Walmart's India (Flipkart) Gambit: Growth Rebirth or Costly Facelift?

On May 9, 2018, Walmart confirmed officially what had been rumored for weeks, and announced that it would pay $16 billion to acquire a 77% stake in Flipkart, an Indian online retail firm, translating into a valuation of more than $21 billion for a firm founded just over ten years ago, with about $10,000 in capital. Investors are debating the what, why and what next on this transaction, with their reactions showing up in a drop in Walmart’s market capitalization of approximately $8 billion. For Indian tech start-ups, the deal looks like the Nirvana that many of them aspire to reach, and this will undoubtedly affirm their hopes that if they build an India presence, there will be large players with deep pockets who will buy them out.

The Players

The place to start, when assessing a merger or an acquisition, is by looking at the companies involved, both acquiring and target, before the deal. It not only provides a baseline for any assessment of benefits, but may provide clues to motives.

a. Flipkart, an Amazon Wannabe?

Of the two players in this deal, we know a lot less about Flipkart than we do about Walmart, because it is not publicly traded, and it provides only snippets of information about itself. That said, we can use that information to draw some conclusions about the company:

1. It has grown quickly: Flipkart was founded in October 2007 by Sachin and Binny Bansal, both ex-Amazon employees and unrelated to each other, with about $6000 in seed capital. The revenues for the company increased from less than $1 million in 2008-09 to $75 million in 2011-12 and accelerated, with multiple acquisitions along the way, to reach $3 billion in 2016-2017. The revenue growth rate in 2016-17 was 29%, down from the 50% revenue growth recorded in the prior fiscal year. Flipkart’s revenues are shown, in Indian rupees, in the graph below:
   
2. While losing lots of money and burning through cash: As the graph above, not surprisingly, show, Flipkart lost money in its early years, as growth was its priority. More troubling, though, is the fact that the company not only continues to lose money, but that its losses have scaled up with the revenues. In the 2016-17 fiscal year, for instance, the company reported an operating loss of $0.6 billion, giving it an operating margin of minus 40%. The continued losses have resulted in the company burning through much of the $7 billion it has raised in capital over its lifetime from investors. 
3. And borrowing money to plug cash flow deficits: Perhaps unwilling to dilute their ownership stake by further seeking equity capital, the founders have borrowed substantial amounts. The costs of financing this debt jumped to $671 million in the 2016-17 fiscal year, pushing overall losses to $1.3 billion. Not only are the finance costs adding to the losses and the cash burn each year, but they put the company’s survival, as a stand-alone company, at risk.
4. It has had issues with governance and transparency along the way: Flipkart has a complex holding structure, with a parent company in Singapore and multiple off shoots, some designed to get around India’s byzantine restrictions on foreign investment and retailing and some reflecting their multiple forays raising venture capital.

While the defense that will be offered for the company is that it is still young, the scale of the losses and the dependence on borrowed money would suggest that as a stand-alone business, you would be hard pressed to come up with a justification for a high value for the company and would have serious concerns about survival. 

b. Walmart, Aging Giant?

Walmart has been publicly traded for decades and its operating results can be seen in much more detail. Its growth in the 1980s and 1990s from an Arkansas big-box store to a dominant US retailer is captured below:

That operating history includes two decades of stellar growth towards the end of the twentieth century, where Walmart reshaped the retail business in the United States, and the years since, where growth has slowed down and margins have come under pressure. As Walmart stands now, here is what we see:

1. Growth has slowed to a trickle: Walmart’s growth engine started sputtering more than a decade ago, partly because its revenue base is so overwhelmingly large ($500 billion in 2017) and partly because of saturation in its primary market, which is the United States. 
2. And more of it is being acquired: As same store sales growth has leveled off, Walmart has been trying to acquire other companies, with Flipkart just being the most recent (and most expensive) example. 
3. But its base business remains big box retailing: While acquiring online retailers like Jet.com and upscale labels like Bonobos represent a change from its original mission, the company still is built around its original models of low price/ high volume and box stores. The margins in that business have been shrinking, albeit gradually, over time.
4. And its global footprint is modest: For much of the last few years, Walmart has seen more than 20% of its revenues come from outside the United States, but that number has not increased over the last few years and a significant portion of the foreign sales come from Mexico and Canada. 

Looking at the data, it is difficult to see how you can come to any conclusion other than the one that Walmart is not just a mature company, but one that is perhaps on the verge of decline.

Very few companies age gracefully, with many fighting decline by trying desperately to reinvent themselves, entering new markets and businesses, and trying to acquire growth. A few do succeed and find a new lease on life. If you are a Walmart shareholder, your returns on the company over the next decade will be determined in large part by how it works through the aging process and the Flipkart acquisition is one of the strongest signals that the company does not plan to go into decline, without a fight. That may make for a good movie theme, but it can be very expensive for stockholders.

The Common Enemy

Looking at Flipkart and Walmart, it is clear that they are very different companies, at opposite ends of the life cycle. Flipkart is a young company, still struggling with its basic business model, that has proven successful at delivering revenue growth but not profits. Walmart is an aging giant, still profitable but with little growth and margins under pressure. There is one element that they share in common and that is that they are both facing off against perhaps the most feared company in the world, Amazon. 

a. Amazon versus Flipkart: Over the last few years, Amazon has aggressively pursued growth in India, conceding little to Flipkart, and shown a willingness to prioritize revenues (and market share) over profits:

Source: Forrester (through Bloomberg Quint)

While Flipkart remains the larger firm, Amazon India has continued to gain market share, almost catching up by April 2018, and more critically, it has contributed to Flipkart’s losses, by being willing to lose money itself. In a prior post, I called Amazon a Field of Dreams company, and argued that patience was built into its DNA and the end game, if Flipkart and Amazon India go head to head is foretold. Flipkart will fold, having run out of cash and capital.

b. Amazon versus Walmart: If there is one company in the world that should know how Amazon operates, it has to be Walmart. Over the last twenty years, it has seen Amazon lay waste to the brick and mortar retail business in the United States and while the initial victims may have been department stores and specialty retailers, it is quite clear that Amazon is setting its sights on Walmart and Target, especially after its acquisition of Whole Foods. 

It may seem like hyperbole, but a strong argument can be made that while some of Flipkart and Walmart’s problems can be traced to management decision, scaling issues and customer tastes, it is the fear of Amazon that fills their waking moments and drives their decision making.

