Description

Notes:

- All numbers above in Financial Information in Euros

- I assume GBP.EUR = 1.15

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This is an event-driven idea with several strong catalysts over the next 12 months that revolve around C&C Group's acquisition of Conviviality's Direct (aka on-trade; wholesale; or non-retail) group for £1. We have heard no chatter about this idea, and the press related to Direct has been ugly due to its near collapse.

The thesis is:

- Due to the backing of AB InBev (providing guarantee on all trade creditor debt), the purchased on-trade business will not death spiral and will be in a stronger position than it was with Conviviality (before Conviviality almost destroyed it through incompetence).

- As they now control a major distributor with enormous reach, C&C can aggressively push its own brands of cider and beer, esp in England and Wales, where it lacks market share. Their brands will return to growth.

- The close-knit relationship with AB InBev is intriguing and bodes well for C&C. Perhaps AB InBev and push C&C brands beyond the British Isles.

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Summary:

Pre Conviviality Direct

- C&C manufactures and distributes several brands of cider and beer, most notably Magners, Bulmers, and Tennant's.

- Almost all their business is in the British Isles (Great Britain and the island of Ireland), esp the island of Ireland and Scotland.

- The stock price has declined quite a bit over the past few years as its cider brands have lost market share and suffered from increased competition and have failed to break out of the Ireland/Scotland markets. It bottomed out recently at E2.60. Before the Conviviality Direct deal, they had taken several steps to grow sales, including a deal with AB InBev to distribute their ciders in Great Britain. At E2.60, the stock traded at about 12x unlevered FCF (before the Conviviality Direct deal).

Conviviality Direct

- I will not recount every detail, but I encourage all to read the RNS releases starting in March 2018. The level of incompetency is startling. The result was that Conviviality went from a £800mm TEV company (with less than £200mm debt) to a £100mm TEV company (with the equity wiped out) in one week! 

- On March 8, 2018, Conviviality announced they would fall short of EBITDA guidance by about 20%. Half of the shortfall was due to a spreadsheet error! The other half was due to margin pressure in the Direct business. They clarified this statement with a subsequent statement on March 13, 2018.

- On March 14, 2018, the company announced that they owed £30mm in taxes in two weeks, and that they were unaware of this until now. Further, they had no cash available to pay the tax.

- Rumors were swirling in the UK spirits industry with the March 8 announcement, and all hell broke loose with the March 14 announcement. Suppliers refused to deliver to Conviviality, and of course, customers forgot to pay their bills: the dreaded death spiral of any distributor. Many small suppliers would certainly have had to go under if their accounts receivable from Conviviality was worthless.

- The CEO (Diana Hunter) was terminated on March 19.

- The attempted equity raise of £125mm was un-successful and Conviviality filed for Administration. Even before the Administrators had been assigned, C&C agreed to purchase the Direct business on April 4, 2018 for £1. And the creditors, owed about £180mm, agreed to take a haircut and only £102mm of debt was transferred with the sale. (Note: technically, they did not agree to a haircut as the remaining debt remained with the parent company in Admin and they might get some of the proceeds from the sale of the retail business).

- And there is one more key detail. AB InBev provided “financial support” to the deal. This was not spelled out in the regulatory filings, but several articles and industry insiders agree that AB InBev has formally guaranteed all trade payables from both before and after the Administration filing. I have not been able to determine how long this guarantee will run, but clearly AB InBev wants C&C to be stable and successful.

- The AB InBev guarantee stopped the death spiral in its tracks. Suddenly, the Conviviality Direct business was more stable than it ever had been. Suppliers would be fully compensated for all past deliveries and would now have a more stable business partner going forward. I have spoken to two industry insiders—one in UK wines and one in UK spirits—and both believe that there will be no significant defections among suppliers. In fact, they would not be surprised if the new Conviviality Direct attracts some new suppliers over time now that it is more stable partner because of its brands EBITDA and because of AB InBev.

- And a similar story on the customer front: they have little incentive to defect to new distributors (and different brands) now that Direct is stronger. And they now must “remember” to pay their bills to Direct now that Direct will be an ongoing business partner.

Valuation

If my thesis is correct, what is this worth?

Pre-Conviviality Cap Structure:

Shares: 310mm à Mkt Cap = €930mm

Net Debt: €173mm

TEV = €1,103mm

This is from August 31, 2017 balance sheet. FY 2018 ends Feb 2018. They acquired a large group of pubs in H2 FY’18. These are not included in these numbers.

FY 18 EBITA = €93mm

Unlevered FCF = €78mm (14x)

Pro Forma the Conviviality Acquisition

All we added was €117mm of working capital debt. For distributors, I tend to consider true working capital debt outside the TEV but subtract the interest from EBITDA. The reason is that this debt scales with the business.

Before the final death spiral orgy (but including overhead, the spreadsheet error, and margin pressure), the Direct FY ’18 EBITDA was about £43mm. Subtract the working capital interest and apply a 20% tax rate and the result is unlevered FCF of £30mm, or €34mm.

If we add in only this, Unlevered FCF = €112mm (<10x) and note that our pro forma TEV is the same because they paid £1.

Further, I believe the new Conviviality Direct will outperform the old one. Even before the death spiral, Conviviality Direct had lost control of its AR and its margins. It was doing bad deals to grow at any cost. DSO was expanding and causing working capital issues. The fact is that Conviviality Direct needs to fire a few customers and let some other customers walk if margins are too low. This may cause a few quarters of short-term under-performance, but in the long run, it will result in higher margins and better cash flow.

The other obvious big upside here is the increased distribution of C&C brands by Conviviality Direct. The C&C Group press release and conference call emphasized this point: “provides direct access to an incremental c.23,000 on-trade customers . . . “ and “enhance access for C&C’s cider and super-premium brands across the on and off-trade in the UK.” I have struggled with how to quantify this except to say that the opportunity is large. It seems plausible that they go from having stagnant cider/beer brands to a consistent HSD/LDD growth given the opportunity in Great Britain cider alone.

Further, the relationship with AB InBev is intriguing. Can AB InBev enable C&C brands to break out of the British Isles? Would C&C eventually be an acquisition target?

Finally, they are now positioned to make small brand acquisitions that they can then blow out via their distributor. The strategy that Coca-Cola has used so successfully.

I struggle with the correct value, but I believe that both the brands and the distributor are worth >15x if the thesis proves correct. This would get us a +60% in the equity.

Additional Reading

http://www.the-buyer.net/insight/cc-ab-inbev-come-to-the-rescue-of-matthew-clark-bibendum/

http://www.harpers.co.uk/news/fullstory.php/aid/23367/Bibendum_and_Matthew_Clark_reassure_suppliers_that_it_is__91business_as_usual_92.html

Catalyst

1) Proving that the Direct business has stabilized (6 months)

2) Showing growth in brands due to owning distribution (12 months)