Beer heavyweight SABMiller Plc is seen as a front-runner to buy Mexico's No. 2 brewery, owned by FEMSA, possibly drawing rival AB InBev into a showdown in the country's lucrative market.

FEMSA, which makes the Tecate and Sol brands, said on Thursday it is in talks regarding its beer business, fueling speculation Mexico could be the next country to be enveloped in the wave of beer industry consolidation of recent years.

A source familiar with the situation told Reuters that FEMSA has spoken with Britain's SABMiller and Heineken from the Netherlands about a possible sale of its beer operation.

Analysts say SABMiller is in a better financial position than Heineken to bid for the FEMSA Cerveza beer unit of FEMSA, which also has soft-drink bottling and convenience store units.

We think FEMSA Cerveza is the right fit only for SABMiller, UBS said in a report, adding that debt covenants would likely limit any bid by Heineken.

Buying FEMSA's beer unit would throw SABMiller into competition in Mexico against AB InBev, which owns half of Grupo Modelo, Mexico's No. 1 brewer and the maker of Corona.

FEMSA's shares have gained more than 17 percent over the last two days while Modelo jumped nearly 8 percent on Friday on speculation it might also be acquired.

FEMSA and Grupo Modelo account for nearly all of Mexico's beer industry, with sales of almost $5 billion last year.

Amsterdam-based Heineken, the world's third-largest brewer, is still digesting its 2008 acquisition with Carlsberg of UK-based Scottish & Newcastle and is seen as less likely to buy FEMSA.

To counter tame sales growth in the United States and Europe, the world's biggest brewers are consolidating to cut costs and increase economies of scale.

SHIFTING TASTES

While consumers in many countries have shifted their tastes toward wine, spirits and cocktails in recent years, beer sales in emerging markets like Mexico are relatively healthy, making them more attractive.

An acquisition in Mexico would be only the latest of several recent big moves in the international beer industry.

SABMiller lost its place as the world's leading brewer last year after Belgium's InBev merged with U.S. brewer Anheuser-Busch in a $52 billion deal.

Also last year, SABMiller and Molson Coors combined their U.S. operations to create a venture with nearly a 30 percent share of the U.S. beer market.

Credit Suisse analysts said during a conference call that FEMSA appears to be trying to complete a sale before Grupo Modelo resolves a dispute with AB InBev related to its takeover of Anheuser-Busch last year.

I think Anheuser-Busch InBev are coming into Mexico and that poses a threat to FEMSA, said Credit Suisse analyst Carlos Laboy. ABI can get its hands on Modelo ... and increase the profitability of Modelo.

Some analysts warn that Femsa's beer unit is poorly run and say the best way to improve it would be through a sale. SABMiller already has operations in Colombia, Ecuador and Peru.

We believe in the long run the ability of small entities to compete in beer will be limited, said Barclays analyst David Belaunde. SABMiller's existing strength and experience in Latin America mean it would be in a position to run the FEMSA Cerveza businesses well.

It was unclear whether FEMSA might sell part or all of its beer operation. Divesting its beer arm would leave it with the Coca-Cola FEMSA soft drink unit and the fast-expanding Oxxo convenience store chain.

(Additional reporting by Martinne Geller in New York; Editing by Gary Hill)

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