The Pricing of Flipkart

Walmart is just the latest in a series of high profile investors that Flipkart has attracted over the years. Tiger Global has made multiple investments in the company, starting in 2013, and other international investors have been part of subsequent rounds. The chart below captures the history:

Barring a period between July 2015 and late 2016, where the company was priced down by existing investors, the pricing has risen, with each new capital raise. In April 2017, the company raised $1.4 billion from Microsoft, Tencent and EBay, in an investment round that priced the company at $11 billion, and in August 2017, Softbank invested $2.5 billion in the company, pricing it at closer to $12.5 billion. Walmart’s investment, though, represents a significant jump in the pricing over the last year. 

Note that, through this entire section, I have used the word “pricing” and not “valuation”, to describe these VC and private investments, and if you are wondering why, please read this post that I have on the difference between price and value, and why VCs play the pricing game. Why would these venture capitalists, many of whom are old hands at the game, push up the pricing for a company that has not only proved incapable of making money but where there is no light at the end of the tunnel? The answer is simple and cynical. The only justification needed in the pricing game is the expectation that someone will pay a higher price down the road, an expectation that is captured in the use of exit multiples in VC pricing models. 

The Why?

So, why did Walmart pay $16 billion for a 70% stake in Flipkart? And will it pay off for the company? There are four possible explanations for the Walmart move and each comes with troubling after thoughts. 

1. The Pricing Game: No matter what one thinks of Flipkart’s business model and its valuation, it is true, at least after the Walmart offer, that the game has paid off for earlier entrants. By paying what it did, Walmart has made every investor who entered the pricing chain at Flipkart before it a “success”, vindicating the pricing game, at least for them. If the essence of that game is that you buy at a low price and sell at a higher price, the payoff to playing the pricing game is easiest seen by looking at the Softbank investment made just nine months ago, which has almost doubled in pricing, largely as a consequence of the Walmart deal. In fact, many of the private equity and venture capital firms that became investors in earlier years will be selling their stakes to Walmart, ringing up huge capital gains and moving right along. Is it possible that Walmart is playing the pricing game as well, intending to sell Flipkart to someone else down the road at a higher price?

My assessment: Since the company’s stake is overwhelming and it has operating motives, it is difficult to see how Walmart plays the pricing game, or at least plays it to win. There is some talk of investors forcing Walmart to take Flipkart public in a few years, and it is possible that if Walmart is able to bolster Flipkart and make it successful, this exit ramp could open up, but it seems like wishful thinking to me.

2. The Big Market Entrée (Real Options): The Indian retail market is a big one, but for decades it has also proved to be a frustrating one for companies that have tried to enter it for decades. One possible explanation for Walmart’s investment is that they are buying a (very expensive) option to enter a large and potentially lucrative market. The options argument would imply that Walmart can pay a premium over an assessed value for Flipkart, with that premium reflecting the uncertainty and size of the Indian retail market.
My assessment: The size of the Indian retail market, its potential growth and uncertainty about that growth create optionality, but given that Walmart remains a brick and mortar store primarily and that there is multiple paths that can be taken to be in that market, it is not clear that buying Flipkart is a valuable option.

3. Synergy: As with every merger, I am sure that the synergy word will be tossed around, often with wild abandon and generally with nothing to back it up. If the essence of synergy is that a merger will allow the combined entity to take actions (increase growth, lower costs etc.) that the individual entities could not have taken on their own, you would need to think of how acquiring Flipkart will allow Walmart to generate more revenues at its Indian retail stores and conversely, how allowing itself to be acquired by Walmart will make Flipkart grow faster and turn to profitability sooner.
My assessment: Walmart is not a large enough presence in India yet to benefit substantially from the Flipkart acquisition and while Walmart did announce that it would be opening 50 new stores in India, right after the Flipkart deal, I don’t see how owning Flipkart will increase traffic substantially at its brick and mortar stores. At the same time, Walmart has little to offer Flipkart to make it more competitive against Amazon, other than capital to keep it going. In summary, if there is synergy, you have to strain to see it, and it will not be substantial enough or come soon enough to justify the price paid for Flipkart.

4. Defensive Maneuver:Earlier, I noted that both Flipkart and Walmart share a common adversary, Amazon, a competitor masterful at playing the long game. I argued that there is little chance that Flipkart, standing alone, can survive this fight, as capital dries up and existing investors look for exits and that Walmart’s slide into decline in global retailing seems inexorable, as Amazon continues its rise. Given that the Chinese retail market will prove difficult to penetrate, the Indian retail market may be where Walmart makes its stand. Put differently, Walmart’s justification for investing in Flipkart is not they expect to generate a reasonable return on their $16 billion investment but that if they do not make this acquisition, Amazon will be unchecked and that their decline will be more precipitous.
My assessment: Of the four reasons, this, in my view, is the one that best explains the deal. Defensive mergers, though, are a sign of weakness, not strength, and point to a business model under stress. If you are a Walmart shareholder, this is a negative signal and it does not surprise me that Walmart shares have declined in the aftermath. Staying with the life cycle analogy, Walmart is an aging, once-beautiful actress that has paid $16 billion for a very expensive face lift, and like all face lifts, it is only a matter of time before gravity works its magic again.

In summary, I think that the odds are against Walmart on this deal, given what it paid for Flipkart. If the rumors are true that Amazon was interested in buying Flipkart for close to $22 billion, I think that Walmart would have been better served letting Amazon win this battle and fight the local anti-trust enforcers, while playing to its strengths in brick and mortar retailing. I have a sneaking suspicion that Amazon had no intent of ever buying Flipkart and that it has succeeded in goading Walmart into paying way more than it should have to enter the Indian online retail space, where it can expect to lose money for the foreseeable future. Sometimes, you win bidding wars by losing them!

What next?

In the long term, this deal may slow the decline at Walmart, but at a price so high, that I don’t see how Walmart’s shareholders benefit from it. I have attached my valuation of Walmart and with my story of continued slow growth and stagnant margins for the company, the value that I obtain for the company is about $63, about 25% below its stock price of $83.64 on May 18, 2018.

Download spreadsheet

In the short term, I expect this acquisition to a accelerate the already frenetic competition in the Indian retail market, with Flipkart, now backed by Walmart cash, and Amazon India continuing to cut prices and offering supplementary services. That will mean even bigger losses at both firms, and smaller online retailers will fall to the wayside. The winners, though, will be Indian retail customers who, in the words of the Godfather, will be made offers that they cannot refuse! 

For start-ups all over India, though, I am afraid that this deal, which rewards the founders of Flipkart and its VC investors for building a money-losing, cash-burning machine, will feed bad behavior. Young companies will go for growth, and still more growth, paying little attention to pathways to profitability or building viable businesses, hoping to be Flipkarted. Venture capitalists will play more pricing games, paying prices for these money losers that have no basis in fundamentals, but justifying them by arguing that they will be Walmarted. In the meantime, if you are an investor who cares about value, I would suggest that you buy some popcorn, and enjoy the entertainment. It will be fun, while it lasts!

