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Discovering Value

This Bud's for You

Anheuser-Busch InBev is not just a leader in the U.S. but a global powerhouse.

Turmoil has returned to the markets. And while stocks are still up substantially from their March 2009 lows, they remain, in our view, fully valued. By our calculations, the price-earnings ratio of Standard & Poor's 500-stock index in early May stood 25% above the long-term historical average P/E. Such a premium might be warranted if the markets were calm and the outlook were clear, but they're not. We believe we're in uncharted waters as the U.S. (and the world) continues to grapple with the aftermath of the bursting of the greatest bubble in history. So we're urging caution and playing defense.

The housing problem. As Americans, we're hoping for a sharp, V-shaped economic recovery. But as investors, we're not betting on it. Our biggest concern is that the housing market, whose collapse helped drive the world economy off the cliff in 2008, isn't yet back on track. Although housing prices have stabilized over the past year, thanks to aggressive government action both to reduce the supply of foreclosed homes and to stimulate demand for housing, problems persist. The most notable: Nearly eight million Americans are not paying their mortgages. It will take forceful action by the government and the banks to stave off another dip in the housing market.

As investors, our primary goal is to not lose money. In light of our many concerns, we are doing two things to protect our portfolios. In the hedge funds we manage, we are adding to our short positions, especially among homebuilders, which we think are particularly vulnerable. In the long portfolios, we are building our positions in dominant blue-chip companies, such as Microsoft (symbol MSFT), Berkshire Hathaway (BRKB), Pfizer (PFE), Kraft Foods (KFT), Yahoo (YHOO) and our newest addition, Anheuser-Busch InBev (BUD).

Every investor has heard of Anheuser-Busch and Budweiser, its flagship brand. But many people may not be aware that a new version of the iconic company, which was acquired by Belgium's InBev in 2008, is now trading again -- and using Anheuser-Busch's former symbol. The new firm, however, is not just a leader in the U.S., as Anheuser-Busch was, but a global powerhouse with exceptional opportunities to cut costs and grow all over the world.

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Anheuser-Busch InBev's history is fascinating. In 1989, three Brazilian investors bought a local brewer, Brahma, for $50 million. Over the next decade, they slashed costs and increased cash flow eightfold, then merged Brahma with its largest rival to form AmBev, then the world's third-largest brewer. In 2004, AmBev merged with Interbrew, a global company with brands such as Bass, Beck's and Labatt, to form InBev. InBev cut costs and raised profit margins over the next four years before acquiring St. Louis-based Anheuser-Busch, forming the world's largest beer maker. It is the dominant brewer in seven of the world's ten largest beer markets, and it is either first or second in 25 of the world's top 31 markets.

The old Anheuser-Busch was a great business (and one, incidentally, that was extremely recession-resistant). But over the years the old firm had become bloated and its leaders complacent, leading to subpar profit margins. With InBev in charge, look for Anheuser-Busch to cut costs and boost profit margins. In fact, change is already evident. In 2009, management sold off non-core assets, cut capital expenditures by $1 billion, and used the proceeds to pay down debt.

Making conservative assumptions about growth, cost cuts and profit margins, we think that in 2012 Anheuser-Busch InBev will generate $9 billion of free cash flow (the money left over to pay dividends, make acquisitions and so on). If the stock, $46 in early May, trades at 15 to 17 times our free-cash estimate, which would be a low multiple for such a high-quality business, then the share price would nearly double.

Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson own shares in all companies mentioned.