Friday, June 21, 2019

Craft Brew Alliance: Speculating on ABI Qualified Offer

Craft Brew Alliance (BREW) is a collection of craft beer brands formed with the merger of Redhook Ale and Widmer Brothers in 2008, but it is best known for its fast growing Kona Brewing brand of beer.  Originally a Hawaiian craft beer, Kona is now positioned as a beach inspired mass marketed lifestyle beer.  If you're unfamiliar with Kona, they recently did a big media buy during the 2019 NCAA basketball tournament, here a link to one of their commercials espousing the island lifestyle.  CBA is ~31% owned by brewing giant AB InBev ("ABI"), in August 2016 ABI entered into a distribution agreement with CBA that laid out a path for ABI to purchase the remaining ~69% they don't already own.  The agreement has a graduated payout schedule based on the date of an announced acquisition, the first two dates have passed and the last deadline for ABI to make a "qualified offer" for CBA is 8/23/2019, the qualified offer has a minimum of $24.50 per share.

Craft Brew Alliance is an unfortunate name, it's now widely agreed the craft beer segment is over-saturated with thousands of breweries, it's difficult for the mid-sized independent brewers to survive as most craft drinkers have migrated to the ultra-local inside your own zip code breweries.  It's much more fun to show up to a party with a growler of IPA from down the street than a 6 pack from a super-regional brand you can get at any Walgreens.  The original version 1.0 craft brands like CBA's stale Redhook or Widmer brands are in free fall and pioneering brands like Boston Beer (SAM) have pivoted to so called "alcopop" and spiked seltzers.  Similarly, Kona has morphed into a mass-marketed lifestyle brand, their two flagship beers (Blue Wave and Longboard) are relatively easy drinking and light.  A small anecdote reflecting that shift, my old college bar now has "$3 Big Wave Thursdays" as the weekly special, it's no longer "craft brew" if 19 year olds are playing beer pong with it.

AB InBev is viewed as over-leveraged after the acquisition of SABMiller, they also cut the dividend in half last October sending their shares to multi-year lows as they deal with declining beer volumes, but since the dividend cut shares have recovered nicely this year.   Acquiring CBA would be a relatively small check (~$325MM) for ABI to write and would fill a hole in their U.S. portfolio where they don't have the rights to the similarly positioned Corona brand.  Additionally, if ABI passes on making a qualified offer, they would owe CBA a $20MM fee and potentially open themselves up to another brewer making an attempt to purchase CBA, how would ABI feel about a competitor (Constellation Brands?) getting a free ride on their distribution system for the next several years?

But the market clearly doesn't believe it will happen, today shares trade for $13.60, the minimum qualified offer price of $24.50 would represent an 80% premium.  The downside is probably in the $8-9 range if there's no offer, so by triangulating the implied odds the market is telling you there's about a 4-1 or 3-1 chance of the deal being completed.  Let's just assume that's right, an interesting way to speculate on the deal getting done is through August $20 call options which are trading for ~$0.20 per contract.  If the deals consummates, it's likely to be all cash and at the minimum price, so we know the timing and we know the price, assuming a small spread, the calls would move up to ~$4.00 or so on a deal announcement, or a 20-1 payout structure.  I'd love to be able to invest in 30 similar trades to spread out the dispersion, but even on its own its a compelling proposition and I have made it about a 1% cost basis position in the calls.

Disclosure: I own BREW August $20 calls

42 comments:

  1. What are your thoughts on the duration mismatch? Options expire a week before the offer deadline.

    Also, if I read the agreement correctly (but I'm not fluent in legalese) AB does have to pay the $20m unless they make a qualifying offer, which is over $24.50. With the stock trading where it is, why wouldn't AB make an unqualified offer instead? They can probably easily buy BREW for $20 / share at this point. They'd have to pay a $20m fee but would save $90m on the takeover.
    Maybe I'm missing something but so far I'm not very enthusiastic. They aren't forced to pay a 100% premium even if they want it, right?

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    1. The duration mismatch worries me a tiny bit, I started building the position before the November ones were available.

