Agenda Industry – Beer Volume by Segment...Source: Beer Marketer’s Insights, 2012 Beer Industry...
Transcript of Agenda Industry – Beer Volume by Segment...Source: Beer Marketer’s Insights, 2012 Beer Industry...
4/17/2012
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“SKIN” AND “DIVORCE” ON THE ROAD TO THE MARKET: Maximizing Brand Value By Motivating Distributor Performance
Co-presented by Andy Christon and attorney Gary Ettelman, Esq.
May 4, 2012
Agenda About Ippolito Christon & Co.
Industry Overview
Untraditional Route to Market
Golden Cases & Distributor Profitability
Valuation of Craft Brewer Rights
Summary and Q&A
Ippolito Christon & Co. Confidential
Ippolito Christon & Co. Andy Christon, President
Founded 1986
Valuation expert (500+ engagements)
Broker/advisor (100+ deals)
Buy/sell merger financing owner succession
estate/gift/divorce expert witness
strategic planning
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Industry - Share of Alcohol
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Category 2000 2010 2011 11-yr chg 1-yr chg
Spirits 29.3 32.7 33.4 4.1 0.7
Wine 12.5 14.7 15.1 2.6 0.4
Beer 58.1 52.6 51.5 -6.6 -1.1
Total Market 100.0 100.0 100.0 0.0 0.0
Source: Beer Marketer’s Insights, 2012 Beer Industry Update
Industry – Beer Volume by Segment
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Bbls (000s) CAGR %
Segment 2007 2010 2011 4-yr 1-yr
Import 29.9 27.3 27.5 -2.1 0.6
Craft 8.5 10.7 12.3 9.6 14.5Super-premium 9.4 11.2 11.2 4.6 0.2
Premium 109.0 101.1 99.0 -2.4 -2.1
Other Domestic 61.1 62.9 60.2 -0.4 -4.3
Total 217.9 213.2 210.2 -0.9 -1.4
Source: Beer Marketer’s Insights, 2012 Beer Industry Update, Craft excludes tax free shipments.
Volume Trends
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Untraditional Route to Market
Know value of your brand
Partner with motivated distributors seeking
to acquire new brands
Negotiate “skin” via up-front marketing
commitment over the long-term
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Benefits to Craft Brewer
Create new revenue stream
Strengthen partnership with distributors
Aid distributor selection process
Model for “buy out” or termination at fair value
Build brand equity & volume profitably
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Benefits to Distributor
Strengthen partnership long-term
Level the playing field in selection process
Valuation model becomes your business plan
Gain greater diversification & Independence
Maximize brand value
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Valuation Methodology
Discounted free cash flow method
Prevalent method for intangible assets
Based on future cash flow produced by the Rights
Multiples
Distributors often consider multiples
Expression of value – not way to calculate value
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Key Assumptions - Rollout
2% market share goal
$6.00 per case GP in 2011
Pricing growth of 1% per year
Aggressive investment spending
Expense Ratio of 67% declining to 32%
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c/e’s (000)
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Golden Cases – Volume
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$000
Ippolito Christon & Co. Confidential
Golden Cases – EBITDA
Golden Cases - Distributor Profitability2011 Operating Results Craft
000’s w/Craft w/o Craft 000’s % IncrC/E VOLUME 5,589 5,361 228 4.3%
GROSS PROFIT $20,745 19,377 $1,368 7.1%
CASH OP EXP 15,608 15,170 438 2.9%
EBITDA $5,138 $4,207 $930 22.1%
- PER CS $0.92 $0.78 $4.08 N.A.
