BRAZILIAN BEER MERGER NEGOTIATIONS:

COMPANHIA CERVEJARIA BRAHMA, S.A.

BUSINESS ANALYSIS AND EVALUATION
Prof. Arturo Capasso

Prepared By
Carullo Danilo
Di Serio Mario
Hossain Shahadat

15th June 2014

1.

Estimate the value of synergies and the maximum intrinsic value

per share of Antarctica.
[(Antartica Equity value + Value of synergies)/number of share]

For estimating value of synergy and maximum Intrinsic value of Synergy, we consider the
Discounted Cash Flow Method (DCF). As per literature, Kaplan & Ruback (1996), the Free CashFlow to the Firm Model (FCFF) is the most commonly-used DCF approach. We consider thsi approach
has the relative advantage on other methods to estimate the intrinsic value and value of synergy in
this merger deal for the given data. We follow the two-stage model for valuing the cash flow. As
we are given with the estimated cash flow for five years (200-2004) . These periods of cash flow
account for the first stage and the second stage accounts for all the remaining expected cash flow
after 2004 as perpetuity. To have a fair valuation, we should have some assumptions and definitions
consistent with the given data and established method of valuation in literatures. Our working notes
comprises with different definitions and assumption what we do not use explicitly in the following
section of calculation. The valuation data are estimated in spreadsheet, enclosed here with, taking
UVA-F-1418X as source file.
Valuation Input :
Cost of capital :
Cost of Debt before tax
Cost of equity
WACC (discount rate ) after tax
Terminal growth rate

Brahma

Antarctica

NEWCO

15%
14.82
14.24%
9.4%

15%
14.44
13.96%
9.2%

15%
14.44
14.24%
9.4%

Weight of capital structure (Note-3)

Debt 31%
Equity 69%
Effective tax rate 14%
(All calculations are based on the attached spread sheet)
Stand alone value of Antarctica (in million) = 3667.50
Equity value of Antarctica (in million) :
= stand alone value of Antarctica- value of net Debt
= 3667.50-1135.30
= 2532.30
Stand alone value of Brahma (in million) : 8186.67
Equity value of Brahma (in million) :
= Stand alone value of Brahma- value of net Debt Minority Interest
= 8186.67-110.00-57.5
= 8019.17
Merged Value of Brahma and Antarctica without synergy (in millions) :
= Stand alone value of Antarctica+ standalone value of Brahma
= 11854.20
Merged value of Brahma and Antarctica with Synergy (in million) = 13703.80

Value of synergy (in million) = ( Merged value of Brahma and Antarctica with Synergy)-( Merged
Value of Brahma and Antarctica without synergy
= 1849.6

2.

What are the relative merits of cash and common stock as form
of payment in this deal?
In your view, does the amount of consideration to be paid depend
on the form of payment?
Why or why not?

Brahma can raise the funds for an acquisition from either debt or equity. The mix will generally
depend upon both the excess debt capacities of the acquiring and the target firm. Now both the firm
operating at a higher debt structure then the expected long-term debt as a percentage of debt and
equity of 31% (UVA-F-1418, p-9), so it should not be wise to raise debt for financing the deal. Lets
assume Brahma prefers equity, there are three ways in which Bramha can use it:
to use cash balances;
to issue stock to the public, raise cash and use it;
to offer stock as payment for the target firm.