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Data Links

1. Walmart Valuation - May 2018

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Fairness Opinions: Fix them or Flush them!

My post on the Tesla/SCTY deal about the ineptitude and laziness that Lazard and Evercore brought to the valuation process did not win me any friends in the banking M&A world. Not surprisingly, it drew some pushback, not so much from bankers, but from journalists and lawyers, taking me to task for not understanding the context for these valuations. As Matt Levine notes in his Bloomberg column, where he cites my post, "a fairness opinion is not a real valuation, not a pure effort to estimate the value of a company from first principles and independent research" (Trust me. No one is setting the bar that high. I was looking for biased efforts using flawed principles and haphazard research and these valuation could not even pass that standard)  and that "they (Lazard and Evercore) are just bankers; their expertise is in pitching and sourcing and negotiating and executing deals -- and in plugging in discount rates into preset spreadsheets -- not in knowing the future". (Bingo! So why are they doing these fairness opinions and charging millions of dollars for doing something that they are not good at doing? And there is a difference between knowing the future, which no one does, and estimating the future, which is the essence of valuation.) If Matt is right, the problems run deeper than the bankers in this deal, raising questions about what the purpose of a   "fairness opinion" is and whether it has outlived its usefulness (assuming that it was useful at some point).

Fairness Opinions: The Rationale

What is a fairness opinion? I am not a lawyer and I don't play intend to play one here, but it is perhaps best to revert back to the legal definition of the term. In an excellent article on the topic, Steven Davidoff defines a fairness opinion as an "opinion provided by an outsider that a transaction meets a threshold level of fairness from a financial perspective". Implicit in this definition are the assumptions that the outsider is qualified to pass this judgment and that there is some reasonable standard for fairness.  In corporate control transactions (acquisition, leveraged buyout etc.), as practiced today, the fairness opinion is delivered (orally) to the board at the time of the transaction, and that presentation is usually followed by a written letter that summarizes the transaction terms and the appraiser's assumptions and attests that the price paid is "fair from a financial point of view". That certainly sounds like something we should all favor, especially in deals that have obvious conflicts of interest, such as management-led leveraged buyouts or transactions like the Tesla/Solar City deal, where the interests of Elon Musk and the rest of Tesla 's stockholders may diverge.

Note that while fairness opinions have become part and parcel of most corporate control transactions, they are not required either by regulation or law. As with so much of business law, especially relating to acquisitions, the basis for fairness opinions and their surge in usage can be traced back to Delaware Court judgments. In Smith vs Van Gorkom, a 1985 case, the court ruled against the board of directors of Trans Union Corporation, who voted for a leveraged buyout, and specifically took them to task for the absence of a fairness opinion from an independent appraiser. In effect, the case carved out a safe harbor for the companies by noting that “the liability could have been avoided had the directors elicited a fairness opinion from anyone in a position to know the firm’s value”.  I am sure that the judges who wrote these words did so with the best of intentions, expecting fairness opinions to become the bulwark against self-dealing in mergers and acquisitions. In the decades since, through a combination of bad banking practices, the nature of the legal process and confusion about the word "fairness", fairness opinions, in my view, have not just lost their power to protect those that they were intended to but have become a shield used by managers and boards of directors against serious questions being raised about deals. 

Fairness Opinions: Current Practice?

There are appraisers who take their mission seriously and evaluate the fairness of transactions in their opinions, but the Tesla/Solar City valuations reflect not only how far we have strayed from the original idea of fairness but also how much bankers have lowered the bar on what constitutes acceptable practice.  Consider the process that Lazard and Evercore used by  to arrive at their fairness opinions in the Tesla/Solar City deal, and if Matt is right, they are not alone:

What about this process is fair, if bankers are allowed to concoct discount rates, and how is it an opinion, if the numbers are supplied by management? And who exactly is protected if the end result is a range of values so large that any price that is paid can be justified?  And finally, if the contention is that the bankers were just using professional judgment, in what way is it professional to argue that Tesla will become the global economy (as Evercore is doing in its valuation)? 

To the extent that what you see in the Tesla/Solar City deal is more the rule than the exception, I would argue that fairness opinions are doing more harm than good. By checking off a legally required box, they have become a way in which a board of directors buy immunization against legal consequences. By providing the illusion of oversight and an independent assessment, they are making shareholders too sanguine that their rights are being protected. Finally, this is a process where the worst (and least) scrupulous appraisers, over time, will drive out the best (and most principled) ones, because managers (and boards that do their bidding) will shop around until they find someone who will attest to the fairness of their deal, no matter how unfair it is. My interest in the process is therefore as much professional, as it is personal. I believe the valuation practices that we see in many fairness opinions are horrendous and are spilling over into the other valuation practices.

It is true that there are cases, where courts have been willing to challenge the "fairness" of fairness opinions, but they have been infrequent and  reserved for situations where there is an egregious conflict of interest. In an unusual twist, in a recent case involving the management buyout of Dell at $13.75 by Michael Dell and Silver Lake, Delaware Vice Chancellor Travis Lester ruled that the company should have been priced at $17.62, effectively throwing out the fairness opinion backing the deal. While the good news in Chancellor Lester's ruling is that he was willing to take on fairness opinions, the bad news is that he might have picked the wrong case to make his stand and the wrong basis (that markets are short term and under price companies after they have made big investments) for challenging fairness opinions.

Fish or Cut Bait?

Given that the fairness opinion, as practiced now, is more travesty than protection and an expensive one at that, the first option is to remove it from the acquisition valuation process. That will put the onus back on judges to decide whether shareholder interests are being protected in transactions. Given how difficult it is to change established legal practice, I don't think that this will happen. The second is to keep the fairness opinion and give it teeth. This will require two ingredients to work, judges that are willing to put fairness opinions to the test and punishment for those who consistently violate those fairness principles.

A Judicial Check

Many judges have allowed bankers to browbeat them into accepting the unacceptable in valuation, using the argument that what they are doing is standard practice and somehow professional valuation.  As someone who wanders across multiple valuation terrain, I am convinced that the valuation practices in fairness opinions are not just beyond the pale, they are unprofessional. To those judges, who would argue that they don't have the training or the tools to detect bad practices, I will make my pro bono contribution in the form of a questionnaire with flags (ranging from red for danger to green for acceptable) that may help them separate the good valuations from the bad ones.

