One Corporate Center Rye, NY 10580-1435 Tel (914) 921-5072 Fax (914) 921-5098 www.gabelli.com Janurary 8, 2003 Gabelli & Company, Inc. Fomento Economico Mexicano, S.A. de C.V. (FEMSA) (FMX- $36 - NYSE) FYE PMV EPADS P/E 2004P $79 $3.72 9.7x Dividend: $0.71 Current Return: 1.95% 2003PF(a) 72 3.33 10.8 Shares O/S: 105.9 Million (ADS equivalent) 2002PF(a) 60 2.96 12.2 52-Week Range: $33.25 - $49.79 2001A 62 2.97 12.1 (a) Assumes acquisition of Panamco (PB 20.73 NYSE) closed on January 1 of the respective year. FEMSA IN SIGNIFICANT TRANSACTION Subsequent to our December 17, 2002 report on Mexican beer, 51% owned FEMSA subsidiary Coca-Cola FEMSA (KOF $18.11 NYSE) announced on December 23, 2002 that it has reached a definitive agreement to acquire Panamerican Beverages (PB $20.84 NYSE) for $3.6 billion. The deal values PB at 8.2x trailing twelve month EBITDA of $444 million, which is higher than the 6.9x EBITDA paid by Pepsi Bottling Group (PBG $26.08 NYSE) for Mexican bottler Gemex. However, because several of the areas that Panamco serves are contiguous to those currently served by Coca-Cola Femsa, there should be additional synergies available to KOF. THE VALUE OF FEMSA Depicted in figure 1 is the value per FEMSA ADS of each of FEMSA s operating units. In each case we have shown FEMSA s interest in Coca-Cola FEMSA at market valuation and then at our model valuation (FEMSA owns 72.2 million shares of KOF; expressed another way, there is 0.69 shares of KOF per share of FEMSA, and there will be 0.8 shares of KOF per FEMSA share once the transaction is complete). In the proforma case, each share of FEMSA will own 0.8 shares of Coca-Cola FEMSA. Coca-Cola FEMSA is currently selling at $18.11 per share, which represents a value to FEMSA of $14.43 per share. Marking the balance of the operating units to model, the value is over $53 per FEMSA share. Marking Coca-Cola FEMSA to model by applying a multiple of 8x EBITDA to our PF2002 estimate for Coca- Cola FEMSA, results in value per FEMSA share of $21.64. Also marking the remaining subsidiaries to model, our PF2002 Private Market Value for FEMSA is around $60 per share. At current market prices, FEMSA is selling at a 40% discount to this value. Figure 1 FEMSA Value Per Share Pre-acquisition Valuation Proforma Model KOF/FMX KOF KOF KOF/FMX KOF KOF Segment Multiple Ratio at Market at Model Ratio at Market at Model Bottler (Coca-Cola FEMSA) (a) 8 0.69 $ 12.42 $ 20.88 0.80 $ 14.43 $ 21.64 Brewer (FEMSA Cerveza) 10 33.11 33.11 33.11 33.11 Packaging (FEMSA Empaques) 6 4.26 4.26 4.26 4.26 C-stores (FEMSA Comercio) 10 4.10 4.10 4.10 4.10 Logistics (FEMSA Logistica) 5 0.67 0.67 0.67 0.67 Holding Co Debt (0.92) (0.92) (3.38) (3.38) FEMSA value per share 53.65 62.10 53.20 60.41 (a) FEMSA owns 72.7 million shares of Coca-Cola FEMSA, which is equal to 0.69 shares of Coca-Cola FEMSA per FEMSA share. Proforma, FEMSA will own 84.4 million Coca-Cola FEMSA shares, or 0.8 shares per FEMSA share. Source: Gabelli & Company, Inc. estimates In the proforma cases, the holding company net debt is increased by the $260 million subscription price of the new KOF shares. The cash will actually be raised by a dividend extraction from the subsidiaries, increasing the net debt levels at the subs, but the exact amounts from each sub are not known, so for illustrative purposes we assumed all the net debt will stay at the holding company level. Buy -Please refer to important disclosures at the end of this report-
BACKGROUND COCA-COLA FEMSA & PANAMCO Coca-Cola FEMSA, a subsidiary of FEMSA (see figure 2 for organizational chart), is a Coca-Cola bottler operating in Mexico and Argentina. It serves a population of approximately 41 million people and generates EBITDA of over $500 million annually. Approximately 92% of EBITDA is earned in Mexico, with the balance from Argentina. Panamco is also a Coca-cola bottler, with operations in Mexico and Central America, Brazil, Venezuela and Colombia. Total population served is 126 million with 2001 EBITDA equaling $530 million. 