      I guess the "unqualified offer" is a risk, but I think that would open themselves up to other bidders, small risk that someone would overpay or force ABI to match a higher bid.

      I do think it's unlikely the ABI will make a qualifying offer, its just a question of how unlikely? ABI has a EV of $290B, what's $90MM among friends? Clearly 3G has a reputation otherwise, Michael Dell would come up with some perverse way to screw over minority shareholders, 3G's reputation isn't so different.

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  2. Thanks for the BREW option idea.

    How do you get to your downside price in the $8-9 range if there's no offer from ABI?

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    1. I'm guessing it'll get punished, maybe something like down to 10x EBITDA net of the ABI payment? Mostly just an estimate.

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  3. Don't understand your logicJune 22, 2019 at 1:38 PM

    The only things tripped by the 8/23/2019 date---are the ability of AB to terminate the agreements if BREW doesn't accept the qualifying offer and the ability to not make the $20M payment. BREW would certainly accept the qualifying offer if proffered and so there is no ability to walk away from the distribution agreement or the $20M payment without wildly overpaying for BREW. How does anyone else buy BREW given AB's 31% stake---they can just say no to selling their shares---and have the option to always top anyone else's bid. If they want to own BREW, they can wait and see how the market prices it after 8/23/2019 and make an offer then. If you are correct regarding $8-$9, they can buy it for way less than $24.50 (and effectively get their $20M back)--I see absolutely no reason (no chance) of AB making an offer. They get nothing....Help me understand. If you truly think it trades to $8-$9, you should be buying the puts.

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    1. Was going to post exactly the same question

      Walking away and coming back with an offer will still save ABI millions

      So why would they stick with their 20+ offer?

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    2. The puts are an interesting idea because I do think its somewhat binary in the short term.

      I don't quite agree with the wildly overpaying comment, it would be a full price, no doubt, but given what SAM paid for Dogfish head and the potential synergies involved here, I think it can be argued as a reasonable price.

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  4. What's the point of this blog if the author never responds to comments?

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    1. What’s the point of being an anonymous asshole asking stupid questions on a free blog with excellent content?

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    2. Easy folks. Anybody here paying?? Dear God. Please chill out

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    3. Yikes. Didn't realize it was this controversial, I have 3 kids, can't always fire up the laptop over a summer weekend.

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  5. It’s excellent posts like these -- which focus on odds betting vs price or story betting -- that make this blog one of my favourite web destinations.

    One initial reaction I had is if you think the market is correctly implying a 1 in 4 chance that ABI exercises its purchase option while an investor's bet payout is 20x, why only 1% allocation? That’s a significant edge upon which one can fit a higher allocation load without ruin risk, dispersion/volatility notwithstanding.

    Or is your lower allocation basically taking a skeptical view of the market's implied deal probability?

    Thank you

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    1. I'm probably just too risk averse, if there were a lot of similar propositions out there I would make the basket a large percentage, but just mentally tougher with only one outcome despite what a stats or game theory textbook would say.

      Similarly, I like ATXI which you mentioned, similar dispersion idea, but haven't bought that one just yet.

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    2. Right I get that all too well. There's a lot of discussion about that difficulty in Fortune's Formula which you may have read.

      ATXI is arguably even less risky now despite the recent jump. Phase 3 studies have both successfully completed (ahead of schedule!) and they'll be requesting an NDA later this year (merger agreement deadline is maximum April 2021). The approval likelihood of neurological indications from NDA filing stage is over 80% compared to less than 60% from Phase 3 stage. Now, the merger agreement had other stipulations regarding the nature of the FDA's approval (schedule IV classification, broad-base usage, no risk & mitigation stipulations etc), so market participants may rightly be handicapping those uncertainties, including an additional cushion for opioid crisis political concerns. In sum, it is still binary, but due to the frequent scarcities that hospitals face in post-surgery IV opioids and the lower chance of opioid abuse in acute settings, the downside case wouldn't quite be zero in a limited-FDA approval scenario where Invagen walks. Another specialty med buyer should have interest.