Question	Green	Red
Who is paying you to do this valuation and how much? Is any of the payment contingent on the deal happening? (FINRA rule 2290 mandates disclosure on these)	Payment reflects reasonable payment for valuation services rendered and none of the payment is contingent on outcome	Payment is disproportionately large, relative to valuation services provided, and/or a large portion of it is contingent on deal occurring.
Where are you getting the cash flows that you are using in this valuation?	Appraiser estimates revenues, operating margins and cash flows, with input from management on investment and growth plans.	Cash flows supplied by management/ board of company.
Are the cash flows internally consistent?	1.     Currency: Cash flows & discount rate are in same currency, with same inflation assumptions. 2.     Claim holders: Cash flows are to equity (firm) and discount rate is cost of equity (capital). 3.     Operations: Reinvestment, growth and risk assumptions matched up.	No internal consistency tests run and/or DCF littered with inconsistencies, in currency and/or assumptions. -       High growth + Low reinvestment -       Low growth + High reinvestment -       High inflation in cash flows + Low inflation in discount rate
What discount rate are you using in your valuation?	A cost of equity (capital) that starts with a sector average and is within the bounds of what is reasonable for the sector and the market.	A cost of equity (capital) that falls outside the normal range for a sector, with no credible explanation for difference.
How are you applying closure in your valuation?	A terminal value that is estimated with a perpetual growth rate < growth rate of the economy and reinvestment & risk to match.	A terminal value based upon a perpetual growth rate > economy or a multiple (of earnings or revenues) that is not consistent with a healthy, mature firm.
What valuation garnishes have you applied?	None.	A large dose of premiums (control, synergy etc.) pushing up value or a mess of discounts (illiquidity, small size etc.) pushing down value.
What does your final judgment in value look like?	A distribution of values, with a base case value and distributional statistics.	A range of values so large that any price can be justified.

If this sounds like too much work, there are four changes that courts can incorporate into the practice of fairness opinions that will make an immediate difference:

1. Deal makers should not be deal analysts: It should go without saying that a deal making banker cannot be trusted to opine on the fairness of the deal, but the reason that I am saying it is that it does happen. I would go further and argue that deal makers should get entirely out of the fairness opinion business, since the banker who is asked to opine on the fairness of someone else's deal today will have to worry about his or her future deals being opined on by others.
2. No deal-contingent fees: If bias is the biggest enemy of good valuation, there is no simpler way to introduce bias into fairness opinions than to tie appraisal fees to whether the deal goes through. I cannot think of a single good reason for this practice and lots of bad consequences. It should be banished.
3. Valuing and Pricing: I think that appraisers should spend more time on pricing and less on valuation, since their focus is on whether the "price is fair" rather than on whether the transaction makes sense. That will require that appraisers be forced to justify their use of multiples (both in terms of the specific multiple used, as well as the value for that multiple) and their choice of comparable firms. If appraisers decide to go the valuation route, they should take ownership of the cash flows, use reasonable discount rates and not muddy up the waters with arbitrary premiums and discounts. And please, no more terminal values estimated from EBITDA multiples!
4. Distributions, not ranges: In my experience, using a range of value for a publicly traded stock to determine whether a price is fair is useless. It is analogous to asking, "Is it possible that this price is fair?", a question not worth asking, since the answer is almost always "yes". Instead, the question that should be asked and answered is "Is it plausible that this price is a fair one?"  To answer this question, the appraiser has to replace the range of values with a distribution, where rather than treat all possible prices as equally likely, the appraiser specifies a probability distribution. To illustrate, I valued Apple in May 2016 and derived a distribution of its values:

Let's assume that I had been asked to opine on whether a $160 stock price is a fair one for Apple. If I had presented this valuation as a range for Apple's value from $80.81 to $415.63, my answer would have to be yes, since it falls within the range. With a distribution, though, you can see that a $160 price falls at the 92nd percentile, possible, but neither plausible, nor probable.  To those who argue that this is too complex and requires more work, I would assume that this is at the minimum what you should be delivering, if you are being paid millions of dollars for an appraisal.

Punishment
The most disquieting aspect of the acquisition business is the absence of consequences for bad behavior, for any of the parties involved, as I noted in the aftermath of the disastrous HP/Autonomy merger. Thus, managers who overpay for a target are allowed to use the excuse of "we could not have seen that coming" and the deal makers who aided and abetted them in the process certainly don't return the advisory fees, for even the most abysmal advice. I think while mistakes are certainly part of business, bias and tilting the scales of fairness are not and there have to be consequences:

1. For the appraisers: If the fairness opinion is to have any heft, the courts should reject fairness opinions that don't meet the fairness test and remove the bankers involved  from the transaction, forcing them to return all fees paid. I would go further and create a Hall of Shame for those who are repeat offenders, with perhaps even a public listing of their most extreme offenses. 
2. For directors and managers: The boards of directors and the top management of the firms involved should also face sanctions, with any resulting fines or fees coming out of the pockets of directors and managers, rather than the shareholders involved.

I know that your reaction to these punitive suggestions is that they will have a chilling effect on deal making. Good! I believe that much as strategists, managers and bankers like to tell us otherwise, there are more bad deals than good ones and that shareholders in companies collectively will only gain from crimping the process.

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Attachments

1. The Fairness Questionnaire (as a word file, which you are free to add to or adapt)

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Keystone Kop Valuations: Lazard, Evercore and the TSLA/SCTY Deal

It is get easy to get outraged by events around you, but I have learned, through hard experience, that writing when outraged is dangerous. After all, once you have climbed onto your high horse, it is easy to find fault with others and wallow in self-righteousness. It is for that reason that I have deliberately avoided taking issue with investment banking valuations of specific companies, much as I may disagree with the practices used in many of them. I understand that bankers make money on transactions and that their valuations are more sales tools than assessments of fair value and that asking them to pay attention to valuation first principles may be asking too much. Once in a while, though, I do come across a valuation so egregiously bad that I cannot restrain myself and reading through the prospectus filed by Tesla for their Solar City acquisition/merger was such an occasion. My first reaction as I read through the descriptions of how the bankers in this deal (Evercore for Tesla and Lazard for Solar City) valued the two companies was "You must be kidding me!".

