acf - boston beer
TRANSCRIPT
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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
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
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
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
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