The best approach depends on several factors like the availability of cash on hand , the perceived
value of the stock, synergy risks, tax factors and accounting considerations.
Cash payment relative merits: Managers who believe that their stock is trading at a price
significantly below than intrinsic value should not use stock as currency on acquisitions, since what
they gain on the acquisitions can be more than what they lost in the stock issue. The decision to use
stock or cash also sends signals about the acquirers estimation of the risk of failing to achieve the
expected synergy from the deal. If Brahma is really confident then it would be expected to pay for
the acquisition with cash so that its share holder would not have to give any of the anticipated
merger gains to the acquired companys shareholders. By cash payment, Brahma shareholders take
on the entire risk that expected synergy value embedded in the acquisition premium will not
materialize. In addition, Brahma does not have sufficient cash to conform to its own working capital
policy to maintain a minimum cash balance of $1.2billion. Other than that the cash transactions
would trigger an immediate tax liability.
Stock swap relative merits: Acquiring firms that believe their stocks are overvalued are
much more likely to use stock as currency in transactions because the potential gain come from the
selling share holders to the acquiring shareholders. In this case, the Brahma shares are underpriced
as per our calculation, so stock transactions may seems not be good solution. But apart from that, if
Brahmas managers believe the risk of not achieving the required level of synergy is substantial,
they can be expected to try to hedge their bets by offering stock .By diluting their companys
ownership interest; they will also limit participation in any losses incurred either before or after the
deal goes through. The synergy risk is shared in proportion to the percentage of the combined
company the acquiring and selling share holder each will own. Stock transactions would also entails
the Brahma to achieve a tax-deferred deal a potential source of gaining value. The stockholders in
the target firm may be able to defer capital gains taxes on the exchanged shares. Since this benefit
can be significant in an acquisition, the potential tax gains from a stock swap may be large enough
to offset any perceived disadvantages. Finally, there might be an accounting rationale to use polling

instead of purchase method in accounting for this merger deal. This might help Brahma to avoid the
probable adverse post deal market reaction for reporting less income due to non-taxable
amortization of goodwill.
The amount paid as consideration should depend on the method of payment. Generally, the
premium paid is larger when an acquisition is financed with stock rather than cash. When Target
Companys stock holder receive cash as consideration they are certain about their value realization
but that might not straight forward in stock transaction. Stock transactions may lead the flow of gain
in a larger proportion from the selling shareholders to the buying shareholder when stock of
acquiring company is not undervalued. The risk of sharing synergy may also give the selling
shareholders a skeptical view in accepting stock of the acquiring company. So, this risk view point
justifies the more premiums in stock transaction for the selling shareholders to neutralize their risk
perspective. The stockholders in the target firm are also aware of this and may demand a larger
premium when the payment is made entirely in the form of the acquiring firms stock. Again, if
stock transaction becomes a source of value for tax and accounting reason , the share holders of the
selling company are ware about that and they may demand more premium.
3.

Assuming a share-for-share transaction, what is the maximum

exchange ratio (number of Brahma shares per Antarctica share)
that Brahma shareholders would tolerate?
What is the minimum exchange ratio that Antarctica
shareholders would tolerate?
What factors determine the maximum and minimum?

No. of outstanding share of Antarctica= 12,000,000

No. of outstanding share of Brahma = 6,907,600
Maximum Equity value of Antarctica (in million) = Equity value of Antarctica + value of synergy
= 2532.30+1849.6
= 4381.83
Maximum value per share (Intrinsic value ) for Antarctica :
= (Maximum Equity value of Antarctica)/(no. of shares outstanding)
= 365.15
Value per share (Intrinsic value) for Brahma:
= (Stand alone value of Brahma)/(no. of shares outstanding)
= 1160.92
The maximum exchange ratio (number of Brahma shares per Antarctica share), based upon value
per share, can be estimated
= Maximum value per share of Antarctica/value per share of Brahma
= 365.15/1160.92
= 0.314537 Brahma share/Antarctica share
Current Market Price of Brahma = 39.60
Current Market price of Antarctica = 637.50
Minimum exchange ratio that Antarctica share holder would tolerate can be estimated as
= Current market price per share of Antarctica/ Current market price per share
of Brahma

