Author: Rocco Huang
Covestor model: Tortoise and the Hare
Disclosure: Long MO
Warren Buffett teaches us that we should invest in a business and not just a piece of paper stock certificate. He also stresses that one should spend more time understanding a business’s assets, because “don’t worry, the liabilities are solid.”
Altria Group (NYSE:MO), more popularly known by its largest subsidiary Philip Morris USA, is mainly a tobacco company. One of the disadvantages of owning Altria stock is the lack of growth opportunities.
In 2008 its international tobacco operations were spun out as Philip Morris International (NYSE:PM), leaving Altria with the mature US franchise. To make things worse (from an investment perspective), the smoking population and cigarette volume have been declining year after year in the U.S., mirroring the rest of the developed world.
Fortunately, Altria also owns a significant 27.1% stake in beer brewer SABMiller plc, which has the greatest exposure to fast-growing emerging markets among major global brewers.
The value of this stake, recorded on Altria’s balance sheet, is only $5.5 billion, according to its latest Form 10-K. Since Altria has a market cap of $59 billion as of 11/30/2011, at first glance one might think the $5.5 billion doesn’t make much a difference.
But the stake is actually worth much more. The understatement results from the Equity Method of GAAP accounting. As Altria’s stake in SABMiller is less than 50% and it has only 3 seats on the 11-person SABMIller board, it doesn’t exercise “control” of SABMiller. Therefore, Altria doesn’t fully consolidate SABMiller into its financial statements, and neither is it allowed to mark the ownership up to its current market value. Instead, Altria simply records 27.1% of SABMiller’s book value on its balance sheet, using the Equity Method.
For a beer brewer, book value is not a strong measure of of its worth. Intangible assets such as brands, distributional rights and future growth opportunities matter much more than the tangible factories and equipments on the ground.
Fortunately, we can conveniently conduct a back-of-the-envelop calculation to put a ballpark number on the stake’s value, because SABMiller stock istraded on the London Stock Exchange.
According to Google Finance, as of 11/30/2011, SABMiller plc has a market cap of GBP 33.55 billion, or about $52.7 billion at the exchange rate of 1.57 GBP/1 USD.
27.1% of that is about $14.3 billion, which is far greater than the recorded book value of $5.5 billion, and accounts for nealry a quarter of Altria Group’s current market capitalization of about $59 billion.
Apparently, Altria is not just a US cigarette company. Put plainly, the Altria recipe is about 3/4 Marlboro and 1/4 Miller Lite!
Of course, things are never that simple. From shareholders’ perspective, Altria’s stake in SABMiller is not going to worth exactly its open market value. There are two obstacles, but fortunately both can potentially be addressed:
(1) Most investors who have adopted the “socially responsible investing” principle simply stay away from the tobacco sector, while some of them think alcoholic beverage businesses are OK. It’s like different varieties and degrees of vegetarianism. The alcoholic beverage business of Altria has suffered collateral damage by association with the tobacco sector, and receives a lower valuation in the stock market than if it were a stand-alone entity, independent from Altria.
Solution: If you don’t care about what Mr. Market thinks, and if you don’t care what your neighbors and friends think of you, then why should you care? You basically get paid a premium for the agony of being ridiculed by your more socially responsible neighbors and friends. There is no free lunch. Weigh the benefits and costs and make your own decision.
(2) If Altria decides to divest the SABMiller stake, almost certainly at a price far above its tax basis book value, then it would have to pay corporate income tax on the capital gains. Ouch – Uncle Sam is going to take a 33% cut, and the Commonwealth of Virginia another 6%.
Solution: Altria can spin out its SABMiller stake directly to existing shareholders, in which case the transaction could potentially be tax free. This maneuver is not new to Philip Morris. In fact, Kraft Foods (KFT) and Philip Morris International (PM) were part of the family until several years ago, when shares were distributed tax-free to Altria shareholders.
So here’s our message to Altria Group:
Listen, Mr. Altria. You should distribute to us, your shareholders from diverse political and social belief systems, the SABMiller shares that we are entitled to, so that the hidden financial value in our SABMiller stake can potentially be unlocked, similar to what happened several years ago when you spun out Kraft Foods and Philip Morris International.
You should become a pure-play tobacco company, so that we can all live happily ever after and not argue among ourselves the social impacts of tobacco and alcohol, and the relative merits and sins between the two.
Mr. Altria, please render unto drinkers the Miller Lite which is theirs, unto smokers the Marlboro that is theirs, unto us the shareholder value that is ours, and all of the rest onto the Bureau of Alcohol, Tobacco, Firearms and Explosives.
