Submitted by David Stockman via Contra Corner blog [10],
While Janet Yellen and her band of money printers work themselves into a tizzy over whether two buzz words - “considerable time” - should be dropped from their post-meeting word cloud, they might be better advised to just read the newspapers. This morning’s WSJ brings word that the lending boom which our monetary central planners are eager to stimulate is apparently off-to-the-races.
Well, sort of. The item in question is a $122 billion globally syndicated loan to facilitate an M&A deal between the world’s two largest beer companies—AB InBev with a 20% global market share and SABMiller with 10%. Needless to say, the only possible reason for creating a monstrosity with $60 billion in sales spread among scores of highly differentiated regional and national beer markets is the “synergy” euphemism—-that is, the “savings” from thousands of job terminations especially in those two paragons of job growth known as North America and Europe.
So the purpose is self-evidently the opposite of the Fed’s intent—whether the sweeping job cuts which Wall Street will peddle to justify the deal actually happen or not. In any event, the deal has virtually nothing to do with real market economics.
Both companies are already giant M&A roll-ups representing a string of mergers that have been going on for two decades, including the $52 billion InBev purchase of Anheuser-Busch six years ago. But you don’t have to be an expert in the beer industry to realize that these rollups were mainly the product of cheap debt and financialization, not free market economics. Recall that the beer industry ran out of true economies of scale 30 years ago when world class breweries reached their maximum efficient size in terms of production and distribution.
What has been happening in the business since then is nearly the opposite—that is, the rise of diseconomies of scale in marketing and branding. The latter is surely attested to by the explosion of specialty premium brands and micro-breweries.
Stated differently, in the absence of drastic financial repression by the world’s central banks there would be no case whatsoever for the globe-spanning beer merger now at hand. The latter will only create more dis-economies of scale as all the pieces and parts from two decades of financially driven M&A create another artificial, discombobulated enterprise which is too big to manage and wrong-sized for the nature of the market which it serves.
But since cheap debt always trumps expensive labor, Wall Street’s M&A machinery will create another giant malinvestment. And having once again shot themselves in the foot, our monetary central planners will bray that the labor market is still too weak and that it must therefore keep rates lower for longer.
Just maybe, however, the Fed’s new financial stability monitoring group might note something suspicious about this mega-debt deal percolating up through the deal machinery. Namely, that both companies are already vastly over-valued momentum plays that can be explained only by the fact that the financial markets have been turned into gambling casinos based on zero cost carry trades, the availability to speculators of sub-economic downside insurance protection and the triumph of “buy-the-dips” one-way trade.
Specifically, the TEV (total enterprise value of debt plus market equity) of the two beer giants combined is currently around $340 billion, yet in the most recently reported LTM period InBev generated just $19 billion of free cash flow (EBITDA less CapEx) and SABMiller under $6 billion. In sum, their combined number for that crucial valuation metric is just $25 billion, meaning that they are trading at 14X free cash flow.
Folks, these two momo plays are in the suds business, not social media! The overwhelming share of their cash flow is generated in Europe and North America were volume has been flat for two decades, as shown below. Even on a global basis, industry growth over the last 17 years has averaged only 2% per annum; and most of that is attributable to China where competition is plentiful, prices cheap, profits scare and the government is increasingly unfriendly to foreign companies.
So what we have here is a giant overvaluation bubble in the suds business. Yet the result of current central bank policy is just more of the same. In fact, at the rumored $122 billion, the loan now brewing would amount to 6.5X free cash flow. In a no-growth business in a world where interest rates must eventually normalize–that is sheer lunacy. But it well explains why our monetary politburo is so reluctant to let interest rates normalize and is so deathly afraid of a Wall Street hissy fit.
None of this would happen in a world with honest interest rates and stable two-way capital markets for the simple reason that the financing could not be raised; boards and CEOs would have no momentum driven stock market inducing them to engage in patently irrational mergers; and, in any event, short sellers would swiftly punish serial roll-up machines that destroy rather than create sustainable economic value.
So here is a news flash for the Fed’s financial stability monitoring committee. The combined beer companies today have about $60 billion of net debt. The merger deal in question would thus double the new company’s debt in order to destroy several thousand breadwinner jobs. You think that might suggest that there are some bubbles out there after all?