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Take-Away Know Value of Brands
Rollout value in millions Termination value in millions
Create Win-Win Craft want distributor focus to build brands long-term Distributors want to acquire brands & build independence Both will maximize profits over long-term
Co-investing over long-term is critical
Up-front marketing commitment is one option
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Finding the Right Balance Between Emerging Craft Brewers
and Distributors
Tied Houses
Large Suppliers Dominate and Control Small Distributors
Make Hay While the Sun Shines
No Incentive for Distributor Investment
No Recognition of Distributor Equity
Brand Diversity Stifled
History
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Strong Distributor Lobbies Obtain Franchise Protection
No Termination Without Good Cause
Written Agreements Complying With Statute Required
No Unreasonable Refusal to Approve Transfer of Rights
Pay to Leave
Leveling the Playing Field
Ettelman & Hochheiser, P.C. Confidential
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Larger Distributors – Mega Distributors
Tremendous Increase in SKU’s
Increased Investment in Brands
Increased Value of Brands
Market Stability
Impact - Distributors
Ettelman & Hochheiser, P.C. Confidential
Less Control of Market
Less Domination of Distributor Focus
Mega Distributors with Huge Bargaining Power
Increased Brand Competition
Foundation for Craft Segment
Impact Brewers
Ettelman & Hochheiser, P.C. Confidential
Craft The Early Years
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Difficult to Get Beer to Market• Mainstream Distributors Lack Interest
• Thrilled to Get Into any Distributor’s House
• Often Small/Undercapitalized Distributors
• Growth Often Restricted
While the King Was Looking Down…
Craft Emerges as the Golden Child
Distributors Battle for Brands
Brand Values Skyrocket
Golden Cases Rule!
Number of Craft Brewers Explode
Craft The King
Ettelman & Hochheiser, P.C. Confidential
Craft Brewers Inherit the Franchise based System
Craft Brewers are the David to Many Distributor Goliaths
Some Distributors Grab and Hold Brands Just to Keep Their Competitors At Bay
Non-Performing Wholesalers a Real Dilemma for Craft
Time to Level the Field Again?
Ettelman & Hochheiser, P.C. Confidential
Distributor Goals:
Grow brands long-term
No “convenience” terminations
Recognition of equity developed in brands
Craft Brewer Goals:
Grow brands long-term
Motivated performing distributors
Ability to divorce non-performing distributors
Common Ground?
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Craft Pushes for Small Brewer Carve-Outs
Large Brewers Try to take Advantage
Ma. Bill: Small Brewer =6 MILLION BARRELS
Plus 20% Threshold
Exception Would Swallow the Rule
Only ABI and MillerCoors Not Small Brewer
Sam Adams, Yuengling, Heineken, Corona, Pabst,
Guinness all others = SMALL BREWERS
True Small Brewers Won’t be Able to Compete
Anatomy of a Really Bad FixMassachusetts HB01897
Ettelman & Hochheiser, P.C. Confidential
Get in Front of the Curve – Control Your Destiny Limit Carve-Outs to True Small Brewers Base Divorce on Objective Standards of Non-
Performance – No Convenience TerminationsRecognize Distributor Equity - Require Payment Before
Termination Authorize Injunctive Relief Simplify Divorce Procedure – Avoid Costly Litigation
Brewer and Wholesaler Cooperation facilitates Implementation
Model Franchise Amendment:A Win-Win
Ettelman & Hochheiser, P.C. Confidential
Q&A
2825 Lewis Speedway Suite 104 St. Augustine, FL 32084 904-460-0735
Providing Business Valuation and Transaction Services Since 1986
Supporting Material for Craft Presentation
May 4, 2012 Q&As by Ippolito Christon & Co.
1. The “Balanced Portfolio” and Distributor Brand Alignment – April 2012 2. In Search of Capacity: Partnering with Contract Brewers – January 2012 3. Craft at a Crossroads – December 2011 4. Partnering with Distributors for Long-Term Growth – November 2011 5. The Route to Market – October 2011
Articles by Ippolito Christon & Co.
1. Focus on Craft Beer – Consolidation, Growth, Capacity – January 15, 2012 2. Follow-up Commentary on “Skin in the Game” – October 26, 2011 3. The Road to Market – March 1, 2011
Article by Gary Ettelman, Esq.
1. Small Brewer Carve-Outs From Beer Franchise Laws – Part 1:
Massachusetts HB 1897: One Step Forward 5 Steps Back. Re-print from Modern Brewery Age, 2012.
The “Balanced Portfolio” and ConsolidationVisit our web site at www.ippolitochriston.com to view prior Q&A’s, which include discussion on consolidation deals, adding or re-aligning brands, and impact of tax law changes that take effect at the end of 2012.
