Whatta year! US beer biz surely "celebrated" 75th Anniversary of repeal of Prohibition with a bang. AB InBev. MillerCoors. Lotsa distrib deals. At sharply rising prices. And all this amidst horrible economic developments. Hard to overstate how historic changes have been. AB InBev simply biggest event in biz since repeal. MC not far behind. Think about it. In 08, InBev bought #1 brewer, and #2 and #3 brewers combined. Both now primarily owned by non-US cos. Top 2 control about 78% of US biz. These are truly extraordinary structural changes.

Creation of MillerCoors JV woulda been "unthinkable" from antitrust perspective not long ago, as Prof Ken Elzinga told Beer INSIGHTS Seminar. If that wasn't enuf, MC's immediate moves to consolidate distrib network and issue new contract led to another unprecedented development: concerted distrib pushback and MC's pullback on consolidation approach and contract details. AB InBev deal had been advanced by some farsighted folks, but few anticipated speed and final shape of how it went down. InBev closed purchase less than 1 yr after August Busch IV told distribs "now is our time" following distrib mtgs with new team. At presstime, radical organizational changes underway.

Between 'em, AB InBev and MillerCoors aim for at least $2 bil in synergies over next 3 years. That's real money. Question is how and when those synergies, with more to come, will be felt in mktplace. So far, earthquakes at top of biz and in general economy haven't had big effect on sales. Tho imports softened considerably in 08, domestic brewers had pretty good yr - up about 1% so far. Overall, biz continued modest growth and trading up of last few years (tho trading down in c-stores). Craft segment slowed but continued to grow, as did light segment, while full-calorie mainstream brands declined.

Upheaval of 08, and current trends in biz, raises lotsa critical questions about what to watch for in 09. How smooth (or not) will the AB InBev and MC transitions be going forward? MC hit ground running despite snafus over contract/consolidation. "If anyone thought we'd drop a case or miss a lick during the transition, I think the numbers show otherwise," said ceo Leo Kiely recently. Indeed, MC JV grew volume slightly and it put up double-digit earnings gain in its 1st qtr, plus already ahead of schedule on cost savings. New MC sales org just now in place. A lot rides on JV's ability to keep momentum on Coors Light and turn Miller Lite around. Those 2 brands about 50% of MC biz. Meanwhile, AB put up its best volume and earnings numbers in years over summer. Can AB InBev maintain momentum as it faces huge debt pressure? It's slowing some in latest data.

New industry structure raises bigger question: will heightened need of global parents for more profits at AB and MC mean US beer biz will be managed more for profits than volume/ share growth goin' forward? If so, how will that affect mktg, promotion tactics, pricing, etc? Then too, will broad economic trends sour current healthy pricing and trading-up? There are increasing signs of trading down, but it's still not pervasive. As AB and MC battle to grow their bizzes, including far more effective entries in high end, can Crown and HUSA bounce back after relatively soft 08? Can craft continue solid growth?

At distrib level, all eyes on pace of consolidation. Many anticipated deal pace to accelerate dramatically, especially after MC's initially aggressive push, and expectations of fed tax changes. But MC backed off, asking prices rose and bankers got reluctant. While still lotsa deals happening at yrend, less than previously thought. In the end, hard to believe that 09 can match the shockwaves of 08. But who knows?

There's a "traffic jam" of m&a deals for SABMiller "forming at its door," said Credit Suisse analyst Carlos Laboy on Beer Insights Seminar panel. A number of those deals "are equity deals, family deals" that won't require $50 bil in cash (like AB InBev), added Carlos. SABMiller faces "pressure" to "keep pace" with AB InBev, and so it "may need to become bigger" than Coke, just as AB InBev now bigger than Pepsi. "Integration of beer and soft drinks in emerging markets is becoming a global and strategic issue, not a local and tactical one," he added. "A lot of deals are still going to be done," predicted Carlos, at different times pointing to FEMSA, Molson Coors, Modelo etc as possibilities.

