boston beer
Post on 17-Jul-2016
76 Views
Preview:
DESCRIPTION
TRANSCRIPT
Boston Beer: To IPO, or not to IPO…
12March
--------------------------------------------------Question 1---------------------------------------------------
Boston Beer, in response to consumers’ preference changes to more flavorful and bitter tasting
brews, was founded in 1894. Boston Beer implements a “quality at any cost” strategy with a
strong emphasis on product differentiation and implementing quality ingredients into its
products. For instance, Boston Beer was the first company to employ a stamped freshness date
on its bottles and ingredients are imported from around the world. Additionally, Boston Beer
relies heavily on contract brewing to gain competitive advantages. Boston Beer’s contract
brewing strategy results in lower overhead and transportation costs, as well as greater
manufacturing flexibility. The expenses Boston Beer saves through contract brewing allows for
an increased marketing budget and intensive sales force, which is greatly important for
differentiating products in a saturated market. Boston Beer’s strategy appears to be paying off;
from 1990 to 1995, its geometric average sales growth and gross margin were 40.4% and
54.4%, respectively. However, Boston Beer is less efficient that some of its competitors; its
operating margin of 6.7% is nearly four times lower than Redhook Ale Brewing Company—but
its margin is greater than Pete’s Brewing Company.
--------------------------------------------------Question 2---------------------------------------------------
Benefits of an IPO
Access to public capital markets will provide Boston Beer with a continual source of
equity funds to expand sales while maintaining a low leverage ratio.
The IPO will provide an exit strategy for the company’s current investors.
The additional equity will allow for debt to be refinanced at preferable interest rates.
The publicity from the IPO offering will benefit the company with marketing and sales,
particularly in new markets where they do not currently have brand recognition.
Disadvantages of an IPO
The company will face underwriting costs associated with the IPO.
A failed IPO could be costly both in financial assets and in firm reputation.
Complying with regulatory reporting standards will create additional costs that are not
present in a private company.
Incorporating the company may have negative tax implications for the current owners.
Current shareholders who do not exit during the IPO will face severe dilution.
Management control will decrease because of fiduciary duties to shareholders. This
could conflict with the company’s product quality processes and result in a shift toward
a short-term earnings focus.
Conclusion
Although their contract brewing model reduces expected capital expenditures, their labor and
marketing intensive sales strategy will require substantial spending to expand into new
markets.To meet projected growth, external funds will be needed. Raising these funds entirely
from debt would create an unacceptable level of debt for a still growing company; thus equity
funding is the preferred option. The company has reached a maturity point where equity can
more easily and cheaply raised in public capital markets rather than through venture or private
equity firms. Additionally, publicity from the IPO will help with brand recognition in new
markets. Given the recent success of competitor IPOs and Boston Beer’s profit margin and
growth potential, the risk of a failed IPO is minimal, and most current shareholders intend to
sell shares in the IPO reducing dilution concerns. Boston Beer should proceed with the IPO.
--------------------------------------------Question 3-5 (Exhibit 3)------------------------------------------
1995 Pro Forma Net Sales: All pro forma sales rely upon the assumption that net sales as of
September 30, 1995 represent 75% of expected year-end revenue. Because the firm’s IPO will
most likely have a more positive impact on Q4 sales than this estimate projects, if anything, the
prices generated by our models are underestimated, not overestimated.
Cost of Debt: BBC explains in its prospectus intent to extinguish outstanding debt carrying
interest rates upwards of 11.5%. Based upon the firm’s low target leverage of 5%, low degree
of operating leverage, and favorable credit history and financial outlook, the model assumes a
cost of debt in line with AAA corporate debt at 7.02%. This estimate seems reasonable and
sensitivity analysis shows a 1% decrease in the forecasted share price requires at least a 2.4%
increase in the cost of debt.
Risk Free Rate: The six-month and 30-year treasury rates given imply a fairly flat yield
curve. Due to the relatively short forecast period and the short-term risk characteristics of this
industry, the model uses the six-month rate as the risk free rate in calculating the cost of equity.
1995 Net Working Capital Requirement: In order to calculate the change in NWC over
1996, the model assumes 1995’s year-end NWC is composed of the existing September 30,
1995 balance plus 10% of fourth quarter net sales due to the firm’s recapitalization strategy.