=0.062118Brahma share/Antarctica Share

If Bramha pay offering stock, it must set the terms of the stock swap, i.e., the number of shares of
the acquired firm that will be offered per share of the acquiring firm. While this amount is generally
based upon the market price at the time of the acquisition, the ratio that results may be skewed by
the relative mispricing of the two firms securities, with the more overpriced firm gaining at the
expense of the more underpriced (or at least, less overpriced) firm. A fairer ratio would be based
upon the relative values of the two firms shares. The correct Exchange Ratio (maximum from the
perspective to buyer shareholders) to use in a Valuation is equal to Value per Share of Target Firm
(with control premium and target-controlled synergies) divided by Value per Share of Bidding Firm.
If the target firm is indispensible for the synergy, acquiring firm should be willing to pay up to the
synergy. If it is the bidder, it should not. For minimum exchange ratio, it depends on the existing
market price of both the company. Because selling shareholders should not accept any offer below
the present market price.
4.

Prepare a brief term sheet outlining your recommendation for

the structure of a proposed combination of Brahma and
Antarctica, addressing all the issues that you believe should be
reflected in a deal between these two companies.

A negotiation which ensures the best interest of all the stake holders of Brahma and Antarctica
is vital to make this strategic deal successful. But, to draft a deal considering all those facts is very
complex. Some of these may be due to the cultural difference between the companies or may be
caused by the rivalry between their boards. This should be a problem of constrained optimization.
We recommend the deal after considering all our previous analysis as follows.
By our analysis we are convinced that NEWCO is uniquely positioned to take advantage of
regional consolidation opportunities and economics of scale, while being better protected from the
higher cost of capital associated with Brazil. The most obvious short term concern for investor is
how brazil anti-trust authorities will finally rule on the proposed merger. Mr. Telles, CEO of
Brahma, should try to convince the Anti-trust authority with the argument that this merger would
lead two Brazilian firms to become united for competing the North American common market and
as well as the Globe. a good competitor by eliminate free competition between them
Brahma should take the lead in management of NEWCO for its proven track of better
organizational culture and market leader. For materializing the all possible source of synergy,
Brahma should emerge with a majority of voting power. Forming an efficient board of directors is
note worthy to send a strong signal to Newcos employees and shareholders about its policies and
future performance. We recommend forming a Board with the leadership of Mr. Tell by comprising
an equitable members from both the company. This board should have enough ownership in
NEWCO to check for better corporate governance.
Brahma should make a stock swap deal rather than cash keeping the exchange ratio in between
maximum and minimum. Because of the rationality we established in our previous analysis . To
negotiate the deal it might be important to consider the special purpose of two significant investor
of NEWCO, Banco grantia and FAHZ . If plain exchange formula fails to address the issue, we
recommend coming out with a customized deal in respect to exchange ratio, voting rights and
dividend for those investors.
A stable workforce is very important for the success of NEW. To incorporate a leading and
wining culture to the new workforce would become a critical factor for the next era. Incorporating
Performance incentive in addition to basic pay may give the worker of Antarctica a good
motivation to put their best effort to earn more in a large setting.

To introduce the NEWCO in North America and as well as in Globe as strong brewing company
and ensure the liquidity , the listing of NEWCO shares in both Brazil and America would be good
idea. As NEWCO going to earn 70% of market share ,they need to delegate power through the
regions. So if it feasible , they may consider to maintain two main office in San Paulo and Rio De
Janeiro keeping the former as Headquarter.
Finally , Braham managers should consider all the facts objectively such that the deal become
acceptable to Antarctica in reasonable term.

Working Notes and Assumptions:

1) Valuation Model : the Free Cash-Flow to the Firm Model (FCFF) is the most commonly-used
DCF approach, on which the value of a leveraged firm can be calculated by discounting the
unleveraged cash flows to the firm at the firm weighted average cost of capital (WACC). Thus,

Indeed, this formula is composed by two stages: the first is computed the present value of cashflows up to some preselected horizon date (5years in our case, 200-2004), and the second is
calculated to the present value of cash-flows beyond the horizon date referred as the terminal value
(TGR represents the terminal growth rate). The terminal value is thereby, the capital cash-flow in
the last forecast year (terminal year) and then adjusting it for the difference between cost of capital
and expected growth rate (Damodaran, 2005).

Expected Growth Rate :

Some literature argue that terminal cash-flow grow at a constant nominal rate in perpetuity,
assuming that Depreciation is equal to Capital Expenditures in the capital cash-flow in the terminal
year, Damodaran (2005) argues that no organization can grow faster than its current economy in
the long-term period. Consequently, TGR at a constant rate shall be computed as the real or nominal
expected growth rate of the economys GDP depending on whether the cash-flows will be included
or not on the inflation parameter on its computation. In our case The estimate growth rate for
Antarctica and Brhama are 9.2% and 9.4% respectively. We consider this rate from the growth rate
of revenue of the year 2004 for both the firm as given explicitly in UVA-F-1418X spread sheet.
This is consistent with nominal GDP forecast of 10% which is available up to 2001. For valuation
of synergy, we consider the terminal growth rate of the Acquiring firm (Brahma) more appropriate.
We do assume that there are no possible synergy from Operating , financial and control sources
other than that are mentioned. This valuation is also based on the presumption that synergy will be
created instantaneously. In reality, it can take years before the firms are able to see the benefits of
synergy. We consider the present time (May 99) exactly one year apart from the year 2000 for
which first estimate is available.
2) Definition of Firm value:
Firm Value = Enterprise Value (EV) + Cash and cash equivalent
Enterprise value = Value of Equity + Net Debt =present value of all future cash flows
Net Debt: Interest bearing debt (long term + short Term) - cash and cash equivalent
The item Other long term liabilities excluded from the calculation of net debt as it does not
represent any interest expenses. From the given excel sheet UVA-F-1418X, we find that Income
statement includes interest only on Debt(plug) which include interest bearing portion of both long
and short term debt. This is quite difficult to trace out the nature of this type of liabilities. These

may include obligations to lessors on assets that firms have leased, to employees in the form of
pension fund and health care benefits yet to be paid, and to the government in
the form of taxes deferred.
2) Free Cash Flow Definition:
We have defined the free cash flow to Firm (FCFF) as follows:
EBIT(1-T)+ Depreciation and Amortization+ (increase)/decrease in WC-Capital expenditures
In this calculation, we ignore the interest received on excess cash and cash equivalent as we
consider the net Debt . To avoid the double affect of Interest tax shield , we have considered it only
in calculating after tax cost of debt.
3) Cost of capital:
The appropriate discount rate for valuation of FCFF is after tax weighted average cost of capital.
Weight average cost of capital: we have used the market value weight to reflect the existing market
condition. Total invested capital= market value of Debt (equal to Book value) + Market value of
Equity
Cost of debt: we have used the rate of interest paid on debt ( both short and long term have the
same rate) as pre tax cost of debt which is explicitly mentioned in estimating the future cash flow in
UVA-F-1418X.
Cost of equity: We have used the CAPM model as the given data is consistent with model.

We see that the capital structure of both Brahma and Antarctica are not stable over the given period
of estimate. We use the weight proposed for valuation of all cash flows in the case as long term
expected mix of debt as a percentage of equity and debt. This is 31%.
4) synergy: we have taken the amount of cost saving and revenue synergy from the section of
Benefit of merger of UVA F-1418 instead value given in the section projected synergy. As the
former provide us the net pretax synergy affect , which make our calculation more easy . We have
adjusted those figures only for taxes to add with the FCCF of NEWCO.
5) Sources of Errors: we believe that before making the final deal, Brahma managers should
consider the reliability of all the assumptions we have in our analysis , specially for discount rate
and terminal value.
References :
1. Kaplan, S.N. and Ruback, R.S. (1996) The Market Pricing of Cash Flow Forecasts:
Discounted Cash Flow vs. the Method of Comparables, Journal of Applied Corporate
Finance 8, no. 4, pp. 45-60.
2. Damodaran, A. (2005) The Value of Synergy, Stern School of Business