59% of 2001 EBITDA came from Mexico and Central America, 6% from Brazil, 19% from Venezuela and 15% from Colombia. The combined company would become the world s second largest Coca-Cola bottler behind CCE, and the largest in Mexico and Latin America. Figure 3 shows the Mexican geography covered by the combined company. The dots indicate locations of bottling plants. The contiguous territories of Panamco and Coca-Cola FEMSA will provide the combined company with synergies in manufacturing, sales and distribution, corporate overhead and procurement. Coca-Cola FEMSA believes it will realize $70 million dollars in synergies within 24 months of the close of the transaction. Figure 2 FEMSA Organizational Structure Figure 3 Proforma Mexican Market Coverage FMX KOF Source: FEMSA, Coca-Cola FEMSA TRANSACTION DETAILS The $3.6 billion purchase price is arrived at as follows: $880 million of PB debt will be assumed by KOF, Coca-Cola (KO $44.07 NYSE) owns 28.5 million PB A shares and 2.2million B shares, for which it will receive 30.4 million ADR equivalent KOF shares valued at $674 million. The remaining 82.57 million PB A shares will receive $22 per share in cash for a total of $1.82 billion and the remaining 6.5 million B shares will receive $38 per share in cash, for a total of $247 million. The transaction is expected to close within 3-4 months. The deal will be largely debt financed, with the exception of the shares Coca-Cola will receive in KOF and $260 million raised by the subscription of FMX to 11.73 million KOF ADR equivalent shares at a price of $22.16. Sources and uses of funds are described in figure 4. Figure 4 Source: Public data, Gabelli & Company, Inc. estimates Sources and Uses of Funds Sources of Funds Uses of Funds Financing secured from JPM Chase & Morgan Stanley $2,050 Class A shares excl Coke (@ $22 per share) $1,817 KOF Cash $420 Class B shares excl Coke (@ $38 per share) $247 FMX subscribes to 11.73mm shares in KOF @ $22.16 $260 KO to receive 30.4mm shares of KOF for its PB shares $674 KO to receive 30.4mm shares of KOF for its PB shares $674 Cash to repay 2003 Notes $150 (28.5 million A shares and 2.2 million B shares) Refinancing of PB Debt $314 Other transaction costs $152 Net cost of options exercised $51 Total $3,403 Total $3,403-2 -
Figure 5 Source: Public Data, Gabelli & Company Inc. estimates KOF Ownership Structure Pre acquisition of PB New Shares Proforma (economic) Voting Rights Offering Coca-Cola interest 42.75 30.0% 30.40 73.15 39.6% 46.40% 73.15 37.6% FEMSA 72.68 51.0% 11.73 84.41 45.7% 53.60% 84.41 43.4% Float 27.075 19.0% 0.00 27.08 14.7% 0 36.96 19.0% Total Shares 142.50 184.63 194.52 (millions of ADR eqivalent shares) Upon the close of the transaction, FMX s ownership of Coca-Cola FEMSA will decrease to 45.7% from 51%. However, FMX will continue to consolidate KOF results, as they will maintain a 53.6% voting interest. A rights offering will be done later, at the $22.16 price FMX and KO were issued new shares to allow public shareholders to return their percentage ownership to 19%. Full subscription would increase the total shares to almost 195 million and dilute FEMSA s economic interest in KOF to 43.4%. However, given the current $18.11 price for KOF, it remains to be seen whether or not the public shareholders will choose to return to their proportionate share prior to the acquisition. Coca-Cola FEMSA s proforma capitalization is shown in figure 6. Figure 6 KOF Proforma Capitalization KOF PB Adjustments Refinancing KOF proforma Balance Sheet as of 09/30/02 ADRs 142.5 42.1 (b) 184.6 Market Price 18.11 18.11 Equity Market Cap. 2,581 3,344 Plus: Debt 304 933 (a) 2,050 (464) 2,823 Less: Cash 540 53 (a) 44 (c) (464) 174 Net Debt (236) 2,650 Total Capitalization 2,345 5,993 (a) Net debt at PB estimated to be $880 million at 12/31/02 (allocation approximate) (b) Equals 11.73 million ADR equivalent shares purchased by FMX and 30.4 million received by KO for its PB shares (c) Equal to $260 million from FMX less the $14 million cash difference between MS & JPM financing and price paid for PB stock, less $151.1 million in transaction costs, less $50.5 million cost for options exercised Source: Public data, Gabelli & Company, Inc. estimates MARKET VALUATION The market is clearly not placing the value on the company that our analysis does. However, the stock shouldn t trade at a take out price. Still, we think the market is undervaluing FEMSA. In figure 7, the lines Majority EBITDA, Majority EBITDA Ex Coca-Cola and Majority