Further consolidation at all levels will be driven by need to take costs out of system. That's "driving factor" for distribs, said consultant Joe Thompson. Then too, "cost cutting is a natural byproduct of scale," said consultant Mike Mazzoni. Hence, rush to bigness. Taking costs out of system, "taking non-working dollars out of the equation" is what InBev has historically done "exceptionally well," said Carlos. In Brazil, InBev able to "reallocate profit pie of industry towards itself" and "squeeze" distribs. So US distribs have "brand new need to become more efficient than before" because there's a "new sheriff in town." All 3 panelists agreed AB InBev would "invade" distrib profits tho quite possibly from bigger profit pool. If AB sells 1.4 bil cases in US and distribs deliver at $3.00 per case, cutting 10% of costs brings $420 mil or so, which ABI could split with distribs. "Too economically important" for AB InBev, sez Joe, so it will have to consolidate. But "real driver" is "pressure coming" from increased efficiency in MC system, sez Mike, where a dozen distribs control about 300 mil cases, 20% of non-AB biz.

Then too, there's "almost another sea change" happening for distribs, striking "more of a competitive balance," said Joe. AB providing better portfolio for its system and at same time its network continues picking up [non-aligned] brands. This is "kind of a double whammy" on MC system, said Joe. In recent West Coast deals (Sacramento, Seattle etc) "about $15 million of gross profit went out" of MC system into AB system (thru Crown, Alaskan, etc). "You begin to see that balance of power begin to shift."

Yet distrib consolidation is US "has actually slowed down," said Joe as "buyers starting to push back and say 'no mas'." That's even tho "a lot of transactions are trying to close" by yrend in "rush to beat the unknowns of the tax situation." Between sellers wanting "premium" prices, tight credit mkts, buyer pushback, slowdown may last into Q2 09, sez Joe. "Prices have gone up 20-30%" in last yr, said Mike, "but value hasn't." In recent yrs, "as an incentive for sellers," added Mike, buyers "willing to give up some of synergies. Now people are asking for all of the synergies and more." Yet buyers should capture synergies, sez Mike, since buyer takes on risk. "If you're a buyer and you give away all the upside, you're working for the bank, simple as that," said Mike.

Carlos pointed to Mexico and China as "hidden jewels" in AB InBev deal. Modelo "not a particularly well-run company," said Carlos. It has 8 breweries and could run on 4, he believes. While Modelo has EBITDA margin of 30%, it "should be running at 40-45%," argued Carlos (InBev at 44% in Brazil). So improving margin in Mexico, and ultimately acquiring other 50%, presents "ton of upside" for AB InBev, sez Carlos. Modelo has "very weak rights" in its arbitration case, sez Carlos, and "we believe they are going to have to sell." While Carlos had previously viewed DoJ approval of AB InBev acquisition of rest of Modelo as likely, recent LUSA ruling has forced him to reconsider that perhaps there is "a whole new better role" for Constellation under AB InBev. Carlos also said InBev got China "practically for free" in AB deal. Mike agreed that AB acquisition by InBev "really not for the US," but "huge opportunities" to take 2 "major iconic brands" like Bud and Corona and grow them internationally. It will be "more of a defensive environment" here in US where "share growth will be difficult" for AB InBev. Will US be managed more for profitability than growth? "Categorically," responded Mike.

The "next round in antitrust activity in beer will involve issues at the distributor level." So predicted economics prof Ken Elzinga at Beer INSIGHTS Seminar Nov 17.

Tho Ken quipped that economists ain't great forecasters, that only folks worse are "stockbrokers, financial analysts, central bankers, Congress and your brother-in-law," he knows what he's talking about. Ken's been analyzing antitrust issues in beer for decades and was recently consultant on both MillerCoors JV and AB InBev deal. US antitrust authorities will be less active in "policing" brewer-level deals goin' forward, Ken believes. But there will be "concern with the level of concentration taking place in beer distribution" across US, Ken added. In addition, feds may consider some 3-tier regulations "to be anti-competitive and fair game for their scrutiny." Ken didn't specify potentially problematic regs. But he warned that industry needs to remain price-competitive. Commended brewers' history of fierce head-to-head competition, especially compared to "blight" of price-fixing in other bizzes. "If that changes, if the industry has a reputation for not having fierce head-to-head competition, but instead 'stodgy, get along in bed with my rivals,' the Justice Department will take a very different look at consolidation." Distrib deals that result in big MC/All Others distribs with say 2/3 mkt share might have to be defended on basis of economic efficiency (as MC successfully argued) and/or other factors. Would Justice prohibit a MillerCoors/AB distrib deal in big metro area? "I think it probably would prohibit such a combination," said Ken.

