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STZ Finishes $650M Debt Offering

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The world’s leading premium wine and spirits distributor, Constellation Brands Inc. (STZ), took a step forward in completing its pre-announced acquisition of Crown Imports by finishing the sale of additional Senior Notes. These notes are slated to mature in March 2023.

The company had issued $650 million of Senior Notes with a coupon rate of 4.625%, of which it received $641 million in net proceeds after deducting all the expenses related to the issuance. It intends to use all the net proceeds, along with available cash and existing revolver credit facility and term loan, to finance the acquisition.

At the end of first-quarter of fiscal 2013, Constellation Brands had $69.1 million of cash and cash equivalents. Moreover, the company generated $96.4 million and $76.8 million of cash from operations and free cash flow, respectively. Furthermore, the company has $850 million remaining under its revolving credit facility.

We believe that the financial condition of the company is not strong enough and so it has opted to finance the acquisition in this way. It is anticipated that the acquisition will increase Constellation Brands’ debt-to-EBITDA ratio to mid-four times. However, in next 12 months, the company is expecting to generate strong free cash flow, which will bring its leverage ratio to its targeted range of three to four times.

Apart from this, Constellation Brands has successfully modified its 2012 credit agreement. The amended agreement will facilitate the company a $575 million delayed draw term loan, which it intends to use for completing the acquisition.

In June 2012 the company, in order to enhance its presence in the U.S. beer market, entered into an agreement with Anheuser-Busch InBev (BUD) to acquire the remaining 50% stake of Crown Imports.

The proposed acquisition is expected to complete by December 30, 2012. If for any reason, Constellation Brands fails to close the acquisition by this date, it will redeem the senior notes at par value along with the accrued interest.

Constellation Brands has a 50-50 joint venture with Grupo Modelo S.A.B. de C.V. (Modelo) in Crown Imports. Previously, AB InBev completed its proposed acquisition of Modelo.

Per the agreement, Constellation Brands will pay $1.85 billion to complete the Crown Import acquisition and will hold the right of distribution, marketing and pricing of Modelo brands in the U.S. AB InBev will be responsible for maintaining the supply and quality of products along with innovations.

Crown Imports is the largest beer importer in the U.S. and markets Modelo brands, such as Corona Extra, Corona Light, Modelo Especial, Pacifico, Negra Modelo and Victoria. After completion of the deal, Constellation Brands will become the largest multi-category supplier of beer, spirits and wine and on a volume basis, the third-largest total beverage alcohol company in the U.S.

During fiscal 2012, Constellation Brands earned $215 million of equity earnings from Crown Imports, which was 50% of the total earnings. Therefore, Constellation Brands believes that the acquisition will be significantly accretive to its earnings per share and free cash flow.

The company reiterated its fiscal 2013 adjusted earnings per share guidance in the band of $1.93 to $2.03 per share. Though the guidance excludes any impact from the acquisition, we expect the transaction to contribute positively to the fiscal 2013 earnings performance. The current Zacks Estimate of $1.99 per share is approximately at the midoint of the company’s guidance.

Our Recommendation

Constellation Brands is the largest wine company in the world and commands a dominant position in the premium wine segment in the U.S. The company is also a leading producer of wines in Canada and New Zealand. This provides a competitive edge to the company and bolsters its well-established position in the market.

Moreover, continued focus on brand building and promotion along with strategic acquisitions will accelerate Constellation Brands’ growth opportunities while strengthening its market position. Additionally, in an effort to generate strong margins, Constellation Brands is focusing on higher priced segment across all key categories. The company also recently acquired a California based wine company - Mark West - which is anticipated to enhance its presence in the wine market.

However, the company faces intense competition from other well-established players in the industry, including Beam Inc. (BEAM) and Diageo plc (DEO). Moreover, Constellation Brands encounters competition from local and regional players in the respective countries, which may dent the company’s future operating performance.

We currently have a Zacks #2 Rank implying a short-term Buy rating. However, our long-term recommendation on the stock remains ‘Neutral’.

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