Description

Introduction

Craft Brew Alliance (BREW) is a publicly traded beer company selling >700,000 barrels per year, largely distributed in the US. Admittedly, my analysis of why this company is a short isn’t driven by in-depth analysis and overview of the company bottom up-fundamentals, but based on an understanding of industry competitive dynamics, lack of barriers to entry, stage of market growth, their brands and where their brands compete. I come to this perspective being someone who’s own net-worth is tied to the same industry (although hopefully a different fate than BREW). If I was employed with BREW and had a meaningful position, I would liquidate all of my shares.

My write-up is hopefully simple and short. We all know how to read a 10K and source analyst research.

Industry Background: Market Share Back Alley Knife Fight

The days of continued craft beer growth is over. 2018 craft beer for the first time since it was a thing shrunk nationally. Industry conferences for many months have been foretelling stories of soon to be bankruptcies, layoffs and retracement. The good times are over, they’re not coming back and expanding internationally is not going to save anyone.

Dave Engbers did a podcast with Craft Beer & Brewing Podcast recently called “Is Founders’ the Last of the One Million Barrel Breweries?” where I think he (reluctantly) summed up the situation well saying “… I think all the national players are already here. If you open a brewery now your business model has to be for your local community, maybe your region. There is great liquid all over the world. There are great breweries all over the world now... the local thing honestly has been kind of a thorn in our side. We make great liquid and there are a lot of people are saying [to us] ’we only sell liquid that is from our zip code’… I look at national numbers, last year nine out of the top twenty largest breweries in the US were negative… a lot of friends in the industry continue to struggle.”

What this dynamic has and will continue to do to the very large craft breweries is force them to retrench to core markets / cut costs, double-down on core brands or beers which match trends that are taking share (e.g. low-calorie beers, hazy etc.), chase the other 86% of the market that isn’t craft, try to expand to new markets or some combination.

BREW Strategy

This is simplified but a useful way to think about it – BREW’s portfolio is largely shrinking except for a few select beers within Kona (which they’re focusing), mainly Big Wave Golden Ale. That’s their pony. They’re increasing marketing spend on Kona, expanding brewing capacity to 100,000 barrels in Hawaii (doubling down in their core) and continuing to leverage partnership with AB InBev for distribution throughout the US and internationally.

The problem with this approach is their competitors are doing the exact same thing. Look at the needle mover of what they’re trying to do with Big Wave outside of Hawaii. Most of the largest craft breweries have lost their grass roots credibility and are now betting on beers your Coors Light drinking uncle might want to try (similar to Big Wave). Many of them are also distributing with AB InBev and also Miller Coors. There’s almost nothing proprietary in brewing in terms of beers. Citra / Galaxy hop combo (that’s what drives the taste in Big Wave) is probably the most common two hops you’ll find in any craft beer brewpub, and that’s all Big Wave is on the least intense / cheap scale. All this to say there’s nothing glaringly special about the pony BREW has picked. When Kona and their closest ten competitors all do the same thing at the same time, what you’re left betting on is an overall trend of whether these large ‘craft’ breweries (if you can call them that still) can claw share away from AB and Miller Coors brands. There’s no reason I can think of that Kona has an edge in this game and this is a trend I don’t really want to bet on.

Acquisition Target?

If you’ve made it this far, I encourage you to see Palmer’s write up on BREW from March 2017, where he lays out the acquisition rationale for BREW in great detail. Basically, AB InBev has a distribution agreement with BREW and framework to acquire remaining shares at no less than $24.50 per share (already own ~1/3 shares). He thinks the deal incentivizes both sides to merge sometime before August 23, 2019. In fairness he also assumed EBITDA would be $35 mm in 2018 which is ~2x what it actually turned out to be, so under that assumption his logic was more compelling.

I can see where this view comes from. My own perspective (from making mistakes) is I don’t want to buy a company with crumbling fundamentals and an unjustifiably high trading multiple based on acquisition speculation. It rarely works. 

I also don’t see how AB InBev wins acquiring BREW for the price contemplated in the agreement. The only brand they can or plan to do anything with I’d imagine is Kona (which is what BREW is trying to scale and further entrench in its home market). There are obviously reasons they would want the brand. There’s also crossover to strategy and rationale similar to Goose Island pre and post acquisition. But this needs to be taken in context of price paid, and understanding once AB acquires something the brand undoubtably takes a hit.

Follow a simple paper calculator for a second. Round numbers ~$24.50 share price implies >$500 mm EV (debt and shares increasing with time). Let’s be generous and imagine Kona can grow to ~520,000 barrels in the next couple years. Say there’s enough levers AB can increase EBITDA/barrel by say ~30% (btw EBITDA is ~3x operating earnings, but I digress…), from ~$24/barrel to ~$31/barrel, implying ~$16 mm of run rate EBITDA attributable to KONA and say generous ~$9 mm from the rest. This implies ~21x multiple on EBITDA. If you assume EBITDA equals unlevered FCF or economic earnings (it doesn’t and BREW has negative on both btw) and say that (for some reason I can’t justify) BREW can grow ~2% forever implies ~2.5-3.0% unlevered return at >$500 mm EV for acquiring BREW (or worse than the risk-free rate).

Thesis

The thesis is simple. I think it’s highly likely debt adjusted per share top line continues to shrink, the forces driving this aren’t going to change soon, there’s no miracle acquisition coming to save them with an unjustified purchase price and Kona Big Wave isn’t going to save the day.

Catalyst

Death by a thousand cuts missing numbers

Not being acquired by end of August