As consultant to InBev, Ken could not comment on prospect of DoJ challenging InBev purchase of the rest of Modelo or get too deep into DoJ decision to make InBev divest Labatt USA. But he did point out DoJ's move of LUSA looked like "a handful of people" at DoJ interested in a "handful of consumers" in a couple of upstate NY mkts and one WA mkt. If the antitrust concern is purely in consumers, "maybe you don't count noses," Ken suggested. "My concern is whether they can pull off a remedy that from a cost-benefit analysis is worth the candle." Can DoJ "protect a handful of consumers" and not "somehow muck up the Labatt brand?" We know a few distribs askin' exact same question.

Newly minted AB prexy Dave Peacock kinda constrained in presentation at Beer INSIGHTS Seminar this yr, as he spoke less than 24 hrs before InBev deal closed. But Dave gamely answered some probing questions, lots about distrib end of biz. Top of many minds: AB InBev branch strategy. Branches are "key strategic asset," reiterated Dave. They help AB understand distribs, provide better input. Tho many believe AB InBev will either sell 'em all or buy up system, Dave said: "There's never an all-or-nothing solution." AB will investigate oppys, but often "better for an independent neighbor to buy an independent neighbor." So "don't look for some massive new branch strategy of divesting or over-investing…. Like in past it will be a bit of a hybrid." What about consolidation and how will AB InBev approach compare to MC's? "We are very pro-consolidation, and have been for a long time," Dave pointed out. Since 80s, AB went from 960 to 600 distribs.

In theme Dave sounded several times, said "shared services is another way you can get there." In any case, mkt forces will "dictate" consolidation, he believes. But "it's going to be very hard for us to have a direct impact…. We don't have a plan, there's no map. We just know less is probably better and the system has seen that." With overlapping MillerCoors distribs in same mkts, "it's clear" MC system has to make some moves. But that ain't case with AB InBev. What about AB distribs sharing services with MC distribs? Dave called notion a "little perverse," but also: "We'd have to look at it" case by case. There are "certain geographies where it makes a lot sense." Elsewhere no. "For us what's absolutely critical, sales and marketing [would] have to be separate."

Did AB's exclusivity policy shrink AB distribs' share of profit pool? "It was not the exclusivity program itself" that "impacted" distrib profits. AB's "inability to crack the high end, and bring brands that make sense to our wholesalers" was bigger problem. If AB had brands with "meaningful" share of high end, "I don't think I'd have a wholesaler" in US asking why AB has exclusivity. Dave also defended InBev's mktg record. Tho some say InBev has rep for slashing mktg $ and not being very good at it, Dave cited 12.5% increase in mktg spend InBev reported in Q3. InBev also has strong brands in S America and Stella has been "very well marketed," Dave insisted. So: "I don't think there's any fact that demonstrates on a consistent basis that InBev has a process for cutting marketing."  

Brewers and distribs alike need scale to succeed, MillerCoors ceo Leo Kiely stressed in remarks to Beer INSIGHTS Seminar Nov 17.  That need for scale one of “inexorable forces” that drive brewer and distrib consolidation.  Using Coors as example, Leo pointed out that in 93 Coors was “vying” with Stroh, Heileman and Pabst for 3d spot in US beer.  “Why am I standing here?” Leo asked.  For one, Coors is a “magic brand” and Coors family invested in biz.  Another “fundamental” reason Coors still standing: even tho Coors was a “scale player” then in just 13 of 215 DMAs, as Coors went natl it “learned to deal in multi-brand houses.” Usually came in “either behind a declining brand” or into an operation already selling many other brands.  Now, “your scale as a distributor is my asset.  Virtually every one of you has a higher share of market than I can aspire to.  I think that’s great for our brands.”  Strength/scale of distribs fit into Leo’s theme of “interdependence” between brewers and distribs.  Important to system to have independent distribs, said Leo, but brewers/distribs depend on each other to win in mkt.  Examples:

Coors and Miller put “great beers” and “cool” mktg behind Blue Moon, MGD 64 and Coors Light, but aligned distrib efforts equally critical to their recent success.    

