acf - boston beer

7/22/2019 ACF - Boston Beer

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BOSTON BEER

COMPANYnitial Public Offering


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Company Background

The Boston Beer Company:

largest company in the craft beer segment in

1994

shares astonishing growth with others in thespecialty beer industry in the early 90s

currently in the process of going public,

following its competitors, Redhook Brewing and

Petes Brewing, in an Initial Public Offering(IPO)

The case study is set in 1995, all current data

would be as of Dec 1995


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Business Models

Main CompetitorsRedhook Brewing and PetesBrewing

Regional BrewersRedhook

Owned and operated production facilities

Large capital investment Little expenditure on sales and marketing

Contract BrewersBoston Beer and Petes

Outsourced the brewing of their premium beers to contractors

Intensive sales and marketing

Lower capital and overhead costs

Lower transportation costs

Greater manufacturing flexibility


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Operating Strategies

Brewing Strategy

Boston Beer is exclusively a contract brewer

Redhook possesses and control its own brewery

Petes (in a newly negotiated agreement with Strohs

Brewery) produces its products at both company-owned andthird party breweries.

Production Strategy

Boston Beer focuses on producing the highest quality beer

products in its industry Select rare breeds of ingredients in Europe to differentiate

from mass beer producers.

Use of product freshness stamps


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Operating Strategies

Product and Distribution Strategy

Intensive advertising to raise brand recognition

Educational marketing to teach distributors and retailers

about the virtues and characteristics of quality beer

Redhook has a larger distribution networks which involved along-term distribution arrangement with Anheuser-Busch

Diversified and innovative product line - Boston Beers has a

variety of 14 products while Petes and Redhooks only have

6 varieties.


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Ratio AnalysisRedhook Petes Brewing Boston Beer

Year ended 9mths

ending

Year ended 9mths

ending

Year ended 9mths

ending

Year

1993

1994

1995

1993

1994

1995

1993

1994

1995

Return on Equity

Profit before

taxes/NetSales(%)

27.8 22.2 18.0 1.1 1.7 3.5 6.3 7.9 7.6

Net Sales/Assets 0.8 0.6 0.3 5.7 6.8 4.4 3.2 3.6 3.3

Assets/Equity 1.5 1.3 1.2 6.7 6.2 6.2 2.7 4.8 2.5

Return on Equity

(pre-tax%)

32.0 16.0 6.4 41.1 70.8 97.0 55.3 137.7 62.4

Margins

Gross Profit

Margin(GP/Net

Sales %)

46.3 41.8 34.4 47.0 45.0 49.7 54.0 54.0 46.2

SGA/Net sales(%) 17.4 18.8 17.6 45.5 43.2 42.8 47.6 46.2 44.8

Operating

Profit/Net Sales

(%)

28.9 23.1 16.8 1.4 2.0 3.9 6.3 7.7 6.8

Interest Exp/NetSales (%)

1.4 0.9 N/A 0.3 0.3 0.4 0.0 0.2 0.2

Aggregate Size

Measures

Net Sales (000s) 11484 14929 17929 12236 30837 41988 77151 114833 108905

Total Assets

(000s)

20044 34689 84553 3118 5918 12983 24054 31776 31846

Barrels

Sold(000s)

74 94 111 69 180 246 475 714 688

Growth Rate (of

Barrels)

48% 27% 138% 161% 62% 50%

Total

Shareholders

15000 26059 74372 400 1040 1987 8854 6600 13229


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Size Measures

Boston Beer enjoys impressive sales performance,

ranking it the leading craft brewer in the industry Redhook appears to stagnate in sales growth

Boston Beer sold almost 4 times the volume of Petes

and more than 6 times the volume of Redhook

Redhook Petes Brewing Boston Beer

Year ended 9mths

ending

Year ended 9mths

ending

Year ended 9mths

ending

Year 1993 1994 1995 1993 1994 1995 1993 1994 1995

Net Sales

(000s)

