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