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Anheuser Busch InBev – SABMiller acquisition may lead to painful debt hangover

Anheuser Busch InBev’s deal for SABMiller may finally show how much foam there is in the debt market.

It would not only be a massive merger, but it could create a massive amount of new debt. And the world’s largest beer company has already been nursing a pretty bad debt hangover. AB InBev (BUD) already has $43 billion in net debt, which is its liabilities minus its cash and easy to liquidate assets. That’s a legacy of past deals. The deal that combined Anheuser Busch with InBev in 2008 generated $45 billion in debt, some of which has been paid down. And the combined company took on more debt when it bought Mexican brewer Grupo Modelo last year.

The SABMiller deal will only add to that. It’s not clear what the world’s largest brewer would pay for its second place rival. Shares of SABMiller (SBMRY) shot up 23% on the news of the deal, giving the company a market cap of nearly $92 billion. SABMiller has net debt of nearly $12 billion. Add those together and that puts the value of the deal at $104 billion.

How much of that will be financed by new debt? AB InBev’s majority owner Brazilian investment firm 3G hasn’t been debt shy in the past. Nearly 90% of InBev’s purchase of Anheuser Busch was paid for with debt. 3G used about $16 billion in new debt to finance Heinz’s nearly $50 billion acquisition of Kraft, which took place earlier this year. And 3G secured $12.5 billion in financing to help Burger King buy Canadian doughnut chain Tim Horton’s, which was slightly more than the cost of the deal before assumed debt.

If AB InBev were to finance half of the SABMiller acquisition, rather than use cash or shares, that would bring the combined company’s net debt to $107 billion. High debt is fine if a company is producing a lot of cash flow. And investors are particularly tolerant of high debt levels if that cash flow is growing. But AB InBev’s cash flow dropped by about $500 million in the past year. SABMiller’s is up, but only by about 2%.

Combined, the two companies’ net-debt-to-ebitda ratio of 4.5 would be one of the highest in the booze business. Heineken has debt equal to just over two-and-a-half times its cash flow. Diageo’s ratio is 3.3.

Issuance of investment grade corporate bonds has been at a record pace this year. Last year broke records as well. In 2014, AB InBev raised $850 million in debt for which it agreed to an interest rate of 4.6% over 30 years. Bond investors will likely serve up AB InBev-SABMiller more debt to do the deal, but the rate they charge the newly combined company will make clear just how drunk the debt market really is.