Goin’ forward, MC will continue to “encourage” distrib consolidation, but can’t and won’t “force” it.  “I think at one point we felt our role was by the end of the year to get out and tell everybody how we saw the map in every part of the country.  We realized that: A, that was overly ambitious; B, that really isn’t our job; and C, we’re going to be in a much better place as an industry and as MillerCoors if we’re encouraging appropriate consolidation and facilitating making that happen.”  A “little over” 60% of MC volume in shared houses when JV formed, about 10% “in play” now and MC expects to pass 80% by end of 09.  Asked why, if MC “listened to distributors” and made key changes in contract, it still “insists” on right to unilaterally change contract “right after it’s signed.”  Leo said: “We don’t have any intent to change [the contract] back the minute it’s signed….  That just isn’t the way we play ball.”  At presstime, 2/3 of distribs have signed. 

What about challenge of mktg Coors Light/Miller Lite when history is that brands “source” volume from each other?  A “piece of cake,” Leo bounced back: “With a 1-2 punch you’re a much stronger boxer.”  Some data suggests “overlap” between Lite and Coors Light “relatively small,” said Leo.  With Coors Light in “great place” on refreshment and Lite “owning taste” in category, “I think I like that hand.”  MC organization now “in place,” said Leo.  Job losses didn’t affect brewery workers/infrastructure but concentrated among mgmt team and non-brewing operations.  About 900 jobs “impacted” out of total of over 3000.  

AB InBev got off to shaky start. Deal closed Nov 18, forming world's largest brewer with $36 bil in revs, $11 bil in EBITDA and a mountain of debt. Stock went down, then sank like a stone after AB InBev announced hugely discounted stock issue Nov 24. Next day, seesawed back up 16%. Still, ABI share price way down in 1st week. Then too, before deal, combo of AB and InBev had mkt cap of $80-90 bil. Now about $15 bil. It's as if $52 bil went straight to (happy) AB shareholders and all that value simply evaporated for AB InBev. At least for now.

InBev issued 1 bil new shares for 6.45 Euros apiece (had been 20 day before). That 70% discount called "extraordinarily steep" by BreakingViews columnists in NY Times. That's "just the type of use of proceeds that investors find toxic right now." To get deal done and keep majority, controlling shareholders bought 2.8 bil Euros worth of new issue, more than 2x what they planned a month ago. But paying back $9.8 bil bridge loan thru rights issue "gets AB InBev only to base camp in scaling its debt mountain," wrote FT's Lex. ABI still has to sell $7 bil in assets, "very challenging" within 1 yr time frame, say several observers. As deal closed, Brito commented: "We have a list of five assets that are prized assets. From what we see today we only need to sell two or three to get to the $7 billion." Could include Busch Entertainment, Korean beer biz, perhaps German domestic biz and/or packaging. But here's kicker: ABI must also pay off another $12 bil within 2 yrs. That totals over $29 bil of debt reduction, over half what it borrowed. Presuming ABI gets there, it will again be financially robust. Lex: "As investors gain confidence that debt can be tamed, they might also realize how cheap AB InBev now is."

AB InBev got clearance from US Dept of Justice Nov 14, but in somewhat surprising ruling, must sell off Labatt USA, based on increased mkt concentration in Buffalo, Syracuse, Rochester, NY where LUSA has double-digit share. ABI can brew Labatt in Canada for just 3 yrs. Lazard Freres is handling deal for AB InBev; book is already out reportedly asking about $100 mil for 1.4-mil-bbl co with 55 employees. Deal for virtually all of LUSA.

As AB InBev era began, Brito sent employees upbeat letter, saying "main strength of our company will be our people." Despite that, morale for rank-and-file AB employees low. They're walking around like "Katrina victims," said one, uncertain about what's next. It's like a "ghost town," said another. Tuff to go from such sadness, uncertainty and disconnect to full embrace of InBev's rigorous ZBB ways. Meanwhile, 11 of 17 most sr mgrs (on strategy committee) have left co, many with extraordinary riches. But AB also named US mgt team under prexy Dave Peacock, including key compatriots like newly-minted mktg veep Keith Levy, sales veep Evan Athanas, etc. Tho there are many challenges, InBev mgt team has been thru 3 of these in last 8 yrs and usually "overdelivered," Brito sez.

Craft segment leader Boston Beer continued double digit core brand depletion growth in 3d qtr even as rev per bbl up 5% and economy weakened. That's impressive. For 9 mos, its core brand depletions up about 10% (in line with shipments). But Boston's cost of goods sold per bbl up 10% in 3d qtr. And so its margins eroded again. Boston took net loss of almost $300,000 for qtr, vs net income of $3.2 mil in Q3 07. Plus it has spent $33 mil so far in 08 on fixing up Pennsy brewery, and took $22.9 mil in charges in wake of recall last spring (some or all could be recovered). Boston had to recall nearly 1 mil cases. Boston's total cap ex in 08 will be $110-120 mil, it reiterated. Boston down to $10.6 mil in cash (had $72 mil thru 2d qtr 07 before it bought brewery). Boston still has $50 mil line of credit that it has yet to tap and sez that plus cash-on-hand and future cash flow "will be sufficient to fund future cash requirements." As Boston lowered its 2008 earnings per share guidance to 60 to 80 cents (down "sharply" from previous $1.70-2.00, said AP), analysts cut estimates and stock dropped 8% day after earnings announced. Another concern: continued pressure on 09 costs and strong possibility of more margin erosion. Boston again expects 2009 cost hikes of 8-11% per bbl, which will be "somewhat offset" by planned price hikes "targeted" at 3% and some efficiencies. But gross margins "could be down below full year 2008," Boston acknowledged. What's more, Boston still expects another $25-45 mil in 09 cap ex for Pennsylvania Brewery. "Plant startups and the weight of Diageo production are clearly heavier and will last longer than expected," wrote Deutsche Bank's Andrew Kiely. While Boston still sets pace for craft segment sales, it's seemingly bedeviled by increased costs of its new biz model.

The chess match continues as InBev and Modelo maneuver over fate of AB's 50% stake in the Mexican brewer. Strongest language yet in most recent assertion (Nov 6) by InBev ceo Carlos Brito that Modelo can't stop its deal with AB. While InBev recognizes Modelo has right to ask for arbitration over issues if it disagrees with AB, InBev "does not recognize any rights whatsoever of [Modelo] having any say over" InBev's transaction with AB. Contract "very clear," Brito insisted during conference call last week. Modelo has "no say at all." That said, InBev "admires Modelo" a lot, Brito reiterated, for its brand building and profitable biz in Mexico. "We'd love to continue the partnership," he added, and conversations continue to that end.

Ten days earlier, Modelo's ceo Carlos Fernandez had quite different message during Modelo conference call. Modelo agreement with AB "prohibits AB from taking action that would result in a transfer or disposition of its interest in Grupo Modelo and Diblo to a competitor in the beer business," Carlos insisted again. Same agreement provides AB can't "transfer" any part of its investment "without first giving the controlling shareholders" of Modelo oppy to purchase share AB transfers. Modelo seeks protection in case deal done before arbitration, he added. Finally, he "clarified" that Modelo's controlling shareholders "are not, under any circumstance, considering selling their interest in Grupo Modelo. On the contrary, they would be willing to buy under the right circumstances."

What if MillerCoors contract gave a deadline to sign its new agreement and 40% of its network declined? That's even tho MC execs pushed really hard for signatures and made significant concessions. Certainly, no one expected this, especially given what's happened in past. Distribs signed previous agreements virtually unanimously, despite objections. We're in uncharted waters. Environment has changed. As Nov 12 deadline approached, both NBWA and Calif Beer and Bev Distrib Assn wrote MillerCoors and asked for extension. But MillerCoors prexy Tom Long responded Nov 12: "We will not extend the deadline nor make further changes to the agreement." For distribs who don't sign, legacy Miller and Coors agreements will still be in force, spokesman Pete Marino told INSIGHTS.

