BOSTON BEER INC -CL A SAM
October 22, 2017 - 4:42pm EST by
pcm983
2017 2018
Price: 172.85 EPS 6.60 6.93
Shares Out. (in M): 12 P/E 26.2 25.0
Market Cap (in $M): 2,128 P/FCF 22 22
Net Debt (in $M): -72 EBIT 131 137
TEV ($): 2,056 TEV/EBIT 16 15

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  • Still overvalued
  • Potential Acquisition Target
  • winner
  • Channel stuffer
 

Description

  • Boston Beer Company, which essentially founded the craft beer movement, has been besieged by the very competitors it laid the groundwork for over the last few years – the stock has gone from a growth darling to a fallen angel – the current valuation is attractive in the context of the broader alcohol industry and the strength of the business’s core franchises

  • Under the backdrop of a beer industry that is facing challenging volume trends, aggressive competition among the megabrewers, craft brewers, and other innovative spirit concepts that are gaining share, SAM has struggled to remain relevant and defend its niche; the brand has lost its way and now occupies a challenging position whereby it is not considered a craft beer given its long history and size, but it also lacks the scale of the megabrewers

  • SAM is a strategic asset in a consolidating beer industry that is materially under-earning due to poor expense controls and lack of scale; the business needs to either find a way to return to profitable growth or rationalize its cost structure to align with flat to declining volumes

  • Recent M&A speculation, in combination with the upcoming retirement of the current, long-time, CEO Martin Roper, increase the likelihood of a strategic transaction (A recent Bloomberg article noted that while Jim Koch has publicly disavowed selling the company to the megabrewers, a company like Constellation Brands could be a good fit as an acquirer given their target areas and SAM’s product portfolio which includes a lot of non-beer products)

    • While there is no perfect way to evaluate precedent transactions in the space, given the idiosyncratic growth rates, production levels, and product portfolios of each target, a number of precedent transactions have occurred in recent years at valuations substantially higher than where SAM trades today

    • A few notable deals in recent years:

      • STZ purchased Ballast Point in 2015 for ~$1Bn or ~10x forward sales (that being said, STZ recently wrote-down some of the Ballast Point goodwill and said the unit has not performed to expectations; they probably overpaid and future deals likely will have more reasonable valuations)

      • Lagunitas initially sold a 50% stake to Heineken in 2015, and in May 2017, subsequently sold the remaining stake to Heineken (The rumored valuation in 2015 was ~1Bn, and while revenue wasn’t disclosed, the news reports stated a target of 800k barrels for the next year, so assuming a rough number of $250 / barrel, projected revenue was ~200mm, putting the deal at ~5x sales)

      • In April 2017, TSG Consumer Partners invested $265mm in BrewDog at a $1.2Bn valuation; news reports put sales at $88mm for 2016 (suggesting a valuation of >5x sales depending on what forward sales were projected to be)

      • In August 2017, Sapporo purchased Anchor Brewing Company for $85mm, or ~2.5x sales (in an article on the deal, the author noted that Anchor Brewing’s sales were actually down 4% YoY)

  • With the exception of its Twisted Tea and Truly Sparkling franchises, all of SAM’s core products have seen volume declines in recent periods (earlier in the year volume was projected to decline double digits for the year, but management indicated on the 2Q17 earnings call that trends have stabilized somewhat and volume should only decline low to mid-single digits for the year)

    • Truly has actually been the one bright spot in an otherwise challenged business of late, given its fast adoption and current popularity among influencers and other tastemakers

  • The long-time CEO, Martin Roper, is slated to retire in 2018

  • The company hired its first CMO, a former senior executive of Moet & Chandon, in mid-2016; he is working on implementing a marketing strategy that will ensure the brand remains relevant in an increasingly crowded craft beer space

  • SAM is facing a challenging competitive environment – players in the beer space continue to consolidate – i.e., AB Inbev, Molson Coors, etc. – many smaller craft players are electing to either sell to the megabrewers or are raising capital from private equity

  • Precedent transactions in the space indicate that acquirers are willing to pay relatively high multiples for strong franchises – numerous deals in the mid to high teens EBITDA multiple range