How can a distributor capture growth and improve profitability, while keeping core suppliers happy?
• Although core suppliers want distributors to focus 100% on their brands, suppliers realize that distributors can significantly improve their profitability by adding incremental “golden cases.”
• The craft segment is not a zero sum game – overall beer volume can increase without cannibalizing core brands. Opposition to new brands can be overcome by reinvesting increased profits into additional sales and marketing efforts to drive top line growth of all brands.
• Both core suppliers and distributors should be concerned about the proliferation of SKUs and loss of marketing focus on key brands. Higher volume brands are more profitable for distributor and retailers because volume drives efficiency. According to Beer Business Daily, the top four craft SKUs deliver 94% of the growth and 90% of the volume.
How does brand alignment affect consolidation?
• Similar to consolidation of MillerCoors houses after the announcement of its “roll-up strategy launched in 2008, AB signaled it would approve territory expansion based on “score” as an aligned partner and identify “Anchor Wholesalers.” Carlos Brito’s recently stated share of mind for the A-B portfolio reflects this strategy and the concept of Anchor Wholesalers. If you want to grow in the A-B system you will have to be an Anchor Wholesaler.
• With core volumes declining for the third year in a row, expect more transactions related to acquiring new brands and consolidation.
• In this new environment it is important to know the value that specific brands add to your business, as well as the total value of your business as a standalone entity and in consolidation.
What tax law changes will occur in 2013 and what actions should I take?
• Under current tax law, in 2013 the long-term capital gains rate will increase by a third from 15% to 20%, and the highest federal tax bracket for ordinary income will increase from 35% to 39.6% for individuals.
• In addition, the cumulative tax free gift exemption will decrease from $5.12 million to $1.0 million per individual. Also, the maximum gift/estate tax rates will increase from 35% to 55%.
Whether you plan to buy, sell, gift or just stay in the game, you need to determine the value of your business to plan a transaction before the tax rates increase in 2013.
Since our formation in 1986, Ippolito/Christon has used the same Free Cash Flow valuation model that Anheuser-Busch described in its 2011 CONSOLIDATION GUIDE. Contact us in strictest confidence for a fixed fee calculation and summary report of your “Consolidation Value,” based on a schedule of identifiable consolidation benefits and modeling template designed for quick turnaround.
April 2012
Andy Christon, President 904-460-0735 ippolitochriston.com
The craft segment is projected to increase by 8+ million barrels over the next 5-7 years. Will craft brewers have the financial resources to produce and distribute the higher anticipated volume, and still remain independent?
We expect more consolidation within the segment. However, craft brewers should be able to develop new partner-ships to gain economies of scale in production and distribution. They can remain financially independent and possibly avoid deep debt by tapping contract brewers with excess capacity and partnering with financially strong distributors to build brands over the long-term.
Conventional financing likely will be available to “seasoned” craft brewers looking to expand. However, new investment on a massive scale may not be necessary because of the capacity being created by declining volume of the mainstream brands. Total domestic U.S. beer volume has declined by 8.4 million bbls over the past three years, including an offsetting increase of 2.3 million bbls sold by craft brewers. Therefore, the decline of non-craft domestic brewers has freed up over 10 million bbls of production since 2008, almost equaling the total annual volume of 10.7 million bbls sold by craft brewers in 2011.
Major suppliers such as North American Brewing, A-B, MillerCoors, and craft-dedicated contract brewers can obtain a higher return on existing investment by offering excess brewing capacity to crafters. The partnership can be a win-win for both, but craft brewers must be careful in structuring the contract brewing supply agreement to avoid potentially destructive pitfalls.
How does a craft brewer gain access to market-created excess capacity?
Contract brewing will continue to expand because it is a viable alternative to investing in costly capital improvements. The partnership between the craft brewer and the contract brewer is becoming intertwined, as the craft brewer seeks to establish on-site control of personnel and of the brewing process. In this arrangement, the craft brewer directly manages sales, marketing, distribution, and the quality of product contracted, while avoiding costly capital improvements and lowering expenses with greater economies of scale.
What are the challenges to balancing growth and capacity?
