BOSTON BEER COMPANY

Initial Public Offering

Company Background
The Boston Beer Company: largest company in the craft beer segment in 1994 shares astonishing growth with others in the specialty 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

Business Models
Main Competitors Redhook Brewing and Petes Brewing Regional Brewers Redhook
Owned and operated production facilities Large capital investment Little expenditure on sales and marketing

Contract Brewers Boston 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

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 and third 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

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 a long-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.

Ratio Analysis
Redhook Year ended Year Return on Equity Profit before taxes/NetSales(%) Net Sales/Assets Assets/Equity Return on Equity (pre-tax%) Margins Gross Profit Margin (GP/Net Sales %) SGA/Net sales(%) Operating Profit/Net Sales (%) Interest Exp/Net Sales (%) Aggregate Size Measures Net Sales (000s) Total Assets (000s) Barrels Sold(000s) Growth Rate (of Barrels) Total Shareholders 46.3 41.8 34.4 47.0 45.0 49.7 54.0 54.0 46.2 27.8 0.8 1.5 32.0 22.2 0.6 1.3 16.0 18.0 0.3 1.2 6.4 1.1 5.7 6.7 41.1 1.7 6.8 6.2 70.8 3.5 4.4 6.2 97.0 6.3 3.2 2.7 55.3 7.9 3.6 4.8 137.7 7.6 3.3 2.5 62.4 1993 1994 9mths ending 1995 Petes Brewing Year ended 1993 1994 9mths ending 1995 Boston Beer Year ended 1993 1994 9mths ending 1995

17.4 28.9

18.8 23.1

17.6 16.8

45.5 1.4

43.2 2.0

42.8 3.9

47.6 6.3

46.2 7.7

44.8 6.8

1.4

0.9

N/A

0.3

0.3

0.4

0.0

0.2

0.2

11484 20044 74 48% 15000

14929 34689 94 27% 26059

17929 84553 111

12236 3118 69 138%

30837 5918 180 161% 1040

41988 12983 246

77151 24054 475 62%

114833 31776 714 50% 6600

108905 31846 688

74372

400

1987

8854

13229

Size Measures
Redhook Year ended 9mths ending 1995 17929 84553 111 Petes Brewing Year ended 1993 12236 3118 69 138% 74372 400 1994 30837 5918 180 161% 1040 1987 9mths ending 1995 41988 12983 246 Boston Beer Year ended 1993 77151 24054 475 62% 8854 1994 114833 31776 714 50% 6600 13229 9mths ending 1995 108905 31846 688

Year
Net Sales (000s) Total Assets (000s) Barrels Sold(000s) Growth Rate (of Barrels) Total Shareholders Equity(000s )

1993 11484 20044 74 48% 15000

1994 14929 34689 94 27% 26059

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

Profitability
Redhook Petes Brewing Boston Beer

Year ended

Year
Gross Profit Margin (GP/Net Sales %) SGA/Net sales(%) Operating Profit/Net Sales (%) Interest Exp/Net Sales (%)

1993 46.3

1994 41.8

9mths ending 1995

34.4

Year ended
1993 47.0 1994 45.0

9mths ending 1995

49.7

Year ended
1993 54.0 1994 54.0

9mths ending 1995

46.2

17.4 28.9

18.8 23.1

17.6 16.8

45.5 1.4

43.2 2.0

42.8 3.9

47.6 6.3

46.2 7.7

44.8 6.8

1.4

0.9

N/A

0.3

0.3

0.4

0.0

0.2

0.2

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 General Administrative expense Petes Brewing is least profitable Gross profit margins of contract brewers are also higher and more stable

Return On Equity
Redhook Year ended Year Return on Equity Profit before taxes/NetSale s(%) Net Sales/Assets Assets/Equit y Return on Equity (pretax%) 1993 1994 9mths ending 1995 Petes Brewing Year ended 1993 1994 9mths ending 1995 Boston Beer Year ended 1993 1994 9mths ending 1995 27.8 22.2 18.0 1.1 1.7 3.5 6.3 7.9 7.6

0.8 1.5 32.0

0.6 1.3 16.0

0.3 1.2 6.4

5.7 6.7 41.1

6.8 6.2 70.8

4.4 6.2 97.0

3.2 2.7 55.3

3.6 4.8 137.7

3.3 2.5 62.4

Boston Beer and Petes have higher ROEs due to lower asset holdings and shareholder equity Redhook has much lower ROE due to heavy capital investment. ROE has declined approximately 50% of previous year Redhook has lower asset turnover

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

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 to outside 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.

