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Grokking the DOJ Suit to Stop ABI - Modelo

Dear Client:

"Today, Modelo aggressively competes head-to-head with ABI in the United States." So begins the Department of Justice's lawsuit, which seeks an injunction to stop the ABI - Modelo deal, which would in turn put the kibosh on the ABI - Constellation deal. The deal is the biggest to be opposed by the Justice Department since 2011, when it sued to block AT&T's proposed $39 billion takeover of T-Mobile USA.

So the DOJ is not seeking a remedy, but merely to block the deal. In fact, in a conference call with reporters, Bill Baer, Assistant Attorney General in charge of the Department of Justice's Antitrust Division, was asked about "any possibility of a remedy through court action." Bill said, "We are going to court to seek an injunction against the transaction. Obviously the parties are free to propose fixes that will avoid the need for an injunction. But at this point what we are asking the district court to do is enjoin the transaction." In talks with ABI, Bill said they had frank and candid discussions about what their concerns were and what they were prepared to do, but "in the end we were just too far apart."

PRICING KEY. The complaint tends to put a lot of emphasis on price competition. The complaint describes how ABI often leads up on pricing and how MillerCoors follows. But lately, "Modelo has resisted ABI-led price hikes." The complaint, which cites many internal strategy communications, quotes from Crown Import's "Momentum Plan" which the DOJ says seeks to narrow the price gaps between Modelo brands and premium brands. ABI internal documents acknowledge that Modelo has put "increasing pressure" on ABI by failing to follow on pricing.

SUPPLY AGREEMENT NOT ENOUGH. What about ABI selling its 50% stake in Crown Imports and their much ballyhooed ironclad supply agreement which would ensue between ABI and Crown? The DOJ's complaint says that Crown would still remain "simply an importer, required to depend on ABI for its supply of Modelo-branded beer."

FACADE. In fact, the DOJ seemingly holds the sale of the stake in Crown and the supply agreement with contempt as it was "designed predominantly to help ABI win antitrust approval."

Here's the money shot: The DOJ sale of Crown's stake and the supply agreement are a "facade of competition between ABI and its importer. In reality, Defendants' proposed 'remedy' eliminates from the market Modelo -- a particularly aggressive competitor -- and replaces it with an entity wholly dependent on ABI." The DOJ then quoted from a memo supposedly from Crown chief Bill Hackett (which has been oft-repeated on CNBC and other shows) to employees saying that "our #1 competitor will now be our supplier.... it is not currently or will not, going forward, be business as usual," although your editor has not confirmed where that came from because in all of our and others' conversations with Bill he's usually said it is actually going to be "business as usual."

BUY BACK PROVISION NO BUENO. And then there's that ten year buy-back provision, which the DOJ says gives ABI the opportunity to have "full control of all aspects of the importation, sale, and distribution of Modelo brands in the United States." It's curious that ABI either didn't have the opportunity to drop that provision or the DOJ simply didn't wanted more, but they kind of glossed over it.

The DOJ provided a graphic which it says shows how the deal creates a more vertical industry:



CONSTELLATION'S PAST PRICING BEHAVIOR. And then there's Constellation. The DOJ points to the divergence in strategy in the past between what Constellation wants and what Crown/Modelo want. Constellation has been "inclined to follow ABI's price leadership before the acquisition, [so] it is unlikely to reverse course after -- when it would be fully dependent on ABI.... In addition Constellation would need to preserve a strong relationship with ABI to encourage ABI from exercising its options to terminate the agreement in 10 years."

LOCAL MARKETS. The DOJ also has issues with the combined ABI and Modelo market shares in 26 local markets. In these particular markets, the DOJ says that reduced competition would "likekly increase its prices in that local market by at least a small but significant and non-transitory amount."

Here are the markets that the DOJ has issues with, in order of their combined ABI - Modelo HHI change after the merger.

Oklahoma City, OK
Salt Lake City, UT
Tampa/St Petersburg, FL
Houston, TX
Jacksonville, FL
Minneapolis/St Paul, MN
Denver, CO
Birmingham/Montgomery, AL
Memphis, TN
Las Vegas, NV
Dallas/Ft Worth, TX
Orlando, FL
Los Angeles, CA
Phoenix/Tucson, AZ
Raleigh/Greensboro, NC
Miami/Ft Lauderdale, FL
Hartford, CT/Springfield, MA
Richmond/Norfolk, VA
Chicago, IL
New York, NY
Atlanta, GA
Sacramento, CA
Boston, MA
San Diego, CA
Baltimore, MD/Washington, DC
San Francisco/Oakland, CA United States


AS FAR AS CONSTELLATION, it said that it is "disappointed with the DOJ decision. The proposed transaction would further establish Crown Imports as a more independent and competitive entity and solidify its position as a major player in the U.S. beer industry. We will provide further comment when appropriate."

WHAT NEXT? Well, the two sides get together to set a dockett. We stress that the two sides could still settle on a remedy, although it seems like Bill Baer wasn't signaling he was looking for one. This thing sure caught Wall Street by surprise, which was convinced it was going through and is still holding out hope. Writes UBS' Melissa Earlam in a note today:

"We still believe a deal will happen, but completion is likely to be delayed beyond Q1 13 and may require concessions. We did expect some concessions, especially re the 10-year call option to buy Crown that ABI is most likely to have to give up. ABI disputes the suit and we believe is willing to offer reasonable concessions. DoJ's sentence "the companies' attempt to fix this anticompetitive deal through the sale of Modelo's existing interest in Crown and a temporary supply agreement is not sufficient to prevent consumer harm". We see the word "temporary" as key."

Not so sure about that now. We'll see.

Until tomorrow, Harry

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