11484 14929 17929 12236 30837 41988 77151 114833 108905

Total Assets

(000s)

20044 34689 84553 3118 5918 12983 24054 31776 31846

Barrels

Sold(000s)

74 94 111 69 180 246 475 714 688

Growth Rate(of Barrels)

48% 27% 138% 161% 62% 50%

Total

Shareholders

Equity(000s

)

15000 26059 74372 400 1040 1987 8854 6600 13229


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Profitability

Redhook has higher operating profit margin due to its

operating strategy of a company-own production capacity

Boston Beer and Petes has higher Selling and GeneralAdministrative expense

Petes Brewing is least profitable

Gross profit margins of contract brewers are also higher

and more stable


Year ended 9mths

ending

Year ended 9mths

ending

Year ended 9mths

ending

Year 1993 1994 1995 1993 1994 1995 1993 1994 1995

Gross Profit

Margin

(GP/Net Sales

%)

46.3 41.8 34.4 47.0 45.0 49.7 54.0 54.0 46.2

SGA/Net

sales(%)

17.4 18.8 17.6 45.5 43.2 42.8 47.6 46.2 44.8

Operating

Profit/Net Sales

(%)

28.9 23.1 16.8 1.4 2.0 3.9 6.3 7.7 6.8

Interest Exp/Net

Sales (%)

1.4 0.9 N/A 0.3 0.3 0.4 0.0 0.2 0.2


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Return On Equity

Boston Beer and Petes have higher ROEs due to

lower asset holdings and shareholder equity

Redhook has much lower ROE due to heavy capitalinvestment. ROE has declined approximately 50% of

previous year

Redhook has lower asset turnover


Year ended 9mths

ending

Year ended 9mths

ending

Year ended 9mths

ending

Year 1993 1994 1995 1993 1994 1995 1993 1994 1995

Return on

Equity

Profit before

taxes/NetSale

s(%)

27.8 22.2 18.0 1.1 1.7 3.5 6.3 7.9 7.6

Net

Sales/Assets

0.8 0.6 0.3 5.7 6.8 4.4 3.2 3.6 3.3

Assets/Equit

y

1.5 1.3 1.2 6.7 6.2 6.2 2.7 4.8 2.5

Return on

Equity (pre-

tax%)

32.0 16.0 6.4 41.1 70.8 97.0 55.3 137.7 62.4


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Disadvantage of

Contract Brewing Strategy Downside risk of financial distresses in second-tier

brewers which were contracted for brewing

Risk of interruptions to Bostons product supply Inconsistency in premium beer image as premium

beers are brewed in the same facilities as lower

quality brews of second-tier beers


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Initial Public Offering

Boston Beer has a promising future prospect.

To take advantage of favourable market conditions

the company has decided to go public.

Going public: selling the companys shares tooutside investors and allow the shares to be publicly

traded.

It is a value judgment based on a balance between

the COSTS and BENEFITS of going public.


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Advantages of an IPO

Enhances liquidity and allows existing private

investors to harvest their wealth

Permits diversification for founders

Facilitates the raising of new capital (corporatecash)

Establishes a value for the firm

Facilitates merger negotiations

Enlarges potential markets for the companysproducts


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Disadvantages of an IPO

It is a complicated, expensive and time-consuming

process

High cost of reporting

The need to abide by disclosure requirements Increasing agency issues caused by managers self-

dealings

The result of a low share price due to inactive market

The need to maintain control by the management The need to maintain a good relationship with

investors


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Boston Beers IPO

Rapid growth in the Craft-brewing segment is a

positive signal for advantageous opportunity.

Conclusion: it is more profitable going public asthe need for growth outweighs the costly and time-

consuming process.

Competitors IPOs have been successful

Redhooks and Petes.


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Determination of Price

Initial public offering: thefirstsale of stock by a

private company to the public.

Primary step: determination of the price per share

It represents the amount of capital Boston Beer canraise from the public offering.

