Fall

08
12

March

Boston Beer: To IPO, or not to

IPO

--------------------------------------------------Question
1--------------------------------------------------Boston Beer, in response to consumers preference changes to more flavorful
and bitter tasting brews, was founded in 1894. Boston Beer implements a
quality at any cost strategy with a strong emphasis on product differentiation
and implementing quality ingredients into its products. For instance, Boston
Beer was the first company to employ a stamped freshness date on its bottles
and ingredients are imported from around the world. Additionally, Boston Beer
relies heavily on contract brewing to gain competitive advantages. Boston
Beers contract brewing strategy results in lower overhead and transportation
costs, as well as greater manufacturing flexibility. The expenses Boston Beer
saves through contract brewing allows for an increased marketing budget and
intensive sales force, which is greatly important for differentiating products in a
saturated market. Boston Beers strategy appears to be paying off; from 1990 to
1995, its geometric average sales growth and gross margin were 40.4% and
54.4%, respectively. However, Boston Beer is less efficient that some of its
competitors; its operating margin of 6.7% is nearly four times lower than
Redhook Ale Brewing Companybut its margin is greater than Petes Brewing
Company.
--------------------------------------------------Question
2--------------------------------------------------Benefits of an IPO

Access to public capital markets will provide Boston Beer with a continual
source of equity funds to expand sales while maintaining a low leverage
ratio.

The IPO will provide an exit strategy for the companys current investors.

The additional equity will allow for debt to be refinanced at preferable

interest rates.

The publicity from the IPO offering will benefit the company with
marketing and sales, particularly in new markets where they do not
currently have brand recognition.

Disadvantages of an IPO

The company will face underwriting costs associated with the IPO.

A failed IPO could be costly both in financial assets and in firm reputation.

Complying with regulatory reporting standards will create additional costs

that are not present in a private company.

Incorporating the company may have negative tax implications for the
current owners.

Current shareholders who do not exit during the IPO will face severe
dilution.

Management control will decrease because of fiduciary duties to

shareholders. This could conflict with the companys product quality
processes and result in a shift toward a short-term earnings focus.

Conclusion

Although their contract brewing model reduces expected capital expenditures,

their labor and marketing intensive sales strategy will require substantial
spending to expand into new markets.To meet projected growth, external funds
will be needed. Raising these funds entirely from debt would create an
unacceptable level of debt for a still growing company; thus equity funding is
the preferred option. The company has reached a maturity point where equity
can more easily and cheaply raised in public capital markets rather than through
venture or private equity firms. Additionally, publicity from the IPO will help with
brand recognition in new markets. Given the recent success of competitor IPOs
and Boston Beers profit margin and growth potential, the risk of a failed IPO is
minimal, and most current shareholders intend to sell shares in the IPO reducing
dilution concerns. Boston Beer should proceed with the IPO.
--------------------------------------------Question

3-5

(Exhibit

3)-----------------------------------------1995 Pro Forma Net Sales:

All pro forma sales rely upon the assumption

that net sales as of September 30, 1995 represent 75% of expected year-end
revenue. Because the firms IPO will most likely have a more positive impact on
Q4 sales than this estimate projects, if anything, the prices generated by our
models are underestimated, not overestimated.
Cost of Debt:

BBC explains in its prospectus intent to extinguish

outstanding debt carrying interest rates upwards of 11.5%. Based upon the
firms low target leverage of 5%, low degree of operating leverage, and
favorable credit history and financial outlook, the model assumes a cost of debt
in line with AAA corporate debt at 7.02%. This estimate seems reasonable and

sensitivity analysis shows a 1% decrease in the forecasted share price requires

at least a 2.4% increase in the cost of debt.
Risk Free Rate:

The six-month and 30-year treasury rates given imply a

fairly flat yield curve. Due to the relatively short forecast period and the shortterm risk characteristics of this industry, the model uses the six-month rate as
the risk free rate in calculating the cost of equity.
1995 Net Working Capital Requirement:

In order to calculate the

change in NWC over 1996, the model assumes 1995s year-end NWC is
composed of the existing September 30, 1995 balance plus 10% of fourth
quarter net sales due to the firms recapitalization strategy.
CAPX:

Historical analysis shows an average 3.3% capital intensity ratio.

