Boston Beer Case Study Analysis

1.  Boston Beer’s strategy is primarily focused on growth through differentiation. The sources of its competitive advantage can be classified as a company that provides high quality beer with unique flavors, a market driven approach, and a very efficient contract brewing strategy.

In terms of quality, the company created a premium beer by its selective use of ingredients and less water. Boston Beer has won honors such as being the first American beer sold in Germany due to its use of only barley, yeast, hops, and water as its ingredients. With the increase in health consciousness among beer drinkers and the rise in more distinctive and flavorful brews, the Boston Beer Company has been able to use its packaging and commercials to communicate its quality commitment to consumers. It is its image for quality among consumers that allows the company to keep high prices and profits when compared to major brewers such as Coors, Budweiser and Miller.

Contract brewing has allowed the company to use extra brewing space among other firms to brew beer. The Boston Beer Company has benefited from such practice in that no capital was required to purchase facilities and equipment during a period in which it was growing at a double digit rate. Additionally, these breweries were distributed throughout the Unites States thus allowing the company to maximize freshness of the beer it sold. Such outsourcing approach has resulted in a higher focus on selling the product and low transportation costs.

Sustainability will depend on the company’s ability to differentiate itself from major American brewers. It will be critical for the Boston Beer Company to continue focusing on its commitment to quality as it continues its path for growth by investing excess capital in research and development as well as bolstering its image as a company that brews premium beer with unique flavors. In terms of valuation, the company is profitable and creates business value in addition to having a trustworthy and capable management team able to produce stable double-digit returns in equity and gross margins. It is the largest and most successful of the small craft brewers, generates significant cash flow, and has minimal debt. It appears that the stock price should be higher than the $10 to $15 per share initially estimated by underwriters based on the facts previously mentioned.

2.  In recent decades, the concept of an IPO with dual class stock structures have become increasingly popular, especially in situations when mature and/or family-owned companies go from private to public ownership. By utilizing this structure, companies such as Google, Ford Motor Company, and Facebook have been able to raise substantial equity capital without relinquishing control from the founders and management of the organization. From an investor’s perspective, however, the purchase of a non-voting share of common stock relinquishes the voting power that traditionally accompanies such an investment.

As a result, investors may require a higher return than if they held Class A voting shares. Jim Koch decided to pursue a dual stock structure for the Boston Beer Company as a result of the unprecedented growth of both his organization and the niche industry in which the company operated. Additionally, by retaining voting power in the organization, Koch shielded the organization from a potential takeover from the large and well-capitalized players in the domestic and import beer markets. While choosing this structure provided the operational control the founder desired, such a decision potentially impacts amount of capital raised in an IPO. Investors purchasing a public equity offering in this situation may require a lower purchase price since the ownership interest in the organization has been diluted to an insignificant share.

3. Investing in IPOs generally come with risk. According to a recent study, IPOs generally increase 18% in the first days of trading, but underperform in the following 3 years when compared to stocks of similar size.1 The overall beer industry in the US generated 5 billion in revenues in 1994, and analysts expected little to no growth in the industry through 2000. In order to grow, Boston Beer must continue to increase its market share in the overall beer market. The market continues to be dominated by the large scale breweries like Anheuser Busch, Adolph Coors Co, and Miller Brewing Co. Craft Breweries are beginning to increase their share in the overall market. It is expected that craft breweries will account for 5% of the overall beer market in 2000, up from 1.4%.

However, there is increased competition in the craft beer market. There were 165 new craft brewers in 1994. This increased the total of craft breweries in the US to 750. Boston Beer will be competing with these 750 breweries for 5% of the 5 billion in US beer revenues. Boston Beer does not plan to pay a dividend. Returns from investing in Boston Beer will solely be from growth. The company plans to release 19 million shares in the IPO. At a price of $15 per share, it would be trading at over 57 times its 2004 earnings. This will require significant growth from Boston Beer in the coming years to realize returns in this investment. Boston Beer will be competing with a growing market for a small share of the overall US beer market.