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  6. I tend to agree that the puts are a better way to play this and have a bunch of 10 puts. I think it will trade down well below the $8-9s and wouldn't be surprised at $5. Having said that, I hedged my puts with a 20/22.5 call spread. they are cheap enough just in case the purchase does happen.

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    1. It could trade down that low temporarily, might be a good buy to keep on your watchlist if it does because ABI could come back to the table and buy it on the cheap as others suggested. Either way, it'll be interesting to watch.

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    2. So we're to believe ABI bought up 31% of the company & formed a multi-year distribution agreement with them just to later renege on the deal in order to tank the shares to then come back later & buy them up? Sounds a bit conspiracy theory to me, especially considering the relatively low dollar amounts involved here for the remaining 69% at the agreed upon price. We'll know either way soon enough. Side note, the new Kona ad campaign looks promising. Was actually surprised by the # of views on YouTube.

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    3. ABI has owned their stake for over a decade, so the distribution agreement wasn't struck at the same time as their investment, but rather in a peak craft beer M&A environment we've since come down from. But I agree with your overall sentiment/tone.

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    4. To renege on the deal? What deal? There was never a buying deal, it was just an _option_. From the August 2016 conference call:

      ===
      For obvious reasons, it's imperative to clearly state that ABI has no obligation to acquire CBA.
      [.. ]
      It would be nice to see CBA share price at $23.25 or $23.50. But at the same time, we've tried to build in a series of cash flows that make the company viable in any event. So irrespective of whether or not, conditions evolve where ABI would make that qualifying offer, then our shareholders are well protected and the company's well protected, and I can hold my head high and this team can feel like we did a good job on behalf of all of our stakeholders, shareholders and employees alike.

      If that doesn't happen, then we're in a really materially strong position because we still have all of the agreements enforced. We have access to the best distribution network in the world for another almost 10 years at $0.25 a case and we have $20 million in our pocket in order to figure out how to reinvest in the business.
      ===

      I think it is optimistic to assume AB would basically pay 40% (or whatever) too much for BREW, just to be nice to BREW shareholders. How would that go with the famous 3G zero budgeting accounting department where you probably have to file a request to get a stapler?

      BREW sales haven't exactly skyrocketed. $14 is just about close enough to $24.50 that AB might consider overpaying but they might as well snap it up at $18. No conspiracy in that. Simply business.

      And yes, if they don't make a qualifying offer AB is stuck with the distribution agreement. However, if they buy out the company at a lower price that doesn't matter anyway. There's a risk that somebody else tries to snap up BREW but how likely is that given how intertwined they are with AB?

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    5. It's an interesting situation nonetheless but I'd say the chance of a qualifying bid is way lower than the 25% - 33% mentioned in the blog post. I also really don't like that if AB makes a last minute offer you are toast with the August options - a very real risk. The Aug 20 calls are an interesting idea but I'm not sure the risk/reward is very attractive.

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    6. Well even if you cut the illustrative chance of a qualifying bid in half to 12.5% - $16.5%, you'd still be in the money wrt to the payout on the August options. I think that was more in tune with the author's point (of course assuming ABI doesn't literally wait till the last possible day to make an offer).

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  7. Thanks for the idea. I'm just getting familiar with this situation, but if ABI really wanted to acquire Craft Brew Alliance, why not make an offer in the first or second year of the agreement? They'd pay less.

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    1. They were tied up in the SABMiller acquisition, the graduated price scale is pretty small, especially in the context of ABI's balance sheet. Additionally, maybe they wanted to see Kona play out a little bit more, including the results of the March Madness media buy.

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  8. On Craft Brewing Alliance's most recent 10-K, it discusses its relationship with AB. (page 17)

    "The A-B Distributor Agreement is also subject to immediate termination, by either party, upon the occurrence of standard events of default as defined in the agreement. Additionally, the A-B Distributor Agreement may be terminated by A-B, with six months’ prior written notice to us, upon the occurrence of any of the following events:

    any A-B competitor or affiliate thereof acquires 10% or more of our outstanding equity securities, and that entity designates one or more persons to our board of directors

    we are merged or consolidated into or with any other entity or any other entity merges or consolidates into or with us without AB’s prior approval

    This is different than the change-in-control clause you see in the 8-K, as these conditions have no three-year time limit. From my understanding, this clause is in effect for the duration of the agreement.