Based on a likely decrease in efficiency due to rapid expansion, the model

forecasts a 3% capital intensity ratio--this includes restricted investments
(Exhibit 1).
Depreciation:

Depreciation was not included in the calculation of free cash

flows because net CAPX was used.

1995 Value of Debt:

Boston Beers debt is private, so the market value will

be very similar to, if not exactly the same as, its book value.
--------------------------------------------------Question
6--------------------------------------------------The underwriting prospectus for the IPO suggests a share price of $12.50 per
share, which is the starting point for analyzing the different scenarios. In order
to determine the scenario that was most realistic, we attempted to rule out the
ones that were not and a summary of our analysis is found in Exhibit 4.

(1)

First we analyzed the information asymmetry in the IPO.

The offering

presents information about almost 1.5 million shares offered in the IPO from
current stockholders. It is unlikely that management are willing to offer shares at
$12.50 if the fair market value really is $29 per share, thus weakening the belief
in the second scenario.
(2)

Analysts expectations and comparable metrics. Analysts are generally

very positive in regards to the Craft Brewing Segment, expecting continued

growth in 1995. A conservative market share estimate of 5% of the total
domestic beer market by 2000 compared to only 1.4% in 1994. In addition, both
Petes Brewing Company and Redhook Ale Brewery have recently completed
successful IPOs resulting in growing share prices. These factors both build up
expectations for BBCs upcoming IPO and are likely to be incorporated in BBCs
IPO price. This might mean that BBC will be trading at a slight expectation
premium above what the fair value of the company is, thus strengthening the
reliability of the first scenario with a stock price of $12.13.
In addition, by comparing P/E ratios of Petes Brewing Company, 100, and
Redhook Ale Brewery, 36, with BBC for the three different scenarios weakens the
third scenario because of an implied P/E ratio of 17.9, which is below both of the
two comparable companies. The first scenario giving an implied P/E ratio of 41.9
and the second scenario showing an implied P/E ratio of 99.9 are both around
the two competitors P/E ratios, strengthening the plausibility of these scenarios
when looking at the P/E ratio isolated.
(3)

We also used industry growth trends to compare the expected sales of BBC

in 2000, considering a constant market share, to the 2000 sales forecasted in

each scenario. The results allowed us to rule out the third scenario because the
sales forecasted in 2000 are less than half of what we would expect with
conservative assumptions of the craft industry growth. The other two scenarios
were fairly close to the expected revenues in 2000.
(4)

The second scenario was ruled out when analyzing the growth trends of

BBC in recent years. BBC has already undergone rapid growth and we expect
that high growth phase to taper off sooner rather than later. Ten more years of
high growth is unreasonable and unrealistic.
Lastly, the second scenario can be ruled out again when looking at
revenues projected for 2006. If the craft brewing industry grew to ten percent of
the total domestic beer market by 2006, which is an aggressive assumption,
then BBC would have to double its current percentage of market share in the
craft industry. We also find that assumption fairly unreasonable due to the
competitive nature of the craft industry now and into the future.
Conclusion
Scenario 1s price of $12.19 seems most realistic due to the consensus of the
above methodologies. Its implied, intrinsic PE ratio is in line with growth
sentiments in the market; information asymmetry in equity markets implies that
the firm would make an offering at a price that accurately reflects firm value
given insider information (the closest being scenario 1s estimated price);
analyst estimates of industry growth and BBCs market share are close to
scenario 1s projected revenue trends; finally, scenario 1s growth trends
accurately reflect BBCs slow decline from high-growth to maturity. In
conclusion, scenario 1 seems most likely.

If the model is changed to assume conservative long-term growth rates of

3% and 5%, scenario 1s estimated price becomes $15.64 and $20.2
respectively. Thus, we believe a good estimate of BBCs equity value per share is
between $15 +/- $5 depending on the markets premium.

Exhibit 1

Exhibit 2

Exhibit 3: Scenario 1

Exhibit 3: Scenario 2

Exhibit 3: Scenario 3

Exhibit 4