It is critical that expanding craft brewers search competitively for quality contract brewers and use industry-specialized legal counsel and professional financial advisors to assist in evaluating, negotiating, and drafting a strong supply agreement. The supply agreement must address a wide-variety of issues including: quality control, pricing, flexibility and capability to produce new products, redundancy and alternative sources, and the ability to shift or terminate production as dictated by the market.
IN SEARCH OF CAPACITY:
PARTNERING WITH
CONTRACT BREWERS
Our policy is to provide transaction & valuation services to closely-held distributors & craft brewers in ways that build profitable partnerships long-term. Since our formation in 1986, we have declined offering our specialized services to major brewers as we view such engagements as a conflict of interest.
January 2012
Ippolito Christon & Co.2825 Lewis Speedway ◆ Suite 104
St. Augustine, FL ◆ 32084(904) 460-0735 www.ippolitochriston.com
for Craft Brewers
Call Andy Christon in complete confidence to develop win-win partnerships with contract brewers and distributors. Ippolito Christon & Co. also can help you value your business, raise new capital, combine with another brewer, or negotiate the buyout of minority owners.
What does Dr Pepper’s “Secret Formula” of the last 30 years have to do with craft beer?
Don’t try to beat them – join them…It’s competition versus the value of Golden Cases. The fight for distribution between independent craft brewers and the two dominant beer suppliers appears similar to the battle fought and won by Dr Pepper, vs. Coke and Pepsi.
Long ago, Coke identified “Anchor Bottlers” to execute an overall business strategy, and in the process tried to squeeze out Dr Pepper and 7UP – two “upstarts” – through bottler consolidation and new brand development (Mr. PiBB and Sprite). The strategy was partially successful. Coke recognized that franchised bottlers are critical to a supplier’s success because the franchisees “own” access to the marketplace through perpetual and exclusive distribution agreements. As the table shows, Dr Pepper survived and grew to a 6.3% share (8.6% “trademark” share) because it effectively partnered with independent Coke and Pepsi bottlers to build equity in a unique brand long-term. 7UP, on the other hand, (not shown) has fared poorly, declining to 0.9% share in 2010.
At a similar crossroads today, how will A-B and MillerCoors likely respond to the competitive gains of independent craft and regional brewers?
First, they will try to limit access to their distribution networks. A-B went on record recently to discourage its distributors from acquiring outside brands. Both also will continue to shift their product mix with Land Shark, Top Shock, Blue Moon, and other craft look-alikes.
Second, they will seek to acquire established craft brands, especially those of small suppliers possessing a “mystique” or brand image that is difficult to imitate. An example in the non-alcoholic category was Coke’s purchase of Honest Tea. Coke initially purchased a 40% stake in the company and later the rest. It then shifted distribution from beer distributors to the Coke network.
What does the craft brewer do at this critical crossroads?
The value of Golden Cases will rule. Despite the ongoing sales and marketing battles, the added profits and value created by Golden Cases that go to the distributor will outweigh the pressure brought to bear on the distributor by the primary supplier. Dr Pepper Snapple Group showed the value of incremental Golden Cases by receiving a combined $1.7 billion from Coke and Pepsi in 2010 for a 20-year continuation of Dr Pepper distribution rights. The key to success for secondary suppliers is to partner with distributors who put skin in the game to build the brands L-T. Your success at getting distributors to put skin in the game with you also will ensure that the distributor will gain greater financial independence and less business risk by running a well diversified portfolio of premium beverage products.
CRAFT AT A CROSSROADS
Our policy is to provide transaction & valuation services to closely-held distributors & craft brewers in ways that build profitable part-nerships long-term. Since our formation in 1986, we have declined offering our specialized services to major brewers as we view such engagements as a conflict of interest.
December 2011
Ippolito Christon & Co.2825 Lewis Speedway ◆ Suite 104
St. Augustine, FL ◆ 32084(904) 460-0735 www.ippolitochriston.com
for Craft Brewers
Top Soft Drink Brands 2010
Brand ShareCoke 17.0%Diet Coke 9.9%Pepsi-Cola 9.5%Mt. Dew 6.8%Dr Pepper 6.3%Sprite 5.6%Diet Pepsi 5.3%
Source: Beverage Digest / Fact Book 2011
Call Andy Christon in complete confidence to learn how to partner with distributors in ways that will be a win-win for both distributor and craft brewer. Ippolito Christon & Co. also can help you value your business, raise new capital, combine with another brewer, or negotiate the buyout of minority owners.