    Then it says in the Brewing Agreement:

    "The agreement also contains specified termination rights, including, among other things, the right of either party to terminate it if (i) the other party fails to perform any material obligation under the agreement or any other agreement between the parties, subject to certain cure rights, or (ii) the A-B Distributor Agreement is terminated."

    Then in the International Distributor Agreement:

    "The International Distribution Agreement contains specified termination rights, including, among other things, the right of either party to terminate the International Distribution Agreement if (a) the other party fails to perform any material obligation under the International Distribution Agreement, subject to certain cure rights or (b) the Brewing Agreement (as defined below) is terminated pursuant to certain specified provisions thereof."

    Essentially, this suggests that if AB doesn't buy the rest of the shares and someone else wants to take over CBA, AB can first terminate the distributor agreement, then terminate the brewing agreement, then terminate the international distributor agreement. If this is the case, I don't think a competitor can "hitch a ride" on AB's distribution system for the next several years if AB doesn't buy out CBA. If this is the case, isn't the $20mm payment the only "cost" to AB of not making an offer, and perhaps this $20mm fee is better than overpaying for the entire company?


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    1. Interesting - thanks, I didn't catch that change (or more likely a clarification) in the 10-k.

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    2. Except AB is in the business of making, distributing & marketing (mainly) beer so I don't think they'd view owning BREW as a "cost" but rather core to why they exist. No different than the 500+ other brands they care for. https://www.ab-inbev.com/our-brands.html Why would they be overpaying? Based on what it's worth to you or me in the market? You & I aren't in the beer business, so that thinking fails to account for the strategic value AB may assign to it since again this is core to why AB exists. A good starting point for wanting to own this asset would be exactly what they're doing which is positioning Kona as a lifestyle brand competitor to Corona. What value does AB assign to that if it works? What value does AB assign to having BREW fall into STZ's hands & they get it to work? or SAM's?

      Separately (directed @MDC), can you put some data around this: "peak craft beer M&A environment we've since come down from." There's been some very large deals in the craft brew space. Ballast Point for $1B in '15, SAM (itself currently at an all-time high) paying $300 million for Dogfish in March (and partially based on a $314 SAM share price at the time).

      Regardless, I don't think AB or BREW for that matters wants Kona to be viewed as a craft beer anyway. It rather wants to be a Corona competitor. As I see things the strategy has shifted away from even the nomenclature of the company itself & the payoff if successful is much higher than simply being another craft brew. Corona isn't a craft brew.

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    3. I think you are confusing 'what is BREW worth to AB' with 'at what price can AB buy BREW'. Of course BREW sells beer so it's a strategic asset for AB. However, that does not imply AB will pay a huge premium when they can also acquire BREW for a smaller premium.

      And given AB's huge stake and the brewing/distribution agreements I think it is very unlikely a competitor will snatch BREW away if AB is trying to buy it.

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    4. Dogfish feels like an outlier and not a continuation of the Ballast Point or Lagunitas transactions from a few years back, but like you mention, I think Kona/CBA shouldn't be bucketed into the craft beer category, or at least that's not how ABI would position Kona. The other brands would likely be sold or scrapped.

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  9. And I'd add I do think STZ is hoping AB passes on this so they can then buy up the company. That's why I'll buy any selloff if AB passes, especially if it's down to the $8 level being tossed around here.

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    1. That's one reason I doubt an extreme downside and why the puts offer little speculative value in my view.

      At $10, BREW would be trading at ~1.5x EV/sales vs 2.7x at $24.50. STZ trades for 6.3x vs ABI's 5x. STZ's higher multiple should be because its beverages are faster growth, something it shares with Kona but BREW doesn't get that benefit as a standalone listed security.