The Tesla/Solar City Deal

In June 2016, Tesla announced that it intended to acquire Solar City in a stock swap, a surprise to almost everyone involved, except for Elon Musk. By August 1, the specifics of the deal had been ironed out and the broad contours of the deal are captured in the picture below:

At the time of the deal, Mr. Musk contended that the deal made sense for stockholders in both companies, arguing that it was a "no-brainer" that would allow Tesla to expand its reach and become a clean energy company. While Mr. Musk has a history of big claims and perhaps the smarts and charisma to deliver on them, this deal attracted attention because of its optics. Mr. Musk was the lead stockholder in both companies and CEO of Tesla and his cousin, Lyndon Rive, was the CEO of Solar City. Even Mr. Musk's strongest supporters could not contest the notion that he was in effective control at both companies, creating, at the very least. the potential for conflicts of interests. Those questions have not gone away in the months since and the market concerns have been reflected in the trend lines in the stock prices of the two companies, with Solar City down about 24% and Tesla's stock price dropping about 8%.

The board of directors at Tesla has recognized the potential for a legal backlash and as this New York Times article suggests, they have been careful to create at least the appearance of an open process, with Tesla's board hiring Evercore Partners, an investment bank, to review the deal and Solar City's board calling in Lazard as their deal assessor. Conspicuously missing is Goldman Sachs, the investment banker on Tesla's recent stock offering, but more about that later.

The Banking Challenge in a Friendly Merger

In any friendly merger, the bankers on the two sides of the deal face, what at first sight, looks like an impossible challenge. The banker for the acquiring company has to convince the stockholders of the acquiring company that they are getting a good deal, i.e., that they are acquiring the target company at a price, which while higher that the prevailing market price, is lower than the fair value for the company. At the same time, the banker for the target company has to convince the stockholders of the target company that they too are getting a good deal, i.e., that they are being acquired at is higher than their fair value. If you are a reasonably clever banking team, you discover very quickly that the only way you can straddle this divide is by bringing in what I call the two magic merger words, synergy and control. Synergy in particular is magical because it allows both sides to declare victory and control adds to the allure because it comes with the promise of unspecified changes that will be made at the target company and a 20% premium:

In the Tesla/Solar City deal, the bankers faced a particularly difficult challenge. Finding synergy in this merger of an electric car company and a solar cell company, one of which (Tesla) has brand name draw and potentially high margins and the other of which is a commodity business (Solar City) with pencil thin margins) is tough to do. Arguing that the companies will be better managed as one company is tricky when both companies have effectively been controlled by the same person(Musk) before the merger. In fact, it is far easier to make the case for reverse synergy here, since adding a debt-laden company with a questionable operating business (Solar City) to one that has promise but will need cash to deliver seems to be asking for trouble. The bankers could of course have come back and told the management of both companies (or just Elon Musk) that the deal does not make sense and especially so for the stockholders of Tesla but who can blame them for not doing so? After all, they are paid based upon whether the deal gets done and if asked to justify themselves, they would argue that Musk would have found other bankers who would have gone along. Consequently, I am not surprised that both banks found value in the deal and managed to justify it.

The Valuations

It is with this perspective in mind that I opened up the prospectus, expecting to see two bankers doing what I call Kabuki valuations, elaborately constructed DCFs where the final result is never in doubt, but you play with the numbers to make it look like you were valuing the company. Put differently, I was willing to cut a lot of slack on specifics, but what I found failed even the minimal tests of adequacy in valuation. Summarizing what the banks did, at least based upon the prospectus (lest I am accused of making up stuff):

Tesla Prospectus

Conveniently, these number provide backing for the Musk acquisition story, with Evercore reassuring Tesla stockholders that they are getting a good deal and Lazard doing the same with Solar City stockholders, while shamelessly setting value ranges so wide that they get legal cover, in case they get sued.  Note also not only how much money paid to these bankers for their skills at plugging in discount rates into spreadsheets but that both bankers get an additional payoff, if the merger goes through, with Evercore pocketing an extra $5.25 million and Lazard getting 0.4% of the equity value of Solar City.  There are many parts of these valuations that I can take issue with, but in the interests of fairness, I will start with what I term run-of-the-mill banking malpractice, i.e., bad practices that many bankers are guilty of.

1. No internal checks for consistency: There is almost a cavalier disregard for the connection between growth, risk and reinvestment. Thus, when both banks use ranges of growth for their perpetual value estimates, it looks like neither adjusts the cash flows as growth rates change. (Thus, when Lazard moves its perpetual growth rate for Solar City from 1.5% to 3%, it looks like the cash flow stays unchanged, a version of magical growth that can happen only on a spreadsheet).
2. Discount Rates: Both companies pay lip service to standard estimation technology (with talk of the CAPM and cost of capital), and I will give both bankers the benefit of the doubt and attribute the differences in their costs of capital to estimation differences, rather than to bias.  The bigger question, though, is why the discount rates don't change as you move through time to 2021, where both Tesla and Solar City are described as slower growth, money making companies.
3. Pricing and Valuation: I have posted extensively on the difference between pricing an asset/business and valuing it and how mixing the two can yield a incoherent mishmash. Both investment banks move back and forth between intrinsic valuation (in their use of cash flows from 2016-2020) and pricing, with Lazard estimating the terminal value of Tesla using a multiple of EBITDA. (See my post on dysfunctional DCFS, in general, and Trojan Horse DCFs, in particular).

There are two aspects of these valuations that are the over-the-top, even by banking valuation standards:

1. Outsourcing of cash flows: It looks like both bankers used cash flow forecasts provided to them by the management. In the case of Tesla, the expected cash flows for 2016-2020 were generated by Goldman Sachs Equity Research (GSER, See Page 99 of prospectus) and for Solar City, the cash flows for that same period were provided by Solar City, conveniently under two scenarios, one with a liquidity crunch and one without. Perhaps, Lazard and Evercore need reminders that if the CF in a DCF is supplied to you by someone else,  you are not valuing the company, and charging millions for plugging in discount rates into preset spreadsheets is outlandish. 
2. Terminal Value Hijinks: The terminal value is, by far, the biggest single number in a DCF and it is also the number where the most mischief is done in valuation. While some evade these mistakes by using pricing, there is only one consistent way to get terminal value in a DCF and that is to assume perpetual growth. While there are a multitude of estimation issues that plague perpetual growth based terminal value, from not adjusting the cost of capital to reflect mature company status to not modifying the reinvestment to reflect stable growth, there is one mistake that is deadly, and that is assuming a growth rate that is higher than that of the economy forever. With that context, consider these clippings from the prospectus on the assumptions about growth forever made by Evercore in their terminal value calculations:
   

   

   Tesla Prospectus

   I follow a rule of keeping the growth rate at or below the risk free rate but I am willing to accept the Lazard growth range of 1.5-3% as within the realm of possibility, but my reaction to the Evercore assumption of 6-8% growth forever in the Tesla valuation or even the 3-5% growth forever with the Solar City valuation cannot be repeated in polite company. 