  • SAM needs to rekindle its brands and restore focus on profitable growth – Jim Koch (Chairman and Founder) has a distaste for SAM’s non-beer portfolio (i.e., Cider, Twisted Tea, and Truly Sparkling) – he has always been passionate about craft beer

  • The business has lost its focus with the recent focus on Truly Sparkling, hard cider, and twisted tea – while these have been attractive areas for growth of late, they have diluted the brand equity of the business – people no longer view SAM as a craft beer player, but rather incorrectly identify them with the megabrewers

  • SAM’s products tend to under-index among young people – this is a material problem which will be an obstacle for the business in the future

  • Unlike some other craft brewers which use limited TV & radio advertising, SAM utilizes a substantial amount of TV & radio advertising – SAM’s spending on SG&A / sales & marketing expenses is high relative to a number of its competitors

    • SAM’s spending on TV may actually be value destructive – it further reinforces the notion in consumers’ minds that SAM is similar to the megabrewers

    • SAM could substantially decrease its TV ad spending, while actually improving the brand and positioning it more along the lines of a craft brewer – it needs to do everything possible to restore consumers’ perception of it as a craft brewer

  • SAM needs to find a way to reinvent the brand in a way that resonates with young people – it needs to restore its public perception – the way to do this is by utilizing newer media such as Instagram, and Snapchat, as well as by engaging influencers

  • Jim Koch has continually raised alarm about a bubble brewing in the craft beer space with a large amount of entrants to the space, and about the consolidation among the megabrewers and among wholesale alcohol distributors – his recent Op-Ed lays out the strategic rationale for why SAM needs to engage in a transformational corporate strategy to address to the current headwinds facing the business (https://www.nytimes.com/2017/04/07/opinion/is-it-last-call-for-craft-beer.html)

    • The increasing negotiating power of the megabrewers has enabled them to pressure distributors to focus more on the products in their portfolios

    • The consolidation of the wholesale alcohol distributors has put additional negotiating pressure on SAM

    • Jim Koch has repeatedly stated he would not sell to the megabrewers; that leaves the options of potentially selling to a company like Constellation Brands (i.e., companies not viewed as being megabrewers), selling to or partnering with private equity, engaging in a joint venture similar to what Lagunitas did with Heineken (which culminated in the eventual sale of the business to Heineken), or acquiring other craft brewers to gain additional scale

    • An additional option SAM could pursue is seeking to divest the non-beer product portfolio (namely Twisted Tea, Hard Cider, and Truly Sparkling) – this would enable SAM to realize full value for these successful innovations, and return to focusing on excelling as a craft beer brewer – this would simplify the operations of the business and the brand messaging to consumers

    • While Jim Koch controls 5 of 8 board seats, he has repeatedly expressed his lack of interest in the non-beer products as he is most passionate about beer – it seems that he might be supportive of such a plan

      • Additionally, despite Jim Koch’s control of the board, he wants to do what is best for the company and wants to see the company succeed; it is apparent that he has been disappointed with the company’s performance in recent years

      • SAM is essentially Jim Koch’s life work and he likely does not want to see it slowly fade into irrelevance

  • SAM’s recent capital allocation record is sub-par – in 2015 and 2016, it purchased ~ $301mm of stock at an average price of ~ $192.14, while the current stock price is ~ $173.

    • It likely should have deployed this capital to improve the efficiency of the business, to improve the market position of the core product portfolio, or to execute strategic M&A

    • SAM continues to spend amply on marketing, despite declining volumes – it should rationalize its marketing spending and deploy marketing dollars into newer media to attract younger customers (i.e., utilize social media much more and limit spending on legacy media like TV)

  • The announcement of Martin Roper’s imminent retirement, combined with the recent hiring of the company’s CMO, provides a great opportunity to bring-in a talented CEO to help turnaround the business – SAM should think more broadly than just traditional beer executives – it needs someone with an excellent record in correctly understanding changing consumer tastes (i.e., someone who has been successful in the high fashion industry)

  • If SAM can find a way to potentially monetize the Truly Sparkling, Cider, and Twisted Tea businesses, and simultaneously begin a turnaround of the Sam Adams beer portfolio, it would likely create substantial shareholder value in the context of the current valuation of the business