      I've seen comments above suggesting that STZ wouldn't put in a competing bid if ABI ponies up, but given that STZ has 8 of the top-15 imported beers in the US (as well as some of the fastest growing), I fail to see how riding that multiple spread even at $24.50 wouldn't interest them? What's it to them if ABI terminates its distribution agreement shortly after an acquisition? Merger would take months to close and they'd then have 6 months to rearrange distribution per their own network. They're largely done absorbing the massive 2013 Modelo purchase so it seems like light work in comparison. Counterpoint: you'd still love to acquire such an asset for cheaper than value if you're either company and rarely do equities get acquired for ridiculous premiums to unaffected.

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    2. Good points. Plus by STZ acquiring BREW they’d be taking a potential threat to Corona in-house vs letting it fall into the hands of another competitor with the resources to advance the Kona strategy. That alone must have value to STZ.

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  10. The question I'm struggling with it. Does anyone actually NEED to buy this? It's easy to point out how it could be a competitive advantage. But it's difficult to point out a need for a competitive advantage and to justify costs.

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    1. No, but if you're competing in an industry where share of mind = avoiding declining or sales or growing sales, Kona might look like untapped goodwill (untapped volume, untapped pricing power, untapped margins).

      In numerical terms, here's an illustration of the marginal value that Kona alone would represent to either ABI or Constellation Brands (assume ex-Kona stuff is bonfired):

      2019E Barrels sold...........500,000
      $ Turnover.................~$160M
      At-scale EBITDA (40%).......$64M
      FY18 BREW wholeco EBITDA....($10M)
      Marginal EBITDA "acquired".....$54M

      Marginal value to ABI (13x EV/EBITDA)......~$700M
      vs Price paid for BREW wholeco today........$330M

      Marginal value to STZ (17x EV/EBITDA)......~$900M
      vs Price paid for BREW wholeco today........$500M

      Of course these all assume current multiples and normalized margins, current (normal) macro conditions etc etc. But it also assumes volumes don't grow from here, which based on Kona's proven share-of-mind grab is probably conservative.

      So, acquiring BREW isn't necessary, but it's relatively easy placer mining if you're an at-scale producer.

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    2. Thanks for laying that out.

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  11. Well no news on buyout after today's call. Not sure if I'm going to exit my position since the announcement could be after the options expire.

    Thoughts?

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    1. I added some of the $20 Sept expiration calls as some regret insurance. Appears to be big long shot that ABI will make a qualified offer, although management sounded like it was still on the table, who knows. Sized it knowing that it was unlikely.

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  12. Really nice blog and great discussion. One more thought on the relative mispricing of the option in your calculation: this very much is predicated on the "break-up" price assumed to be low. An alternative scenario is (for arguments sake) that the current price is equal to the "fair" price (price if offer does not come), because the market attaches a zero probability. In this case, the option would be overvalued relative to stock.

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  13. Glad I purchased September puts. Up 240% as of Friday. Feeling a bit greedy so I may hold a bit longer. Could see a dead cat bounce.

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    1. I would not be surprised if next week is a good entry point. Some panic selling, stock drops like a rock and is then swooped up by ABI a few months later. That would be a very low conviction idea though for me, so probably going to pass on a position (again).

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    2. Idk, I mean I personally don't understand the hype some people are presenting regarding the Kona beer. There are thousands upon thousands of craft beers that people prefer. I don't think Kona has the history to become some established long term beer. Maybe ABI would out an offer out there if it got low enough? I just can't see the conviction. I don't think the craft beer market will ever be "solved" by the big guys. My town alone has over 20 local breweries. There are simply too many breweries to acquire. And IMO it's all marketing. Kona has had some success with marketing. It's not actually a better beer and it's not going to stick around. When the money dries up so will the taps. Big guys should stick to cheap long established beer. I think they would have more success bringing back throwback brands and allocating money to market them. People love Hamms, Schlitz, Genny, etc. "Drink your grandfather's beer."

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  14. https://craftbrewallianceinc.gcs-web.com/news-releases/news-release-details/craft-brew-alliance-and-anheuser-busch-announce-expanded

    $16.50

    Sheepishly admit that I still own some having bought after the break, certainly a time when I feel much more lucky than good.

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    1. I feel like an idiot too now .. Didn't buy anything obviously.

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