Not content with creating one set of questionable valuations, both banks doubled down with a number of  of other pricing/valuations, including sum-of-the-parts valuations, pricing and transaction premiums, using a "throw everything at the fan and hope something sticks" strategy.

Now what? 

I don't think that Tesla's Solar City acquisition passes neither the smell test (for conflict of interest) nor the common sense test (of creating value), but I am not a shareholder in either Tesla or Solar City and I don't get a vote. When Tesla shareholders vote, given that owning the stock is by itself an admission that they buy into the Musk vision, I would not be surprised if they go along with his recommendations. Tesla shareholders and Elon Musk are a match made in market heaven and I wish them the best of luck in their life together.

As for the bankers involved in this deal, Lazard's primary sin is laziness, accepting an assignment where they are reduced to plugging in discount rates into someone else's cash flow forecasts and getting paid $2 million plus for that service. In fact, that laziness may also explain the $400 million debt double counting error made by Lazard on this valuation,. Evercore's problems go deeper. The Evercore valuation section of the prospectus is a horror story of bad assumptions piled on impossible ones, painting a picture of ignorance and incompetence. Finally, there is a third investment bank (Goldman Sachs), mentioned only in passing (in the cash flow forecasts provided by their equity research team), whose absence on this deal is a story by itself. Goldman's behavior all through this year, relating to Tesla, has been rife with conflicts of interest, highlighted perhaps by the Goldman equity research report touting Tesla as a buy, just before the Tesla stock offering. It is possible that they decided that their involvement on this deal would be the kiss of death for it, but I am curious about (a) whether Goldman had any input into the choice of Evercore and Lazard as deal bankers, (b) whether Goldman had any role in the estimation of Solar City cash flows, with and without liquidity constraints, and (c) how the Goldman Sachs Equity Research forecast became the basis for the Tesla valuations. Suspicious minds want to know! As investors, the good news is that you have a choice of investment bankers but the bad news is that you are choosing between the lazy, the incompetent and the ethically challenged.

If there were any justice in the world, you would like to see retribution against these banks in the form of legal sanctions and loss of business, but I will not hold my breath waiting for that to happen. The courts have tended to give too much respect for precedence and expert witnesses, even when the precedent or expert testimony fails common sense tests and it is possible that these valuations, while abysmal, will pass the legally defensible test. As for loss of business, my experience in valuation is that rather than being punished for doing bad valuations, bankers are rewarded for their deal-making prowess. So, for the many companies that do bad deals and need an investment banking sign-off on that deal (in the form of a fairness opinion), you will have no trouble finding a banker who will accommodate you.

If this post comes across as a diatribe against investment banking, I am sorry and I am not part of the "Blame the Banks for all our problems" school. In fact, I have long argued that bankers are the lubricants of a market economy, working through kinks in the system and filling in capital market needs and defended banking against its most virulent critics. That said, the banking work done on deals like the this one vindicate everyone's worst perceptions of bankers as a hired guns who cannot shoot straight, more Keystone Kops than Wyatt Earps!

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Attachments

1. Tesla Prospectus for Solar City Deal

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Winning at a Loser's Game? Control, Synergy and the ABInBev/SABMiller Merger!

I have been a long time investor in ABInBev, though I became one indirectly and accidentally, through a stake I took a long time ago in Brahma, a Brazilian beverage company . That company became Ambev in 1999, which in turn was merged with Interbrew, the Belgian brewer, in 2004, and expanded to include Anheuser Busch, the US beer maker, in 2008 to become the largest beer manufacturer in the world.  I made the bulk of my money early in my holding life, but Amber has remained in my portfolio, a place holder that provides me exposure to both the beverage business and Latin America, while delivering mostly positive returns. It was thus with trepidation that I read the news report in mid-September that ABInBev (which owns 62% of Ambev) had approached SABMiller about a takeover at a still-to-be-specified premium over the the latter's market value. While it is entirely possible to create value from acquisitions, I have argued that creating growth through acquisitions is difficult to do, and doubly so when the acquisition is of a large public company. Since ABInBev's control rests with 3G Capital, a group that I respect for its investment acumen, it would be unfair to prejudge this deal without looking at the numbers. So, here we go!

The Fog of Deal Making: Breaking down an acquisition

The first casualty in deal making is good sense, as the fog of the deal, created by bankers, managers, consultants and journalists, clouds the numbers. Not only do you see "control" and "synergy", two words that I include in my weapons of mass distraction, thrown around casually to justify billions of dollars in premiums, but you also see them used interchangeably. When you acquire a company, there are three (and only three possible) motives that are consistent with intrinsic value. 

1. Undervaluation: You buy a target company because you believe that the market is mispricing the company and that you can buy it for less than its "fair" value. In effect, you are behaving like any value investor would in the market and there is no need for you to either change the way the target company is run or look for synergy benefits. 
2. Control: You buy a company that you believe is badly managed, with the intent of changing the way it is run. If you are right on the first count and can make the necessary changes, the value of the firm should increase under your management. If you can pay less than the "changed" value, you can claim the difference for yourself (and your stockholders). 
3. Synergy: You buy a company that you believe, when combined with a business (or resource) that you already own, will be able to do things that you could not have done as separate entities. Broadly speaking, you can break synergy down into "offensive synergies" (where you are able to grow faster in existing or new markets than you would have as standalone businesses and/or charge higher prices for your products), "defensive synergies" (where you are able to reduce costs or slow down/prevent decline in your businesees) and "tax synergies" (where you directly take advantage of tax clauses or indirectly by being able to borrow more money). 

The key distinction between synergy and control is that control does not require another entity or even a change in managers. It can be accomplished by the target company's management, if they put their minds to it and perhaps hire some help. Synergy requires two entities coming together and stems from the combined entity's capacity to do something that the individual entities would not have been able to deliver. Note that these motives can co-exist in the same acquisition and are not mutually exclusive.  To assess whether these motives apply (or make sense), there are four numbers that you need to track: 

1. Acquisition Price: This is the price at which you can acquire the target company. If it is a private business, it will be negotiated and probably based on what others are paying for similar businesses. If it is a public company, it will be at a premium over the market price, with the premium a function of the state of the M&A market and whether you have other potential bidders. 
2. Status Quo Value: This is the value of the target company, run by existing management and based on existing investing, financing and dividend policies. 
3. Restructured Value: This is the value of the target company, with changes to investing, financing and dividend policies. 
4. Synergy value: This can be estimated by valuing the combined company (with the synergy benefits built in) and subtracting out the value of the acquiring company, as a stand alone entity, and the restructured value of the target company. 