Lotsa action as deadline loomed. MillerCoors execs met with Calif ABC and Calif Gov trying to cut controversy off at pass, yet Calif ABC still issued unusual Nov 7 letter raising "significant concerns" with MC agreement. While letter didn't go as far as some hoped, Calif ABC did say "several provisions. . . constitute a degree of ownership and control over the distributor" such that MC "should be a co-licensee or otherwise qualified as the licensee." Provisions like hiring/firing gm, approving biz plan, process for change in ownership or adding brands could be violations. ABC acknowledged provisions were in other agreements, but it had "never been asked to review them previously." ABC didn't say agreement in-and-of itself illegal. In fact, said "it may well be concluded that merely entering into the agreement will not in and of itself result in the potential violations." MillerCoors seized on that: ABC said "signing the Miller Coors … Agreement is not a violation," West prexy Ed McBrien wrote. But ABC also said "actual implementation of these aspects of the agreement… could be problematic." Of course, distrib advocates seized on that. "The law violation goes to the distributor," CBBD prexy Victoria Horton wrote, "for having given through contract, an undisclosed interest in its license to a manufacturer who is not authorized to exercise the privileges of that license, a position that has prevailed under alcohol regulation the past 70 years." That "creates an unacceptable risk," NBWA's Craig Purser wrote. If ABC ruled distribs in violation, license could be suspended, distrib could be terminated, breach loan covenants, etc.

A lot hinges on whether state law supercedes MC contract. MillerCoors execs say so, unambiguously and even in writing, but many view contract language as far less clear. Particularly clause which sez state laws "incorporated…only to the extent that such laws, rules and regulations are required to be so incorporated." Victoria Horton wrote Nov 12: CBBD "would welcome an amendment by MillerCoors to adopt the precise language of their e-mail" such as Ed's point "if any provision conflicts with state law, state law controls." MC exasperated by stubborn persistence of this controversy. Not only have distribs signed other agreements with some of same provisions, but MC had already changed contract, and backpedaled on its consolidation plan too. These were significant concessions, but apparently not enuf. Why is it so different this time? INSIGHTS has heard many possible reasons: growing power of large distribs, fear and uncertainty of smaller distribs, questions about vague clauses that say state law supercedes, poor initial communication by MC, immediate attempted firing of 30-40 distribs and more activist stance by advocates. Given sheer size of some transactions and attendant risks involved, some distribs no longer willing to accept what they view as one-sided contract. Maybe it's just these tumultuous times, but for first time, many distribs are so far just saying no.

In 1st qtr of MillerCoors JV net rev hit $1.95 bil, up 2.1% vs. pro forma figure for same period 07. Rev per bbl up 2.9% excluding contract biz. Cost of goods/bbl rose 5.6%, almost 2X AB cost/bbl trend. But total mktg, gen admin expenses declined 9% as MC saved big Miller Chill launch expenses from 07, beefing up profits. So MC operating income (after special items) increased $18 mil to $171.1 mil, +12%. Net income: $168.2 mil, +15% vs. pro forma figure last yr. That was about $9 per bbl. Compares to about $19/bbl that AB netted on US beer in 3d qtr. As SABMiller released results, cfo Malcolm Wyman expressed confidence in JV's prospects goin' forward because "operationally, I think they're doing things right" and "positioning themselves well" in the mkt, plus synergy benefits on the way, with "$50 mil in integration synergies" by yr ending Jun 09.

Recall MillerCoors sales to retailers +0.7% in 3d qtr, selling day adjusted. Seven of top 12 brands up. Coors Light STRs up 6.8%, but Miller Lite down 3.6% "due to volume declines in the Midwest and Pacific" and going against tuff comp last yr. Coors Light/ Miller Lite combo +1.4%. MC's craft/import brands +5%. But "above premium" down double-digits as Chill/Killian's trends offset double-digit Sparks gain. Banquet/MGD combo eked out 0.2% gain as Banquet's double-digit gain offset MGD's decline. (In 07, MGD still 2 mil bbls, 2.7X bigger than Banquet.) Keystone Light's double-digit gain and High Life increase pushed MC's sub-premium biz up 2.3%. So MillerCoors did better on its subpremium biz than its premium light, other premium brands and super premium biz. Like AB, MC off to slow start in Oct. STR's "off marginally" in Oct, said ceo Leo Kiely, tho there's "a lot of noise" in Oct number given price increases/retailer buy-in.

MillerCoors "more confident than ever that we'll nail the [planned $500 mil] in synergies on time," Leo said during conference call. In fact, MC expects "to accelerate its three-year savings targets" by 6 mos compared to original goal. Same day MC released results, it announced 269 job cuts, 100 from Milwaukee. Another 300-350 positions to be eliminated over next 6 mos, it said.