Anheuser-Busch held its annual national sales meeting in early November, where it expressed great displeasure with distributors who seek to add non A-B brands. What triggered A-B’s aggressive tone toward its distributors?
Mainstream brands are declining, while craft continues to increase share. The chart shows that over the past five years craft volume is up 3.9 million bbls while other domestic and import volume is down 7.5 million bbls. As a result of this growing shift in mix, major suppliers are developing strategies to capture the future growth of the craft category by (a) developing their own “craft-type” brands and (b) re-gaining the commitment of distributors to build in-house brands. We do not believe it to be practical or realistic for A-B to return to “100% Share of Mind” for A-B distributors. However, A-B and MillerCoors now are responding to craft by acquiring craft brands and focusing on improving their product mix with the likes of Land Shark, Top Shock, Blue Moon, Leinenkugel, and other craft look alikes.
In this changing environment, how does a regional craft brewer compete with major suppliers for the loyalty andcommitment of distributors?
First, recognize that distributors seek to acquire high-growth craft and regional brands with high margins to maintain and grow profits in an environment of declining volume of the core domestic brands. Second, take advantage of the fact that you currently have great momentum with high-growth brands handled by independent distributors who control access to the marketplace via the 3-tier system. Third, with core brands in decline, independent distributors are willing to put more “skin in the game” to acquire profitable growing brands that reduce their future dependence on one supplier. The challenge for craft brewers and distributors is to evaluate future prospects of the brand rights and agree on the distributor’s upfront long-term marketing commitment and appropriate spending levels to build brands over the long-term.
Only by partnering with distributors who put “skin in the game” can craft brewers be assured of continued growth and access to the marketplace. Craft brewers and distributors need each other. Craft brewers should act now to cement the partnership with distributors to build brands over the long-term.
Partnering With Distributors for
Long-term groWth
Our policy is to provide transaction & valuation services to closely-held distributors & craft brewers in ways that build profitable part-nerships long-term. Since our formation in 1986, we have declined offering our specialized services to major brewers as we view such engagements as a conflict of interest.
November 2011
Call Andy Christon in complete confidence to learn how to partner with distributors in ways that will be a win-win for both distributor and craft brewer. Ippolito Christon & Co. also can help you value your business, raise new capital, combine with another brewer, or negotiate the buyout of minority owners.
Ippolito Christon & Co.2825 Lewis Speedway ◆ Suite 104
St. Augustine, FL ◆ 32084(904) 460-0735 www.ippolitochriston.com
for Craft brewers
3
2
1
0
(1)
(2)
(3)
(4)
(5)
(6)2007 2008 2009 2010 2011
Craft Major Domestic & ImportsSource: Beer Marketer’s Insights, 2011 Beer Industry Update
+11%
+1%
+10% +10%0%
-1%
+5% +6%
-1%
-2%
Change in Domestic Beer Volume (bbls in millions)
Yuengling
Fat Tire
Dogfish Head
HarpoonYuengling Fat
Tire
Dogfish Head Harpoon
The RouTe to MaRkeT
There has been a lot of talk lately about the distributor-craft brewer relationship. Your last Q&A about “Golden Cases” was very intriguing. How would we structure a deal with a distributor that improves our chances of being distributed by their firm?
Distributors are always exploring opportunities to add value to their business. In recent years, core brands have been in decline whereas craft brewers represent the growing segment of the industry.
Distributors understand that the incremental volume of a proven craft brand seeking to expand into new territories has a higher value per case than core brands because they add little risk while contributing significant profit. The value comes from the fact that the incremental cases require little direct additional operating expense after the initial “skin in the game” is invested by the distributor.