CAPX: Historical analysis shows an average 3.3% capital intensity ratio. Based on a likely
decrease in efficiency due to rapid expansion, the model forecasts a 3% capital intensity ratio--
this includes restricted investments (Exhibit 1).
Depreciation: Depreciation was not included in the calculation of free cash flows because
net CAPX was used.
1995 Value of Debt: Boston Beer’s debt is private, so the market value will be very similar
to, if not exactly the same as, its book value.
--------------------------------------------------Question 6---------------------------------------------------
The underwriting prospectus for the IPO suggests a share price of $12.50 per share, which is
the starting point for analyzing the different scenarios. In order to determine the scenario that
was most realistic, we attempted to rule out the ones that were not and a summary of our
analysis is found in Exhibit 4.
(1) First we analyzed the information asymmetry in the IPO. The offering presents
information about almost 1.5 million shares offered in the IPO from current stockholders. It is
unlikely that management are willing to offer shares at $12.50 if the fair market value really is
$29 per share, thus weakening the belief in the second scenario.
(2) Analysts’ expectations and comparable metrics. Analysts are generally very positive in
regards to the Craft Brewing Segment, expecting continued growth in 1995. A conservative
market share estimate of 5% of the total domestic beer market by 2000 compared to only 1.4%
in 1994. In addition, both Pete’s Brewing Company and Redhook Ale Brewery have recently
completed successful IPO’s resulting in growing share prices. These factors both build up
expectations for BBC’s upcoming IPO and are likely to be incorporated in BBC’s IPO price. This
might mean that BBC will be trading at a slight expectation premium above what the fair value
of the company is, thus strengthening the reliability of the first scenario with a stock price of
$12.13.
In addition, by comparing P/E ratios of Pete’s Brewing Company, 100, and Redhook Ale
Brewery, 36, with BBC for the three different scenarios weakens the third scenario because of
an implied P/E ratio of 17.9, which is below both of the two comparable companies. The first
scenario giving an implied P/E ratio of 41.9 and the second scenario showing an implied P/E
ratio of 99.9 are both around the two competitors’ P/E ratios, strengthening the plausibility of
these scenarios when looking at the P/E ratio isolated.
(3) We also used industry growth trends to compare the expected sales of BBC in 2000,
considering a constant market share, to the 2000 sales forecasted in each scenario. The results
allowed us to rule out the third scenario because the sales forecasted in 2000 are less than half
of what we would expect with conservative assumptions of the craft industry growth. The
other two scenarios were fairly close to the expected revenues in 2000.
(4) The second scenario was ruled out when analyzing the growth trends of BBC in recent
years. BBC has already undergone rapid growth and we expect that high growth phase to taper
off sooner rather than later. Ten more years of high growth is unreasonable and unrealistic.
Lastly, the second scenario can be ruled out again when looking at revenues projected
for 2006. If the craft brewing industry grew to ten percent of the total domestic beer market by
2006, which is an aggressive assumption, then BBC would have to double its current
percentage of market share in the craft industry. We also find that assumption fairly
unreasonable due to the competitive nature of the craft industry now and into the future.
Conclusion
Scenario 1’s price of $12.19 seems most realistic due to the consensus of the above
methodologies. It’s implied, intrinsic PE ratio is in line with growth sentiments in the market;
information asymmetry in equity markets implies that the firm would make an offering at a
price that accurately reflects firm value given insider information (the closest being scenario
1’s estimated price); analyst estimates of industry growth and BBC’s market share are close to
scenario 1’s projected revenue trends; finally, scenario 1’s growth trends accurately reflect
BBC’s slow decline from high-growth to maturity. In conclusion, scenario 1 seems most likely.
If the model is changed to assume conservative long-term growth rates of 3% and 5%,
scenario 1’s estimated price becomes $15.64 and $20.2 respectively. Thus, we believe a good
estimate of BBC’s equity value per share is between $15 +/- $5 depending on the market’s
premium.
Exhibit 1
Exhibit 2
Exhibit 3: Scenario 1
Exhibit 3: Scenario 2
Exhibit 3: Scenario 3
Exhibit 4
top related