  • SAM is a heavily shorted stock – ~ 30% of the float is short

    • The 2Q17 earnings report only showed most improvement, and the stock rose substantially – sentiment around the company continues to be very negative, so you do not need to see that much improvement for the valuation to improve


Base Case (declining organic sales + small margin improvement):


Upside Case (stabilization of sales + margin improvements):




Appendix:

http://adage.com/article/cmo-strategy/craft-brewers-experiment-tv-ads/293391/:

  • The company in 2013 ranked fifth in the beer category in measured media spending at $38 million, which was $4 million more than liquor giant Diageo spent on its beer brands in the U.S., which include Guinness. In the first quarter of 2014, Boston Beer boosted its advertising, promotional and selling expenses by $17.8 million compared with the first quarter of 2013, the company said on a recent earnings call.

  • Kona is owned by the Portland-based Craft Brew Alliance, which also markets Red Hook beer. Anheuser-Busch InBev owns 32% of the company's common stock and Craft Brew has access to A-B InBev's wholesaler network, but the marketer maintains its own ad budget. In 2013, the company spent a mere $136,700 in measured media on its brands, according to Kantar. But Craft Brew Alliance opted to boost advertising on Kona this year after spending years focusing on growing distribution, including a recent expansion into the Midwest, said Robert Rentsch, the company's senior director of brand marketing. "As craft beer grows, so does the level of competitiveness [and] so does the level of resources needed," he said.

3Q 214 Earnings Call:

  • Marc Riddick - Williams Capital:

  • And one last follow-up there and more so on the straight advertising side, I guess. Are you getting a sense that is there a change as far as the kind of bang for your advertising buck that you're getting from the television advertising and how maybe that looks compared to a year ago? Because we are certainly used to seeing your commercials, especially on sporting events and things like that, I was wondering if from a pricing standpoint that you're seeing what type of difference there may be this year versus last.

  • Martin Roper:

  • Measuring the effectiveness of advertising is incredibly hard. It's a lesser variable to pricing, to sales force activity, to retail activation. So I don't think we have a sense that the advertising effectiveness has changed year-on-year. And certainly with the noise in the measurement of effectiveness, I don't think we have any conclusion that our advertising is changing effectiveness. We continue a strategy of buying for media which has been pretty consistent since about 2005 that for us has been pretty effective as measured in total company growth. So we're pretty happy with our approach to media. And when we have media that we like and that we believe tests well, then we're willing to increase the spend.

From profile of Jim Koch:

  • Koch, now 61, says he tries to follow the advice his father gave him when he was starting Sam Adams. “He told me, ‘People don’t drink the marketing, they drink the beer,’ ” Koch recalls.

From Old Profile of Jim Koch:

  • Nobody--not one of them--said something on the order of, "If you're trying to create an image in consumers' minds of a better beer, the first thing you do is brew a better beer." Then it was my turn to get riled. I told them this was a perfect example of where American business is today: looking to sell me-too products through better marketing. And I also said, look, in business you have only two ways of surviving: either your product is better than your competitors', or it's cheaper. There's simply no other foundation on which to build a successful business. None. Better or cheaper, take your pick. It's also why I'm convinced that--right now, anyway--I have a business and General Motors doesn't. Furthermore, unless GM gets its act together, in 20 years The Boston Beer Co. will be bigger than GM. And it won't be because we've grown, either.

https://www.statista.com/statistics/264998/ad-spend-of-selected-beer-manufacturers-in-the-us/

 

  • SAM spends ~ $60mm per year on advertising

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

  • Stabilization of the business - while I don't have a view on specific timing, I think this will be apparent over the next 6-12 months; as mentioned above, sentiment around this company is so negative that even a small improvement should have a substantial impact on valuation
  • Announcement of a review of strategic alternatives / announcement of the new CEO; new CEO would likley evaluate all strategic options after joining the company
    • M&A transaction or JV / partnership with either private equity or a large player in the space
  • Continued growth of the Truly Sparkling franchise - this product has done well post-launch and illustrates that SAM can still innovate successfully
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    Description


    Base Case (declining organic sales + small margin improvement):


    Upside Case (stabilization of sales + margin improvements):




    Appendix: