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

Fitch initially placed ABI and SABM on RWN on 7 October 2015 when ABI announced its first informal offer for SABM at terms broadly in line with this offer. ABI has subsequently raised its offer to SABM shareholders and SABM's Board confirmed it intends to recommend it. With today's announcement there is now certainty that ABI's offer includes an equity component of between 40.45% and 41.6% and that post-completion there will be a USD12bn inflow from the divestment of SABM's stake in MillerCoors.

Upon completion of the merger, we intend to downgrade the combined ABI-SABM to the 'BBB' rating category. The rating will depend on the profile of the combined entity, which is still subject to discussions with a number of counterparties and on more clarity over management's targeted de-leveraging trajectory. The rating would reflect the moderately high leverage of the combined entity at closing, exposure to currency headwinds, some execution risk and the limited access to the cash flow of the core subsidiary, AmBev . These aspects are balanced by the exceptional global reach, market positions and portfolio of brands as well as a large, broadly stable and predictable pre-dividends cash flow of the combined entity, which supports its de-leveraging capacity.

The transaction is subject to shareholder approval and subsequently to anti-trust approvals.

We are likely to affirm the ratings if the takeover fails to complete. With respect to SABM's ratings, we expect to equalise them with ABI's, subject to SABM's debt ranking equally to ABI's debt and to the issuing entities being able to access group cash flow.

KEY RATING DRIVERS
Global Leader
A merger of the two market leaders ABI and SABM will create a global player with combined revenue of close to USD70bn, EBITDA of approximately EUR24bn and pre-dividends free cash flow of approximately USD10bn. This will be due to a presence in many duopoly and oligopoly markets with high profit margins and in several others with medium-term growth prospects, even though volume growth is currently at a historical low point. None of the company's competitors will have the same reach across the world.

Increased Leverage
Fitch calculates that a combined ABI-SABM group would have debt of up to USD124bn (end June 2015: USD51.4bn) at completion. The terms of the offer include an option for the two key shareholders, Altria (approximately 27%) and BevCo (approximately 14%) which they have committed to elect for, to swap their SABM shares into ABI shares and receive a cash payment of GBP3.7788 per share (equal to a total cash disbursement for ABI of approximately USD3.8bn). Based on this, we calculate that ABI's consolidated funds from operations (FFO) adjusted gross leverage should rise to 6.0x by end-2016 (equating to total debt/consolidated EBITDA of 5.0x, up from 2014's 2.6x).

Scope for Subsequent De-leveraging
Management estimates that the transaction will close in 2H16. Based on our estimation of annual pre-dividends consolidated FCF of approximately USD10bn and the planned divestment of SABM's 58% stake in MillerCoors for USD12bn, the merged entity could reduce consolidated FFO adjusted leverage to slightly above 5.0x over two years. However, this would still be high relative to the 4.0x for 'BBB' rated alcoholic beverages companies in Fitch's universe. While a temporary reduction of dividend distributions would enhance ABI's de-leveraging trajectory, management is not currently envisaging this.

Structural Considerations Affect Rating
Structural considerations also weigh on a potential downgrade. Since the acquisition will be made by a NewCo that is fully-owned by Anheuser-Busch inBev NV/SA, the transaction keeps ABI's important subsidiary, AmBev, substantially ring-fenced. We therefore assume debt repayment will not materially benefit from AmBev's cash flows.

ABI's 62%-owned subsidiary AmBev would continue to generate an important portion of the enlarged group's cash flow (pro forma approximately 30% of FCF pre-dividends) but acquisition debt will be placed outside AmBev's perimeter, with ABI only accessing AmBev's cash flow via dividends. AmBev does not guarantee any of ABI's debt. This will exacerbate a mis-match between the debt-free and cash generative AmBev and ABI's highly leveraged capital structure (pro-forma for SABM and taking into account only dividends received from AmBev). We calculate that the part of the ABI group that bears all the debt will have FFO adjusted leverage of approximately 9.0x at closing.

More Challenging Industry Environment
Compared with a year ago, the global beer industry is suffering from a weaker trading environment, with volumes having contracted in many markets and currency depreciation impacting, in particular, ABI's FCF. While both ABI and SABM's most recent results (9M15 and 1H15, respectively) reported sound organic profit growth in Latin America, it was eroded by currency headwinds. In 9M15 ABI's core markets of Brazil and Mexico have reported a contraction of EBITDA of 15% and 8%, respectively.

In the core US beer market, both brewers are losing market share to new independent players offering craft beer and are under pressure to respond with new launches. In 9M15 ABI's sales volumes to retailers were down 1.9% and profit margin contracted by nearly 340 basis points on an organic basis.

Moderate Execution Risks
Integration risks are mitigated by ABI's and SABM's successful track records of managing major M&A in the international beer sector. However, the overall final profile of the combined entity is not yet fully clear and requires some work on the side of ABI's management.

Management has pointed out that discussions with several counterparties are still on-going. These include anti-trust regulators as well as joint venture partners and bottling franchisors. Divestments in China could be necessary to obtain anti-trust approval, in our view. We also believe that retention of key SABM management in charge of the African operations would be critical to continue running those businesses and fully reaping their value-creation potential.

Currency Mismatch
A merger would only partly reduce SABM's and ABI's current currency mismatch, as they fund mostly in euros, US and Australian dollars but generates less than respectively 30% and 50% of operating profit in these currencies. Due to the important contribution to cash flow from South America, Asia and Africa (over 60%), a combined ABI-SABM with acquisition debt raised in US dollars or euros would maintain a hard/soft currency mismatch.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Although subject to shareholder approval, key Fitch forecast assumptions for the merged group include:
- Successful completion of the merger in mid to late 2016 at the terms of the offer submitted by ABI on 11 November 2015
- ABI's and SABM's reported revenues contracting in the low single digits in 2015 and subsequently recovering
- Cost of new acquisition debt of around 3.5%
- Total dividend distributions by ABI unchanged in 2016 and 2017
- AmBev's dividend policy remains unchanged
- Total divestment proceeds of USD12bn from MillerCoors stake

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

Positive rating action is currently not envisaged. If the transaction does not proceed, it will likely lead to ABI's ratings being affirmed.

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

Positive rating action is currently not envisaged. If the transaction does not proceed, it will likely lead to SABM's ratings being affirmed.

FULL LIST OF RATING ACTIONS

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

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

AnheuserBusch Companies Inc
Senior unsecured rating: 'A' maintained on RWN

AnheuserBusch InBev Finance Inc
Senior unsecured rating: 'A' maintained on RWN

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

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