The market value of the company may be

determined using comparable financial data of its

competitors.


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Determination of Price

Comparable multiples analysis: using multiples

from market competitors with similar growth and

riskRedhook and Petes.

Petes is more similar to Boston Beer.

Petescustom (or contract) brewing companies

Redhookregional breweries

Boston Beercustom (or contract) brewing

companies


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Multiples analysis

Petes Brewing

Company

Redhook Ale

Brewery

Offering price $18.00 $17.00

1stday closing $25.25 $27.00

Current price (20/11/95) $24.75 $27.00

P/E ratio

(20/11/95)100 36

P/B ratio(20/11/95) 129 3

ROE (annualised)

(1995)8.6% 129.3%


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Price: P/E analysis

P/E = Price per share/EPS

EPSBoston, 1995= 0.26*4/3 = $0.3467

PetesP/E = 100x

Therefore P = 100*0.3467 = $34.67

RedhooksP/E = 36x implying a price of $12.48

$34.67 is the better valuation given the operational

similarities between the two companies.


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Price: P/B analysis

P/B = P/E*ROE (since book value per share =

EPS/ROE)

P/B = 100*0.4739 = 47.39

Also P/B = MV of equity/BV of equity MV of equity = 47.39*13229000 = $626.9million

Number of shares outstanding post-IPO =

19182119

Post-IPO price = 626.9m/19.2m = $32.68 A price of $32.68 is obtained which is fairly

close to the previous price of $34.67.


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Underpricing

Underpricing: the pricing of an initial public

offering below its market value.

Benefits for investment banks: Increases likelihood of oversubscription hence

reduces risk

Rewards the investors associated with the

investment bank Assists the collection of honest indications of

interest


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Underpricing

Reasons as to why companies do not reject

underpricing:

A price run-up immediately following the IPO will

create excitement

Only a small portion of private shareholders

shares are sold in the IPO

A successful IPO will ensure the ease of raising

capital in the future


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First Day Premium

Premium = (Closing priceIssue

price)/Issue price

Petes1stday premium = 40%

Redhooks1stday premium = 59%

Expected 1stday premium forBoston

Beer = 40%60%


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Underpricing1stday premium

P/E analysis: a price range of $21.67

$24.76.

P/B analysis: a price range of $20.43$23.34.

Appropriate price range: $20$25

Offering price of $12.50 is significantly

lower.


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Short term Returns

30-days return is indicative of the short term

return.

In generalthe IPO offer price is toolow and

the first day run-up is toohigh.

Long term: usually the returns on IPOS are

lower than expected.

Short term: < 1 year, usually IPOs are profitable.

Redhooka monthly return of 16.67%

Petesa 13-days return of 37.5%

Boston Beerlikely to rise by 20% to 30%


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30-days Return

Same formula as before

Premium = (Closing priceIssue

price)/Issue price

1.2*20 = $24.00 and 1.3*25 = $32.50

30 days after the IPO:

Boston Beers stock price will settle at

$24.00$32.50.


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Post-IPO Valuation

The ability to sustain growth and competitive

advantage is essential to its ongoing financial

viability.

Analysts will forecast Boston Beers growth rate

to evaluate its long term performance.

The need to determine long term valuethe

need to forecast growth ratespro forma data

required


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Growth Forecast

Factors affecting the growth forecast:

Macroeconomic datainflation rate (CPI), interest rate

Market riskdegree of variation in response to market

movements

Likely changes in consumer demand in the foreseeablefuture

Focus or objective of the firm in the long run

Past economic data of the company

The firms future capital budgeting and investing needs


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Valuation analysis

A valuation analysis is performed using the

financial data of Boston Beer to determine the

implied growth assumption based on current

market valuations.

Current market valuationsthe offering price of

Boston based on the P/E & P/B ratios of Petesis

the best indication of market investors view of the

craft brewers.