Connecting these numbers to the motives, here are the conditions you would need for each motive to make sense (by itself).

Motive	Test
Undervaluation	Acquisition Price < Status Quo Value
Control	Acquisition Price < Restructured Value (Status Quo Value + Value of Control
Synergy	Acquisition Price < Restructured Value + (Value of Combined company with synergy - Value of Combined company without synergy)

Which of these motives, if any, is driving ABInBev's acquisition of SABMiller, and whatever the motive or motives, is the premium being paid justified? To make that assessment, I will compute each of the four numbers for this deal.

Setting up the ABInBev Deal

The first news stories on ABInBev’s intent to buy SABMiller came out on September 15, 2015, though there may have been inklings among some who are more connected than I am. While no price was specified, the market’s initial reaction was positive, with both ABInBev and SABMiller’s stock prices increasing on the story. The picture below captures the key details of the deal, including both possible rationale and consequences:

There were two key reasons provided to rationalize the potential deal. The first is geographic complementarity, since these two companies overlap in surprisingly few parts of the world, given their size. ABInBev is the largest player in Latin America, with Brazil at its center, and SABMiller is the biggest brewer in Africa. SABMiller’s Latin American operations are outside of Brazil, for the most part and while ABInBev has significant North American operations, SABMiller's North American exposure is entirely through its Coors Joint Venture. While no specifics are provided, the basis for synergy seems to be that after this deal, ABInBev will be able to expand sales in the fastest growing market in the world (Africa) and that SABMiller will be able to increase its revenues in the most profitable market in the world (Latin America). The second is consolidation, a vastly over used term that often means nothing, but  if it tied to specifics, relates to potential costs savings and economies of scale. While the absence of geographic overlap may reduce the potential for cost cutting, ABInBev can use the template that it has used so successfully on prior deals (especially the Grupo Modelo acquisition) to cut costs in this acquisition as well.

There are also negative consequences that follow from this deal. The first is that when anti trust regulators in different parts of the world will be paying close attention to this deal, and it seems likely that SABMiller will be forced to sell its 58% stake in MillerCoors and that Molson Coors, the other JV partner, will be the beneficiary. The second, and this adds to the pressure, ABInBev has agreed to pay $3 billion to SABMiller if the deal falls through.  In summary, though, the challenge is a simple one. ABInBev is paying a $29 billion premium to acquire SABMiller. Is there enough value added to ABInBev's stockholders that they will be able to walk away as winners?

The Players in the Deal
To make a value judgment of this deal, we have to begin by looking at ABInBev and SABMiller, as stand alone companies, prior to this deal. In the picture below, I start with a snapshot of ABInBev:

Capital Mix		Operating Metrics		Geographical Mix
Interest-bearing Debt	$51,504	Revenues	$45,762	Latin America	$18,849.00	42.03%
Lease Debt	$1,511	Operating Income (EBIT)	$14,772	Africa	$-	0.00%
Market Capitalization	$173,760	Operating Margin	32.28%	Asia Pacific	$5,040.00	11.24%
Debt to Equity ratio	30.51%	Effective tax rate	18.00%	Europe	$4,865.00	10.85%
Debt to Capital ratio	23.38%	After-tax return on capital	12.10%	North America	$16,093.00	35.88%
Bond Rating	A2	Reinvestment Rate =	50.99%	Total	$44,847.00	100.00%

Looking past the numbers, it is worth noting that not only does ABInBev has a history of growing successfully through acquisitions but that its lead stockholder, 3G Capital, is considered a shrewd allocator and steward of capital.

On the other other side of the deal stands SABMiller, and the picture below provides a sense of the company's standing at the time of the deal:

Capital Mix		Operating Metrics		Geographical Mix
Interest-bearing Debt	$12,550	Revenues	$22,130	Latin America	$7,812	35.30%
Lease Debt	$368	Operating Income (EBIT)	$4,420	Africa	$6,853	30.97%
Market Capitalization	$75,116	Operating Margin	19.97%	Asia Pacific	$3,136	14.17%
Debt to Equity ratio	17.20%	Effective tax rate	26.40%	Europe	$4,186	18.92%
Debt to Capital ratio	14.67%	After-tax return on capital	10.32%	North America	$143	0.65%
Bond Rating	A3	Reinvestment Rate =	16.02%	Total	$22,130	100.00%

This table, though, misses SAB's holdings in the MillerCoors JV and its other minority holdings in associates around the world, and the numbers for SAB's shares of these are summarized below:

SAB Share of Other Associates
Operating Metrics		Geographical Mix
Revenues	$6,099.00	Latin America	$-	0.00%
Operating Income (EBIT)	$654.00	Africa (mostly South Africa)	$2,221	36.42%
Operating Margin	10.72%	Asia Pacific	$2,203	36.12%
Effective tax rate	25.00%	Europe	$1,675	27.46%
After-tax return on capital	11.00%	North America	$-	0.00%
Invested Capital	$4,459	Total	$6,099	100.00%
SAB Share of MillerCoors JV
Operating Metrics		Geographical Mix
Revenues	$5,201.00	Latin America	$-	0.00%
Operating Income (EBIT)	$800.00	Africa (mostly South Africa)	$-	0.00%
Operating Margin	15.38%	Asia Pacific	$-	0.00%
Effective tax rate	25.00%	Europe	$-	0.00%
After-tax return on capital	11.05%	North America	$5,201	100.00%
Invested Capital	$5,428	Total	$5,201	100.00%

The numbers reinforce my earlier point about geographic complementarity at least at the parent company level, with ABInBev getting a large percent of its Latin American sales in Brazil and SABMiller getting most of its Latin American sales from countries other than Brazil.

Is SABMiller a bargain?

