book Equity 80220 71904 Capex 4124 4649 Norm. EPS 4.04 2.21 Div/Shr 3.6 1.8 Payout ratio 107% 60% Source: Prepared by the author based on the company’s financial statements and Bloomberg. I 11 F-958 -E AB InBev, Valuation Exhibit 4 Transcript of Call With Maddox Marcus (Assistant to CFO AB InBev) and Gerald Overmars (Buy -side Analyst ZMM) Maddox: Thanks for taking the call, Gerald. As I mentioned in my email, I’m reviewing our valuation model and wanted to get your input. Gerald: No worries, what are you after? Maddox: First of all, your revenue outlook. Gerald: I’m afraid that for the first five years, your growth is going to be flat. As you can tell, your sector is getting headwinds and you’re going to have to further integrate your acquisitions. Maddox: And afterward? Gerald: African acquisitions should pay off for the next five years, somewhat correcting what’s happening elsewhere. Let’s call it a growth of 200 basis points and 100 thereafter, into perpetuity. Maddox: Thanks, that’s helpful. What margins do you assume, I mean gross margin, EBITDA margin, all the way to Return on Sales? Gerald: I would use the same margins as 2018. I know some of them were not as good as in 2017, but I don’t see any improvements down the road. At the same time, I don’t expect them to deteriorate either. Maddox: Oh, OK. What assumptions do you see as reasonable for NWC and Capex? Gerald: With all the acquisitions you guys have been doing, it’s difficult to say. I, personally, think that you’re done for a while. Consequently, you can take both Capex and NWC needs as a percentage of sales. I took the same percentage as reflected in the 2017 numbers. Maddox: Thanks for this, Gerald. Very appreciated. Gerald: Anytime. 12 IESE Business School -University of Navarra AB InBev, Valuation F-958 -E Exhibit 5 Transcript of Meeting With Maddox Marcus (Assistant to CVO AB InBev) and Jennifer Spring (Assistant to CEO AB InBev) Maddox: Thanks for meeting, Jennifer. As I told you, I’m reviewing our valuation model and wanted to get your input on some of my input variables. I’ve asked the sa me to Gerald Overmars. Jennifer: Why don’t you show me what Gerald said and I’ll tell you where I agree and disagree? Jennifer (after reviewing Gerald’s data): What a bear! Even being conservative, one could take a 1% growth for the next five years, a 1.5% growth the next 10 years and 2.5% growth thereafter. This would still be well below the long -term GDP growth in mature markets. Also, I believe that making a valuation based on margins, Capex percentage of sales and NWC percentage of sales, solely based on 2018 numbers is not realistic. Knowing that 2018 was a difficult year for the company, at least one should take an average of both 2018 and 2017. Anything else? Maddox: No, that suffices. Many thanks for this. Jennifer: A pleasure. IESE Business School -University of Navarra 13