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SAB-Coke: not the deal investors hoped for

Last week SAB announced a major joint venture with the Coca-Cola Company (US: KO), for which it has long bottled fizzy drinks in South Africa. SAB, Coca-Cola and a smaller South African bottler will pool their operations to create Coca-Cola Beverages Africa, a company with annual turnover of $2.9bn (£1.85bn).

The brewer presented the move as a reinforcement of its position in soft drinks. Why this is attractive was evident in its recent half-year results: strip out acquisitions and lager volumes fell 1 per cent, while soft drinks volumes rose 9 per cent. But management underplayed the potential for cost-sharing between its beer business and the new joint venture. And as part of the deal the brewer is also selling the rights to Appletiser and other local soft-drinks brands to Coca-Cola. The net impact on SAB's soft drinks exposure and bottom line is somewhat unclear.

It's tempting to interpret the move partly as self-defence. SABMiller has long been seen as a target for Anheuser-Busch InBev (BE: ABI), which has grown by acquisition into the world's largest brewer, pushing SAB into second place. Belgian brewer Interbrew (Stella Artois) merged with its Brazilian peer AmBev in 2004. The combined company InBev then bought US leader Anheuser-Busch (Budweiser) in 2008, followed by Grupo Modelo of Mexico (Corona) in 2013. Its strategy is to buy at a reasonable price and then cut costs. Absorbing SABMiller, which dominates Africa, is an obvious next step.

But AB InBev has a bottling agreement with PepsiCo (US: PEP) - Coca-Cola's archrival - in Latin America. If it bought SAB, it would have to ditch either the joint venture with Coca-Cola, or else its own PepsiCo bottling operation. This is not an insurmountable problem, but adds to a lengthening list of difficulties. Already AB InBev would need to sell SAB's Chinese and US businesses for anti-trust reasons; if it also needs to rewrite all its bottling agreements, that might be the final straw - or so SAB may be hoping.

In reality, the Coke deal is hardly the poison pill SAB needs to kill the deal. Instead the UK group needs an alternative partner - one with a commitment to brewing rather than cost-cutting. Heineken (NL: HEIA) is an obvious choice, with strong brands in western Europe, Nigeria and Mexico. But Amsterdam-listed Heineken is controlled by the De-Carvalho-Heineken family, which has no intention of ceding independence. It publicly rebuffed an approach by SAB in September as "non-actionable".

Another pill SAB has quietly swallowed in recent months is a distribution agreement with Grupo Petropolis, the second-largest brewer in Brazil after AB InBev. Intriguingly, it tried to fly the deal under the radar of UK investors; it was only announced locally. Perhaps the group's failure to break into the Brazilian market before - it shut its import business in 2012 - has made it coy. Or perhaps it does not want to stoke takeover talk. If SAB bought Petropolis, it would create yet another anti-trust headache for a mega-merger with AB InBev.

There are other companies SAB could pursue: Molson Coors (US: TAP), its US joint-venture partner, or Castel, a private French group with which it shares rights in North Africa. Any deal of scale would make the Anglo-African brewer harder for AB InBev to swallow. There's a risk that SAB overpays for a partner in its desperation to remain independent - as it arguably did for Australian brewer Fosters in 2011, at the height of the mining boom. Intense competition in the mature Australian market was one reason why the company suffered its worst margin decline in six years in the first half.

For now, however, SAB may need no defence beyond its high share price - now 3,455p, or about 22 times current year earnings. Philip Gorham, an analyst at Morningstar, calculates that AB InBev can pay no more than 3,800p before destroying shareholder value. That's a 10 per cent premium to the current price, which isn't enough to cover shareholders' tax liabilities in the event of a sale. Market froth has probably bought SAB some time.