The acquisition of small, independent beer companies has become common-place in America. Each year, an average of six breweries are purchased by larger players, raising the ire of craft beer traditionalists and the eyebrows of rival brewers also considering an exit. With the price tag on some breweries now approaching $1 billion dollars, many are claiming the beginnings of a craft beer bubble.
Is there any business justification for these multiples? I explore the question in four steps:
- Estimate total company value (Enterprise Value or EV) for instances where the purchase price was well-publicized
- Estimate sales, gross profit and operating profit with a number of simplifying and uniform assumptions
- Perform a crude discounted cash flow analysis (DCF) under both high and low growth scenarios, utilizing unique discount rates and growth rates for each scenario
- Compare this crude valuation to the total company value (EV) to see what type of annualized return the acquirers can expect on their investment
If we see returns on investment (ROI) approaching something miniscule, we may have evidence of a bubble. If not, we may expect to see more $1 billion valuations in the future.
1. ESTIMATING TOTAL COMPANY VALUE FROM PUBLIC CRAFT PURCHASES
I look at five transactions for which data is readily available and reliable. Given (1) the dollar amount offered up and (2) the percentage ownership assumed, we arrive at a rough estimate of total company value (enterprise value).
It is important to note that the dollar amount offers no perspective on the size of brewery at the time of purchase. For instance, while Heineken may have looked like they paid the second highest amount for any brewery (50% stake for $400 million) Lagunitas was by far the most productive brewery on the list, with 640,000 barrels (roughly 75 million liters) of beer being produced every year. On the other hand, Constellation Brands put up $1 billion dollars for a brewery producing less than half of Lagunitas total at the time purchase.
To put things in perspective, I create a timeline highlighting the purchase price per bottle – a measure controlling for the relative size of each brewery.
How to read this chart: Constellation brands effectively paid $10.17 for every bottle of beer produced by Ballast point – a massive amount considering the next largest would be Heineken, paying $3.81 for every bottle of Lagunitas produced.
Takeaway: On the surface, it looks like ABI has made some savvy low-cost purchases, keeping two breweries under $2 per bottle. Constellation wins the “best overpayer” award. They overpay so good.
2. ARRIVING AT SOME SEMBLANCE OF EARNINGS DATA
Sales data is shoddy, profit data is non-existent. In response, I use a number of simplifying assumptions to get to a measure of cash flow.
- I assume a retail price of $15.00 for a six pack. This equates to $2.50 per 350ml bottle. I ignore discounts, changes in pack type, and pricing power derived from consumer loyalty
- I assume a gross profit margin of 30%. This is based off of a comparable company average. One particularly useful comp was the Craft Brew Alliance (CBA).
- I assume an operating profit margin of 10%. THIS IS GENEROUS. After a macrobrew purchases a smaller entity, one of the most heavily-used growth levers is marketing spend. As a result, SG&A spend (which includes marketing spend) is usually over 30% of top-line revenues. Operating margins are more typically south of 5% within the first few years after acquisition. (CBA also useful here)
3. TWO GROWTH SCENARIOS: WHAT INVESTORS EXPECT FROM ACQUISITIONS
High Growth Scenario – Private Equity firm as buyer
For the high growth scenario, I use annual growth expectations and required returns typical of a private equity firm. I define “required return” as the opportunity cost of investing in the craft beer company, as opposed to another investment. For private equity investors, I estimate that the minimum return they require to be roughly 20%.
Low Growth Scenario – Large Brewer (Strategic) as buyer
For the low growth scenario, I use growth expectations more typical of a strategic buyer (i.e. a macro brewer). In this scenario, we assume that maximum profit growth is 10% per year for the initial phase (2016 – 2020) and then tapers off to 5% for a number of years, and then 2.5% into perpetuity – roughly the long term growth rate of the US economy.
For strategic buyers the minimum required return would be something closer to equity market returns. That is to say, if a company like ABInbev could earn a higher return by investing excess cash into public equity markets, they would.
A chart summarizing the two growth scenarios is contained below:
4. DECLINING RETURN ON INVESTMENT: ARE WE IN A BEER BUBBLE?
I compare the crude valuation from the growth scenario above to the total company value (EV) to see what type of return the acquirers can expect on their investment
As you can see, Anheuser Busch (ABInbev) is projected to realize anywhere from 300% to 600% off of their initial investment in Goose Island. Obviously, a huge range. The point is not to stick to the numbers as bible, but to look at the annualized return on these investments through time. See chart below:
If we use the low growth scenario (actually more favorable in terms of total return), we see that the annualized return on investment in craft breweries has come down quite substantially from the 19% returns seen in 2011.
In fact, looking at some of the most recent acquisitions, annualized returns are only a few hundred bps higher than long term equity market returns (see Heineken above, annualizing 7.73% on Lagunitas). Constellation Brands may not even make back what they put in.
While I don’t expect craft acquisitions to stop any time soon, I do note that the observed return compression is evidence of a maturing industry sector. In short, buyer beware. Craft beer valuations seem a bit too frothy – bubbly even.