EBITDA Coca-Cola FEMSA represent the portions of EBITDA that FEMSA is entitled to: A) as a whole; B) Stripping out KOF (leaving largely the brewer), and; C) KOF stand-alone. The EV number is the enterprise value that would be applicable, stripping out all of the minority interest, which eliminates the issue of valuing the minority interest and creates a clean multiple. Based on its share of EBITDA in the subsidiaries, FEMSA is trading at 5.5x PF2002 EBITDA. FEMSA s Coke bottling operation stand-alone is trading at 6.3x PF2002 EBITDA, and the balance of the business, which is largely the brewer, is trading at 4.9x PF2002 EBITDA. We think these are very low valuations for these businesses. Ultimately, we think there are a number of catalysts that could cause the value we have identified in figure 1 to be realized. - 3 -
Figure 7 FEMSA, Select Financial Data 2002PF-2006P FYE 12/31 2002PF 2003PF 2004P 2005P 2006P Net Revenues 7,228 7,618 8,033 8,475 8,945 % Growth 47.9% 5.4% 5.4% 5.5% 5.5% EBITDA 1,644 1,766 1,863 1,950 2,043 % Margin 22.7% 23.2% 23.2% 23.0% 22.8% EP Unit-Continuing Ops 2.96 3.33 3.72 4.11 4.53 % Growth -6.5% 12.6% 11.8% 10.4% 10.2% PF EBITDA Multiple 6.1 5.7 5.4 5.2 4.9 P/E Multiple 12.2 10.8 9.7 8.8 8.0 (Minority Interest marked to Model for Cerveza and Logistica and marked to market for Coke) PF Majority EBITDA 955 1,025 1,079 1,129 1,183 EBITDA Multiple, EV= 5,251 5.5 5.1 4.9 4.6 4.4 Majority EBITDA Ex Coke 517 542 569 596 625 EBITDA Multiple, EV= 2,511 4.9 4.6 4.4 4.2 4.0 Majority EBITDA Coca-Cola Femsa 438 482 510 533 558 EBITDA Multiple, EV= 2,740 6.3 5.7 5.4 5.1 4.9 (Minority interest is ignored and multiple of Majority EBITDA is shown) Source: Public Data, Gabelli & Company, Inc. estimates POTENTIAL CATALYSTS Spin off or sale of brewer Femsa Cerveza. FEMSA has said that a large transaction could precipitate the separation of its business units. As shown in Figure 7, stripping out Coca-Cola FEMSA, Cerveza and the remaining units are trading at 4.9x PF2002 EBITDA of $517 million. 30% of Cerveza, however, is owned by Interbrew (via Labatt), which has rights of first refusal (Note: Labatt originally acquired its 30% stake in Cerveza in two tranches 22% in September of 1994 for $510 million and the remaining 8% in May of 1998 for $221 million). Interbrew has recently appointed John Brock, former COO at Cadbury Schweppes (CSG $25.40 NYSE), as new CEO. FEMSA has dealt with John Brock in the past and describes the relationship as friendly, bolstering the possibility of a transaction with Cerveza. Multiples for brewers have been as high as 12.5x EBITDA over the last several years. Spin off or sale of Coca-Cola FEMSA to Coca-Cola Enterprises (CCE $22.30 NYSE). Coca-Cola FEMSA has so far been successful at consolidating bottling operations in Latin America. It would become KO s second largest bottler, behind CCE, upon consummation of the PB acquisition. Given Pepsi Bottling Group s acquisition of Gemex, KO would likely be agreeable to placing control of the important Latin American market in the hands of CCE. Outside of a sale to CCE, a spin off is the only other likely scenario. Distribution of beer with Coke. If the company remains intact, the opportunity to distribute beer with Coke is a viable catalyst. PB, in some South American markets, is currently distributing beer. PB significantly augments FEMSA s distribution both in Mexico and in other countries and the synergies and potential market penetration would be large. CONCLUSION Given the recent transaction to acquire PB, we think FEMSA is only beginning its transformation process. There are several catalysts that we have outlined that would help to unlock the value in the company. The complexity of FEMSA makes it difficult for the market to accurately value the company and we think this provides an opportunity for investors to purchase shares in the company well below their intrinsic value. Our consolidated PF2002 Private Market Value estimate for FEMSA is around $60 per ADS. The ADSs are selling at around a 40% discount to this value. - 4 -