The first step in this analysis to a valuation of SABMiller, as a stand alone company and with its existing management in place. Based on the numbers, this is a conservatively run company (both in terms of use of debt and reinvestment for growth) and the valuation reflects that:

	SAB Miller	+ 58% of Coors JV	+ Share of Associates	SAB Miller Consolidated
Revenues	$22,130.00	$5,201.00	$6,099.00
Operating Margin	19.97%	15.38%	10.72%
Operating Income (EBIT)	$4,420.00	$800.00	$654.00
Invested Capital	$31,526.00	$5,428.00	$4,459.00
Beta	0.7977	0.6872	0.6872
ERP	8.90%	6.00%	7.90%
Cost of Equity =	9.10%	6.12%	7.43%
After-tax cost of debt =	2.24%	2.08%	2.24%
Debt to Capital Ratio	14.67%	0.00%	0.00%
Cost of capital =	8.09%	6.12%	7.43%
After-tax return on capital =	10.33%	11.05%	11.00%
Reinvestment Rate =	16.02%	40.00%	40.00%
Expected growth rate=	1.65%	4.42%	4.40%
Number of years of growth	5	5	5
Value of firm
PV of FCFF in high growth =	$11,411.72	$1,715.25	$1,351.68
Terminal value =	$47,711.04	$15,094.36	$9,354.28
Value of operating assets today =	$43,747.24	$12,929.46	$7,889.56	$64,566.26
+ Cash				$1,027.00
- Debt				$12,918.00
- Minority Interests				$1,183.00
Value of equity				$51,492.26

 I am adding in my estimated values for SAB's share of the Coor's JV and other associates to arrive at the total value of the operating assets. In valuing each piece, I have estimated equity risk premiums that reflect where each one operates, using a 6% mature market premium for the Coors JV, since it generates most of its revenues in North America, and much higher premiums for the other two parts. At least based on my estimates, the value of equity is $51.5 billion, well below the market capitalization of $75 billion on September 15. (This may be cynical of me, but if used (wrongly in my view) a 6% equity risk premium for SABMiller, based on its UK incorporation, I get a value of $76 billion for its equity.)

Bottom line: To me, SABMiller does not look like it is priced to be a bargain, even at the pre-deal price, and definitely not at the deal price.

The Value of Control

Is SABMiller ripe for a restructuring? It is tough to tell from the outside but one way to measure room for improvement is to compare the company on key corporate finance measures against both the acquirer (InBev) and the rest of the alcholic beverage sector:

	SABMiller	ABInBev	Global Alcoholic Beverage Sector
Pre-tax Operating Margin	19.97%	32.28%	19.23%
Effective Tax Rate	26.36%	18.00%	22.00%
Pre-tax ROIC	14.02%	14.76%	17.16%
ROIC	10.33%	12.10%	13.38%
Reinvestment Rate	16.02%	50.99%	33.29%
Debt to Capital	14.67%	23.38%	18.82%

This comparison may be simplistic, but it looks like SABMiller lags the sector is in its reinvestment rate and return on capital, and that it earns a profit margin that match up to the sector. It also has a debt ratio that is not far off from the sector average. ABInBev has a much higher profit margin than the rest of the sector and pays a lower tax rate. I revalued SABMiller with the return on capital, debt ratio and reinvestment rate set equal to the industry average. (I considered using ABInBev's operating margin but much of that comes from Brazil and it is unlikely that SABMiller can match it in South Africa or the rest of Latin America.

	Status Quo Value	Restructured	Changes made
Cost of Equity =	9.10%	9.37%	Increases with debt ratio
After-tax cost of debt =	2.24%	2.24%	Left unchanged
Debt to Capital Ratio	14.67%	18.82%	Set to industry average
Cost of capital =	8.09%	8.03%	Due to debt ratio change
Pre-tax return on capital	14.02%	17.16%	Set to industry average
After-tax return on capital =	10.33%	12.64%	Result of pre-tax ROIC change
Reinvestment Rate =	16.02%	33.29%	Set to industry average
Expected growth rate=	1.65%	4.21%	Result of reinvestment/ROIC
Value of firm
PV of FCFF in high growth =	$11,411.72	$9,757.08
Terminal value =	$47,711.04	$56,935.06
Value of operating assets today =	$43,747.24	$48,449.42
+ Cash	$1,027.00	$1,027.00
+ Minority Holdings	$20,819.02	$20,819.02
- Debt	$12,918.00	$12,918.00
- Minority Interests	$1,183.00	$1,183.00	Value of Control
Value of equity	$51,492.26	$56,194.44	$4,702.17

Bottom line: Changing the way SABMiller is run adds about $4.7 billion to the value, but even with that addition, the equity value of $56.2 billion is still far below what ABInBev paid on October 15. That suggests that control was not the primary rationale either.

The Value of Synergy

This leaves us with only one option, synergy, and to value synergy, I valued ABInBev as a standalone company and put it together with the restructured value of SABMiller to get a combined company value, with no synergy. I then assumed that the synergy (from geographic complementarity and consolidation) would manifest itself in a higher operating margin, higher reinvestment and a higher growth rate for the combined company:

	Inbev	SABMiller	Combined firm (no synergy)	Combined firm (synergy)	Actions
Cost of Equity =	8.93%	9.37%	9.12%	9.12%
After-tax cost of debt =	2.10%	2.24%	2.10%	2.10%
Cost of capital =	7.33%	8.03%	7.51%	7.51%	No changes expected
Operating Margin	32.28%	19.97%	28.27%	30.00%	Cost cutting & Economies of scale
After-tax return on capital =	12.10%	12.64%	11.68%	12.00%	Cost cutting also improves return on capital
Reinvestment Rate =	50.99%	33.29%	43.58%	50.00%	More aggressive reinvestment in shared markets
Expected growth rate=	6.17%	4.21%	5.09%	6.00%	Higher growth because of reinvestment
Value of firm
PV of FCFF in high growth =	$28,732.57	$9,806.49	$38,539.06	$39,150.61
Terminal value =	$260,981.86	$58,735.57	$319,717.43	$340,174.63	Value of Synergy
Value of operating assets =	$211,952.80	$50,065.35	$262,018.16	$276,609.92	$14,591.76

It is possible that I have been too pessimistic about the potential cost savings or growth possibilities, but given the history of synergy in big deals, I think that I am being optimistic. Based on my estimates at least, the value of synergy in this deal is $14.6 billion (and that is assuming it is delivered instantaneously).
Bottom line: If synergy is the motive for this deal, a great deal has to go right for ABInBev to break even on this deal, let alone create value.

The Disconnect
The history of 3G Capital as successful value creators predisposed me to give them the benefit of the doubt, when I started assessing the deal. After looking at the numbers, though, I don't see the value in this deal that would justify the premium paid. It is possible, perhaps even likely, that there is some aspect of the deal, perhaps taxes or other benefits, that I am not grasping. If so, I would encourage you to use my template, change the numbers that you think need to be changed, make your own assessment and enter them in this shared Google spreadsheet. It is also possible that even the smartest investors in the world can sometimes let over confidence drive them to over react. Time will tell!

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Data Attachments

1. ABInBev Annual Report (2014)
2. SABMiller Annual Report (2015)

Spreadsheets

1. SABMiller: Status Quo and Control Value
2. Value of Synergy 
3. Google Shared Spreadsheet for Deal Analysis

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