4.  The Boston Beer Company filed its initial public offering prospectus with the SEC because they were looking to raise between $26 and $34 million for capital investments in equipment, funding working capital, and general corporate purposes. In the past Boston Beer had financed its working capital and capital expenditures through cash flow from their operations, and had recently entered into a $14 million line of credit agreement with the Fleet Bank of Massachusetts. In November 1995 the limited partnership that made up Boston Beer Company was going to be dissolved and, “at the time of dissolution, the company would distribute $12.5 million to its existing partners by using $1,552,000 in cash and borrowing $10,948,000 against its line of credit at Fleet Bank” (pg. 5). The cash raised from the IPO was planned to be used to allow them to immediately pay back the debt of dissolving the original partnership as well. To address the question of the possibility of a firm being overcapitalized, we can look in even greater detail at what Boston Beer plans to do with its proceeds from the IPO.

The case states that Boston Beer plans to pay back its debt to Fleet Bank, $10,948,000, use $7 million to fund capital expenditures in 1996, and use the remaining proceeds to fund working capital expenses or be invested into investment grade securities. Since repaying the debt and funding capital expenditures add up to almost $18 million, it leaves about $8 to $16 million for working capital expenses and investment grade security investments. Judging by Boston Beer’s past financial data, working capital expenses will not eat up an overwhelming portion of the remaining proceeds, thus leaving a substantial amount of money to be invested in investment grade securities. One of the causes of over-capitalization is idle funds. This means that a company may have such a large amount of funds that it cannot use them properly. That money may be sitting idly in banks or in the form of low yield investments. The investment grade securities that Boston Beer plans to invest in seems to imply that although they would be safe investments, they will not offer a high yield. Following this line of reasoning one could assume that it’s not only possible for a firm to be over capitalized but it could also be argued that Boston Beer would be over capitalized after its IPO depending on how profitable they can be with the investment of their excess funds.

5. If we analyze the other two similar beer companies that went public, Redhook Ale Brewing Co. and Pete’s Brewing Co., their IPO Market Prices were $17.00 and $18.00 accordingly. If we also analyze their estimated EPS of $0.45 and $0.15, their P/E ratios turned out to be 38 for Redhook Ale Brewing Co. and 120 for Pete’s Brewing Co. Assuming Boston Beer Company is a comparable firm, its P/E ratio could fairly range anywhere from 38 to 120. Also, taking into account that Boston Beer is not planning on paying out dividends in the near future, one can assume investors would expect higher earnings growth in the future and therefore a higher P/E ratio would better reflect Boston Beer’s current state. If we assume a P/E ratio of 100, together with its estimated EPS of its ’95 Income Statement of 0.26, that gives an estimated share price of $26.00 dlls (P= ratio x EPS). Table 1, page 5

6. According to Beer Institute figures, per capita consumption for beer has remained stagnant in the last 10 years at 30.6 gallons in 2003 compared to the current 30.4 gallons per person. The real increase in beer consumption will be reflected in more specific segments such as imports and craft beers. It is no secret that consumer preferences have been changing and younger generations are now looking for more unique flavors and high quality ingredients as opposed to the undifferentiated tastes being offered by large brewers. The craft beer industry has increased in the form of production and dollars in recent years. Growth of the craft brewing industry in 2011 was 13% by volume and 15% by dollars compared to growth in 2010 of 12% by volume and 15% by dollars. Craft brewers sold an estimated 11,468,153 barrels of beer in 2011, up from 10,133,571 in 2010.2 Both the short- and long-term prospects appear favorable for well-run domestic craft breweries, given the attractiveness of their unique approach, relative to their large competitors such as Anheuser-Busch, Adolph Coors, and Miller Brewing Company. These organizations continue to hold some competitive advantage to their international counterparts due to the increasingly efficient production, bottling, and distribution throughout the United States and internationally.

The potential for continued growth for the industry does not come without risks of continued globalization and consolidation in the industry. An example of this was InBev’s acquisition of Anheuser-Busch in 2008. Prior to the consolidation of these two entities, the economies of scale and scope associated with production and distribution of domestic and import were not available to gain additional market share.

Table 1
If we also take into account the estimated stock growth rates:

Boston Beer Company’s stock is expected to grow an additional 28.7%, therefore a fair IPO Share Price for Boston Beer would be anything in between $26.00 and $33.00 dlls.

Sources:

1. Eckbo, B. Espen and Norli, Oyvind, Liquidity Risk, Leverage and
Long-Run IPO Returns. Tuck School of Business Working Paper No. 2004-14; Journal of Corporate Finance, Vol. 11 2. http://www.brewersassociation.org/pages/business-tools/craft-brewing-statistics/fact