Figure 8 Private Market Value Analysis 2002PF 2006P Gabelli & Company, Inc. Private Market Value Analysis 2002PF 2003PF 2004P 2005P 2006P FEMSA Cerveza Revenues 1,905 1,989 2,076 2,167 2,263 Brewer EBITDA 516 546 577 608 641 Valuation Multiple 10 10 10 10 10 Segment Value 5,164 5,461 5,767 6,082 6,408 Coca-Cola FEMSA Revenues 3,934 4,132 4,339 4,558 4,787 Coke Bottler EBITDA 958 1,055 1,116 1,167 1,221 Valuation Multiple 8 8 8 8 8 Segment Value 7,667 8,442 8,930 9,332 9,768 FEMSA Empaques Revenues 557 557 557 557 557 Packaging EBITDA 94 93 93 92 91 Valuation Multiple 6 6 6 6 6 Segment Value 564 559 555 552 548 FEMSA Comercio Revenues 1,121 1,233 1,356 1,492 1,641 C-stores EBITDA 49 55 62 69 76 Valuation Multiple 10 10 10 10 10 Segment Value 492 555 621 689 762 FEMSA Logistica Revenues 144 144 144 144 144 Logistics EBITDA 13 13 13 13 13 Valuation Multiple 5 5 5 5 5 Segment Value 65 65 65 65 65 Corp, Other & Revenues -433-436 -440-443 -447 Cons. Adjustments EBITDA 3 2 1 0-1 Valuation Multiple 5 5 5 5 5 Segment Value 15 11 7 2-3 Total Private Market Value 13,967 15,094 15,945 16,723 17,548 Less: Debt (3,114) (2,721) (2,095) (1,393) (610) Less: Min Int (Marked to Model, net of debt) (4,434) (4,764) (5,461) (6,155) (6,914) Plus: Cash and Equivalents 0 0 0 0 0 Equity Private Market Value 6,419 7,609 8,389 9,175 10,023 Shares Outstanding 105.9 105.9 105.9 105.9 105.9 PMV per ADS (dollars) $60 $72 $79 $87 $95 Current Market - Discount to PMV 40.4% 49.9% 54.5% 58.4% 61.9% Note: FMX is not a likely take out candidate. Several founding families control a trust that owns 30% of the economic shares, with 52% voting interest. Source: Gabelli & Company, Inc. estimates Company Reports: Invest in Mexican Beer 12/17/2002 Derek K.Sheeler, CFA (914) 921-5072 Gabelli & Company, Inc. 2003 ONE CORPORATE CENTER RYE, NY 10580 GABELLI & COMPANY, INC. TEL (914) 921-3700 FAX (914) 921-5098 Gabelli & Company, Inc. ( we or us ) attempts to provide timely, value-added insights into companies or industry dynamics for institutional investors. We do not have any formal ratings system for our research reports, and we do not undertake to upgrade or downgrade ratings after publishing a report. We generally write reports on securities that we believe to be undervalued and do not issue any sell ratings. Thus, virtually all of our reports containing recommendations would be considered buy ratings. We prepared this report as a matter of general information. We do not intend for this report to be a complete description of any security or company and it is not an offer or solicitation to buy or sell any security. All facts and statistics are from sources we believe to be reliable, but we do not guarantee their accuracy. We do not undertake to advise you of changes in our opinion or information. Unless otherwise noted, all stock prices reflect the closing price on the business day immediately prior to the date of this report. We do not use price targets predicting future stock performance. We do refer to private market value or PMV, which is the price that we believe an informed buyer would pay to acquire 100% of a company. There is no assurance that there are any willing buyers of a company at this price and we do not intend to suggest that any acquisition is likely. Additional information is available on request. In the last 12 months we have provided investment banking services as a syndicate or selling group member of underwritten offering to approximately 2% of the companies that were the subjects of our research reports (all of which would be considered buy ratings). Our affiliates beneficially own on behalf of their investment advisory clients or otherwise less than 1% of American depository shares of FMX. Because the portfolio managers at our affiliates make individual investment decisions with respect to the client accounts they manage, these accounts may have transactions inconsistent with the recommendations in this report. These portfolio managers may know the substance of our research reports prior to their publication as a result of joint participation in research meetings or otherwise. The analyst who wrote this report may receive commissions from customers transactions in the securities mentioned in this report and may receive compensation that is based upon (among other factors) our revenues from acting as a syndicate or selling group member in underwritten offerings - 5 -
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