Monday, June 16, 2008

Beer Wars

One of the big stories in the business press this last week has been that the Belgian headquartered beer maker InBev has come out with an offer to buy American beer maker Anheuser-Busch, maker of Budweiser and Michelob. Rumors of this deal have been circulating for several months now, resulting in a rise in Anheuser-Busch’s stock price, which as recently as March was trading for around $45 per share. InBev’s offer is at $65 a share.

The first thing to note is that this deal is almost certainly going to go through. InBev has the financing in place to make an all cash offer. On the day the offer was announced, it was at a price 10% above the closing price of Anheuser-Busch stock the day before the announcement. So the holders of Anheuser-Busch stock (the stock symbol is the cutesy BUD, by the way) collectively have a choice: take $65 a share for their stock, or watch the stock price slide back down into the low $50’s is the deal falls through. Hmmm, $65 or $55. Which one would I take? An old saying that involves wishing in one hand springs to mind right now.

Anheuser-Busch is a family run corporation. The current CEO is August Busch IV, who follows August Busch III. But AB is not a family owned company. The Busch family owns only 4% of the stock. They may have stocked the board of directors with their friends, but if they reject the offer, the board members will have a hard time explaining why they turned down InBev’s offer.

Anheuser-Busch is an acquisition target because of their very success. AB’s market share of the US beer market peaked at 52% a few years back. It has since dropped back to about 50%. If they got any bigger, it would attract attention from the Dept. of Justice Antitrust division. So they have no room to grow in the US market. But what the public stock markets demand above all else is earnings growth. As long as AB was growing, they would have a high stock price. Once growth cooled off, the stock price would sag. The single minded focus on the US market meant that they were slow to grow internationally. Low growth, combined with a lack of globalization, made Anheuser-Busch a target. The weak US dollar makes it a relative bargain.

But not that much of a bargain. Although InBev gets to show earnings growth by folding AB’s earnings in with their current operations, they have to justify paying a premium for Anheuser-Busch to their stockholders. The new owners are unlikely to increase sales, given that they would already control 50% of the market. Brewing is a pretty mature industry, so it’s difficult to see where InBev could squeeze any cost out of manufacturing or distribution. They could save money by cutting back on advertising and brand building in the short run (so long to the Clydesdale commercials at the Superbowl), but longer term that will lead to a loss of market share, and lower earnings.

So aside from increasing InBev’s earnings in the short run, I don’t see any logic for this deal in the long run. This may be why InBev’s stock price has been dropping on the Belgian stock exchange.

If this deal does close, I can predict two consequences: One, a less interesting Superbowl come next February. Two, celebrations by the folks who run Miller, Coors, and Sam Adams.

Monday, June 9, 2008

Ed McMahon

“Call no man happy, until he’s dead.”—Herodotus

Every so often real life intervenes in an argument, bringing a concrete example to an abstract argument so spot on that you could not make up a more telling example. Such an event can be pulled from last week’s news stories.

For those who missed the story, Ed McMahon’s house in Beverly Hills is being foreclosed on. Yes, that Ed McMahon. “Here’s Johnny!” “Send in your reply to Publisher’s Clearing House. You may already be a winner.” That guy.

Ed McMahon earned millions annually as a top ranked television personality and pitchman. Make that: he earned millions annually for decades. He is now over $644 thousand in arrears on a $4.6 million mortgage is took out only a few years ago.

When asked about why he is in arrears, his response is that it is because of his inability to work for the last eighteen months due to a neck injury.

The dude is 85 years old! Who the heck goes through life thinking that having to work in your eighties to keep from getting evicted is a workable game plan?

I have been arguing that true wealth is not related to your lifestyle, or to how much you earn. True wealth starts when you have the financial security to continue with your current lifestyle, even if you can no longer continue working. Exhibit number oneof how not to do this is Ed McMahon. I rest my case.

Tuesday, June 3, 2008

The Three Zones of Wealth

In my last post I talked about wealth, and how you could define being wealthy. Being wealthy is not defined by your earned income, and is certainly not defined by your lifestyle. With the collapse of the housing bubble, we are seeing plenty of people who are not only losing their jobs, but whose lifestyles were supercharged by pulling equity out of their homes and spending it. The lifestyle was never sustainable over the long term, and the job loss just accelerated the crash.

For me, wealth means passive income. Loosely defined, passive income is money that comes to you with little or no work on your part. Another way of putting it is with the old saying “Have your money work for you, instead of you working for your money.”

Just because you have passive income doesn’t mean you’re wealthy, however. You have to have enough of it. I’ve got both interest and dividend income that I list on my tax return, but I’m a long way short of being able to retire.

And that brings me to what I really want to write about today. I view wealth as happening in three zones, each of which defines a different way of looking at what it means to be wealthy.

The first of these zones is what I call retirement wealthy. Sometimes I hear this being described as financial independence. You enter this zone when you have enough passive income to pay for your current lifestyle. Once your dividends (or royalties, or rent, or bond interest) are enough to cover your expenses, you’ve got a choice: keep working for income, or retire and do what you want to do. I think this is what most people would define as being rich.

To achieve this state, you have to work both offense and defense. Offense, in terms of increasing your passive income (maxing out your 401K, e.g.) and defense, in terms of decreasing your living expenses (drive used cars, clip coupons).

The next zone of wealth starts where considerations of defense can fade away. You want to go to Tahiti for a week? Charter the jet! Seventy-two inch TV catch your eye? Buy it! This is the level of wealth where you have people to handle the mundane details of daily life. You don’t sit around the house all day waiting for the cable guy. That’s what the housekeeper is for.

Once you have entered the first zone of wealth, the longer you keep working, the closer you get to the second zone. After all, if you are not spending all of your passive income, then it will continue to compound on you. Money is the only animal that will only breed in captivity.

The third zone of wealth is what I call Future Old Money. I saw an interview with the country singer Garth Brooks once. One of the things he said was “I have more money than my children’s children will be able to spend.” Future old money. Fifty years from now, Garth’s grandkids will be toasting him at their dinner parties for making their lives of leisure possible.
Most personal finance writers concentrate on the first zone of wealth. After all, that is the zone that all of us can reach. It only takes time, discipline, and a modicum of knowledge. And most of the focus is on what I call defense, reducing expenses, if only to free up capital to invest.

To get into the second and third zones, however, you’ve got to win big. Even if we saw a way to do that, most of us don’t have enough appetite for risk to get there. I certainly don't.