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Valuation analysis

Setting market capitalisation = market value of

equity, the resulting growth rate will be the implied

growth rate assumed by market investors for the

next ten years.

Where:

Market capitalisation = Boston Beers offering

price*number of shares outstanding; and

Market value of equity = PV of the free cash flows

assuming it grows at the same rate for ten years and then5% until perpetuity.


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Valuation analysis Weighted average cost of capital = 11.84%

Cost of debt (before-tax): (7.02 + 11.50)/2 = 9.26%

Cost of equity:

CAPM= 6.26 + 1.0*5 = 11.26%

Bond-yield-plus-risk-premium= 9.26 + 4 = 13.26%

Cost of equity (average) = 12.26%

Weight of debt = 6.20%

Weight of equity = 93.80% Corporate tax rate = 40%


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Valuation analysisEquationsused in the analysis:

EBIT = Operating margin (pre-tax)*Net sales

NOPAT = EBIT*(1T)

Invested capital = Net new investment inoperating capital (yearly change in working

capital and PP&E)

FCF = NOPATinvested capital

Total value of the firm = Value of operations +Value of non-operations

Total market value of equity = Total value of

firmtotal market value of debt


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Valuation analysis


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Market Sharecraft brewers Sell-side analysts forecasted a growth rate of

25% to 40% for the craft-brewing segment.

Implied growth rate from current market

valuationsis 50.06%.

Wall Street analystsforecasted that the craft beer

segment could conservatively reach5% of total

domestic beer sales by the year 2000.

These data are comparable and can be reconciledto reveal the market sentiments and

expectations of the craft beer segment in the

domestic beer industry.


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Market Sharecraft brewers


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Market Sharecraft brewers


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Market Sharecraft brewersGROWTH RATE

ASSUMPTIONMARKET SHARE IN 2000

(FIVE YEARS TIME)

25% 3.62%

40% 6.38%

50.06% 9.03%

Conclusion: market investors have a more

optimisticoutlook of the craft beer segment

(Boston Beer) than financial analysts.


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Are these growth rates

sustainable?

The growth rates of the companies are unlikely to

sustain in the long run due to the threat of greater

competition

The Big 3 would react to seek expansion into

the specialty segment to protect their market

share

Expansion strategies by investing directly or

indirectly in existing craft brewing companies

Existing Expansion strategies:

Anheuser-Buschs equity/distribution deal with

Redhook

Strohs equity/production arrangement with Petes

Brewing Company


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Are the ROEs sustainable?

ROE = Operating Profit (pre-tax)

Shareholders Equity

Competitionprice reductionsslightly lower

margins

lower operating profits

LowerROEs

Return on equity of these companies is likely to

be unsustainable

Excess capacity expected to diminish in time necessity of raising capital through equity funding

Thus,the ROE of the craft brewing companies

would also fall


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Too Optimistic?

The craft brewing industry is likely to be

overcapitalized given its total size, the abysmal

growth forecast of the overall beer industry, and

the rising competition from major domestic beer

companies into the specialty beer segment

A hyped up reaction in the craft brewing segment

P/E and P/B multiples are overvalued


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Parallels to other

Hot Industries

Beer industry is currently similar to the biotech

industry in the 1970s and the dot.com internet

industry in the 1990s

Shares are oversubscribed and overvalued Hype up reaction for the IPO leading to high first

day run-ups

The craft beer industry is very susceptible to shock


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After Price Determination

Roles of the investment bank:

1. Help Boston Beer determine the preliminary

offering price (or price range) for the stock and the

number of shares to be sold

2. Selling the shares to existing clients

3. Cover the stock after it is issuedongoing

research and coverage by the analysts of the

investment bank to facilitate trade in the secondary

markets.


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Conclusion

Final offering price range: $20 - $25

Implied growth rate: 50%

Growth of the industry is unlikely to besustainable

ROE may deteriorate in the future

The segment is overcapitalised and shares are

oversubscribed Potential overvaluation of Boston Beer

acf - boston beer

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