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 (corporate cash) Establishes a value for the firm Facilitates merger negotiations Enlarges potential markets for the companys products

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 selfdealings 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

Boston Beers IPO

Rapid growth in the Craft-brewing segment is a positive signal for advantageous opportunity.
Conclusion: it is more profitable going public as the need for growth outweighs the costly and timeconsuming process. Competitors IPOs have been successful Redhooks and Petes.

Determination of Price
Initial public offering: the first sale 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 can raise from the public offering. The market value of the company may be determined using comparable financial data of its competitors.

Determination of Price
Comparable multiples analysis: using multiples from market competitors with similar growth and risk Redhook and Petes. Petes is more similar to Boston Beer. Petes custom (or contract) brewing companies Redhook regional breweries Boston Beer custom (or contract) brewing companies

Multiples analysis
Petes Brewing Company
Offering price 1st day closing Current price (20/11/95)

Redhook Ale Brewery

$18.00 $25.25 $24.75

$17.00 $27.00 $27.00

P/E ratio (20/11/95)

P/B ratio (20/11/95)

100
129

36
3

ROE (annualised) (1995)

8.6%

129.3%

Price: P/E analysis

P/E = Price per share/EPS EPSBoston, 1995 = 0.26*4/3 = $0.3467 Petes P/E = 100x Therefore P = 100*0.3467 = $34.67 Redhooks P/E = 36x implying a price of $12.48 $34.67 is the better valuation given the operational similarities between the two companies.

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.

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

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

First Day Premium

Premium = (Closing price Issue price)/Issue price Petes 1st day premium = 40% Redhooks 1st day premium = 59% Expected 1st day premium for Boston Beer = 40% 60%

Underpricing 1st day 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.

Short term Returns

30-days return is indicative of the short term return. In general the IPO offer price is too low and the first day run-up is too high. Long term: usually the returns on IPOS are lower than expected. Short term: < 1 year, usually IPOs are profitable. Redhook a monthly return of 16.67% Petes a 13-days return of 37.5% Boston Beer likely to rise by 20% to 30%

30-days Return
Same formula as before
Premium = (Closing price Issue 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.

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 value the need to forecast growth rates pro forma data required

Growth Forecast

Factors affecting the growth forecast: Macroeconomic data inflation rate (CPI), interest rate Market risk degree of variation in response to market movements Likely changes in consumer demand in the foreseeable future Focus or objective of the firm in the long run Past economic data of the company The firms future capital budgeting and investing needs

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 valuations the offering price of Boston based on the P/E & P/B ratios of Petes is the best indication of market investors view of the craft brewers.

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 then 5% until perpetuity.

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%

Valuation analysis

Equations used in the analysis: EBIT = Operating margin (pre-tax)*Net sales NOPAT = EBIT*(1 T) Invested capital = Net new investment in operating capital (yearly change in working capital and PP&E) FCF = NOPAT invested capital Total value of the firm = Value of operations + Value of non-operations Total market value of equity = Total value of firm total market value of debt

Valuation analysis

Market Share craft brewers

Sell-side analysts forecasted a growth rate of 25% to 40% for the craft-brewing segment. Implied growth rate from current market valuations is 50.06%. Wall Street analysts forecasted that the craft beer segment could conservatively reach 5% of total domestic beer sales by the year 2000. These data are comparable and can be reconciled to reveal the market sentiments and expectations of the craft beer segment in the domestic beer industry.

Market Share craft brewers

Market Share craft brewers

Market Share craft brewers

GROWTH RATE ASSUMPTION MARKET SHARE IN 2000 (FIVE YEARS TIME)

25% 40%
50.06%

3.62% 6.38%
9.03%

Conclusion: market investors have a more optimistic outlook of the craft beer segment (Boston Beer) than financial analysts.

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

Are the ROEs sustainable?

ROE = Operating Profit (pre-tax) Shareholders Equity Competition price reductions slightly lower margins lower operating profits Lower ROEs 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

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

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

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 issued ongoing research and coverage by the analysts of the investment bank to facilitate trade in the secondary markets.

Conclusion
Final offering price range: $20 - $25 Implied growth rate: 50% Growth of the industry is unlikely to be sustainable ROE may deteriorate in the future The segment is overcapitalised and shares are oversubscribed Potential overvaluation of Boston Beer