Distributors want to acquire profitable growing brands that diversify their product offerings and create value over the long-term. They are willing to invest more in building brands provided there is more consistency and less risk. Distributors want consistency in areas such as marketing programs, capacity, and distribution agreements. Distributors want to invest in building brands, but not with a weak distribution agreement that enables the brand to be transferred to a competitor without compensation (e.g., Monster) or at low multiple of gross profit. A solid route-to-market deal should strengthen the partnership, level the playing field in the selection process, and create a business plan that will build value for both distributor and brewer over the long-term.
In a properly negotiated and structured partnership, the distributor can make an initial investment as brands are introduced into new markets. This “skin in the game” can take several different forms: ranging from significant marketing contributions in the early years to a deferred marketing investment. Note that we do not believe an outright sale of distribution rights by a brewer to a distributor is the best way to go to market. In our view, a better way to put “skin in the game” is for the distributor to enter into a long-term marketing commitment that assures building the brands long-term. Also, the properly structured partnership should provide objective criteria for “divorcing” the non-performing distributor equitably.
Craig Purser, NBWA President, reiterated at last week’s Vegas convention the dictum of transforming “brand dependent beer wholesalers into independent brand building distribution companies.” No matter how the initial investment is structured, it is important to develop a mutual working partnership that serves as a win-win for both sides. The challenge for distributors and brewers is to reasonably estimate the economic value and benefit of making significant investments up front. The goal for both partners is to achieve profitable volume for the long-term.
Our policy is to provide transaction & valuation services to closely-held distributors & craft brewers in ways that build profitable part-nerships long-term. Since our formation in 1986, we have declined offering our specialized services to major brewers as we view such engagements as a conflict of interest.
October 2011
CAll ANDY CHrIsToN oF in compleTe confidence To leArN HoW To sTruCTure A DeAl THAT CAN Be A WIN-WIN ArrANgeMeNT For BoTH THe DIsTrIBuTor AND THe CrAFT BreWer. IppolIto ChrIston & Co. Also CAN HelP You VAlue Your BusINess, rAIse NeW CAPITAl, AND NegoTIATe THe BuYouT oF MINorITY sToCkHolDers AND PArTNers.
Ippolito Christon & Co.2825 lewis speedway ◆ suite 104
st. Augustine, Fl ◆ 32084(904) 460-0735 www.ippolitochriston.com
for Craft Brewers
January 15, 2012 Craft Brewers
Ippolito Christon & Co. 1
FOCUS ON CRAFT BEER – CONSOLIDATION, GROWTH, CAPACITY
1. Anything new or noteworthy on the merger and acquisitions front?
Yes –M&A activity associated with craft brewers has increased over the past two years though driven almost exclusively by the two largest mainstream brewers, Anheuser-Busch and MillerCoors.
A-B and MillerCoors likely will continue to pursue similar strategies for expanding into the high-growth craft category. First, both will continue to shift their product mix by developing high quality craft look-alikes with brands like Land Shark, Shock Top, and Blue Moon. Second, the Big Two will seek to acquire established craft brands of small suppliers possessing a promising market position and a “mystique” or brand image that is difficult to imitate. Third, they will try to limit the ability of competing independent craft brewers from accessing their nationwide distribution networks. At its November 2011 national sales meeting in Dallas, A-B went on record to discourage its 533 distributors from acquiring outside brands.
A-B now owns 32.2% of Craft Brewers Alliance (“CBA”) which in turn owns 100% of Redhook, Widmer, and Kona. A-B also recently purchased 100% of Goose Island and added it to the CBA mix. In like fashion, MillerCoors formed Tenth & Blake Beer Company (anchored by long-held Leinenkugal) to form the nucleus of a corporate group devoted to the craft segment. Last year MillerCoors expanded its craft footprint with the acquisition of a minority interest in Terrapin, a popular fast-growing craft brewer located in Georgia.
North American Breweries (“NAB”), ranked #6 by volume nationally, has emerged as another big player on the craft playing field. Owned by private equity firm KPS Capital Partners, NAB now owns five breweries with 2.7 million bbls of sales volume and lots of excess capacity. Its biggest brand is Labatt, but it also has acquired Magic Hat, Pyramid, and other craft brands. It aggressively is attempting to leverage its economies of scale to contract brew for other independent craft brewers. Contract brewing opens a way to gain greater control over the independent brewer and perhaps even engineer a buyout of the craft brewer once a dependency is created.
Sheehan Group (a large family-owned distributor of A-B/imports/other) is another example of increased M&A activity initiated by a distributor. Sheehan started primarily as a beer distributor in the Northeast, but recognized early the importance of expanding its mix beyond its core domestic brands. Sheehan Group now owns distributors in multiple states, an import company, and two craft breweries. Family-owned Reyes Holdings is the largest beer distributor in the U.S. and probably the largest craft distributor nationwide Similar to Sheehan Group, it has been consolidating distributors and brands in multiple states on the MillerCoors side for years.
January 15, 2012 Craft Brewers
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Other Mentions –
1) Alchemy and Science was created to build strong local and regional craft beer brands. Alchemy and Science includes Alan Newman, the founder of Magic Hat, and Jim Koch, the founder of Boston Beer. The company announced the acquisition of Angel City Brewing Company in 2012.
2) The Saint Louis Brewery (Schlafly) sold 60% to a private equity group in 2012.
3) Brock Wagner founded one of the largest regional craft brewers in the South, Saint Arnold Brewing Co., after a career in investment banking.
4) Susquehanna Brewing Company recently was founded by former beer distributors of United Beverage in Pennsylvania.
Caution to Craft Brewers – Most independent craft brewers are product-driven and do not have the tools, experience, desire or capability to evaluate and structure complex M&A transactions. Independent craft brewers would be advised to proceed with caution and engage independent outside financial professionals to assist in evaluating partnerships with large suppliers and private equity groups. NAB, A-B, and MillerCoors are skilled at creating “honey traps” that may appear at first glance inviting to craft brewers looking to partner with a big brewer that offers liquidity, long-term capital, distribution, and production capacity.
However, if you look closely, recently structured mergers and “alliances” may contain onerous covenants and restrictions, margin fees for accessing distribution networks, requirements to use the mainstream brewer’s distribution network for entering new markets, and limits to future ownership and liquidity. In effect, loss of independence in
all areas of important decision-making may be the price the craft brewer pays for gaining access to capital and access to the market when getting into bed with a major supplier.
2. As craft brewers grow and reach capacity, will there be more consolidation? What can a craft brewer do to avoid consolidation and remain independent?
There would appear to be no shortage of brewing capacity in the aggregate, due to the decline in beer shipments nationwide. Total domestic U.S. beer volume has declined by 8.4 million bbls over the past three years, including an offsetting increase of 2.3 million bbls by craft brewers. Therefore, the decline of non-craft domestic brewers has freed up over 10 million bbls of production since 2008, almost equaling the total annual volume of 10.7 million bbls sold by craft brewers in 2011.
The primary question is, how does a craft brewer gain access to this market-created excess capacity? Despite some high profile announcements in the press, does it make financial sense for a craft brewer to spend large sums of money to expand capacity? It may make more sense to pursue contract brewing for the smaller independent craft brewers, but in doing so they should use caution in evaluating options to avoid contractual pitfalls.
January 15, 2012 Craft Brewers
Ippolito Christon & Co. 3
Contract brewing actually is quite common in the industry and will continue to expand, driven by the economics. The reality is that the partnership between the craft brewer and the contract brewer is becoming intertwined, with the craft brewer seeking to maintain on-site control of personnel and of the brewing process. In this arrangement, the craft brewer directly manages sales, marketing, distribution, and the quality of product contracted, while avoiding costly capital improvements and lowering expenses with greater economies of scale.
Contract brewers, including both independent contract brewers and major suppliers such as NAB, A-B, MillerCoors, and others, can benefit by leveraging excess brewing capacity to yield a higher return on investment. The partnership can be a win-win for both, but craft brewers must be careful in structuring the supply agreement to avoid pitfalls discussed elsewhere.
It is critical that expanding craft brewers in need of additional capacity shop competitively for quality contract brewers and use industry-specialized legal counsel and other professional advisors to develop a strong supply agreement. The supply agreement must address a wide-variety of issues including: quality control, pricing, flexibility and capability to produce new products, redundancy and alternative sources, and the ability to shift or terminate production as dictated by the market.
3. What kind of alternative financing options are available for craft brewers looking to expand?
Craft Business Daily (11/18/11) reported that the cost to add new brewing capacity is about $150 per bbl. Therefore, it would take $1.5 billion of new capital to add 10 million bbls of capacity over the next 5 years, doubling the current annual sales volume of craft beer. Although capital likely will be available, we think it will be at a cost not affordable to most craft brewers, either for debt or equity capital. Furthermore, it does not appear necessary or prudent to pursue new investment on a scale this large, in light of the capacity being created by declining overall volume of the mainstream brands in the U.S. beer market.
The amount of capital required to build new “in-house” capacity is significant. The WSJ (12/28/11) reported that Sierra Nevada and New Belgium each plan to invest $75 million for new breweries. Asheville, NC has been mentioned as a desirable site by both craft brewers. Cold Spring (a contract brewer) was reported to be spending $13 million to double capacity to add 125,000 bbls of capacity for craft brewers.
To put this amount of investment spending in perspective, New Belgium’s volume nationwide in 2011 approximated the volume of the A-B distributor in Orlando, Florida. Yet New Belgium’s investment in a new plant will be about 10X greater than the cost of replacing a modern sales and distribution facility for a beer distributor of similar size. In other words, many independent craft brewers will find conventional bank financing “challenging” without careful planning and presentation to beverage-friendly lenders (and there are several) who understand the alcohol beverage business.
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Beer distributors traditionally have been able to arrange conventional bank financing based in a range of 4-5X EBITDA because of stable and predictable cash flow associated with low growth rates, modest capital requirements, and legally protected franchise rights. However, the greater risk associated with higher projected growth of craft brewers lowers the ability to obtain financing and increases the cost. There are many risks associated with managing growth and maintaining sufficient access to product. As we all know, there have been several examples in the press discussing brewers pulling back from states due to difficulty obtaining product.
Private equity companies indicate that they would like to get more involved with craft brewers, but there are limitations. Many traditional private equity firms want to invest at least a minimum of $25 million, which is difficult to find with typical craft brewers. Also, the returns typically required by private equity would frighten away most craft brewers. Finally, the independent nature and personalities of most craft brewers make it difficult to roll-up multiple craft brewers into an “umbrella structure” to create economies of scale…it would be like “herding squirrels up a tree!”
Many craft brewers in the very early stage of development will continue to raise money from “friends & family” type investors – usually less than $5 million and up to 20 investors. However, at later stages of development, craft brewers likely will need to engage professional help to pursue private placement of debt and equity with beverage-friendly lenders and investors.
A craft brewer will raise more capital on better terms by approaching capital providers with a professionally-prepared Private Placement Memorandum that tells the brewer’s story compellingly and convincingly. This document contains detailed volume and financial projections and a comprehensive narrative explaining the brewer’s business plan and the underlying assumptions that support the projections and financial returns expected by the lenders and investors.
4. What is the reality for the growth of craft brewers? Will smaller craft brewers have to get into bed with larger ones? Will private equity become more active?
Many analysts expect that the craft segment will continue to grow and double in size over the next 5 years. However, if craft brewers want to expand from small or regional players and remain profitable and therefore independent, they must gain economies of scale in production and distribution. Although we expect more consolidation within the segment, there are options for craft brewers to remain independent including contract brewing and partnering with distributors to build brands over the long-term. Involvement of large private equity is likely to be limited.
In 2011, Yuengling bypassed Boston Beer to become the #8 ranked brewery in the U.S. despite less geographical reach. Yuengling is available in only 14 states versus Boston Beer in all states. Craft brewers may be better served by emulating the Yuengling model of “Pebble in a Pond,” controlling growth and expanding outward to contiguous territories from a core base by partnering with exclusive distributors who have the experience,
resources, and commitment to build new craft brands long-term.
Ippolito Christon & Co.Providing Business Valuation & Transaction Services to the Beverage Industry Since 1986
Follow-up Commentary on “Skin in the Game”October 26, 2011
The purpose of this note is to set the record straight on misconceptions aboutIppolito/Christon’s view of “skin in the game,” which surfaced in the trade press and atthe NBWA Convention in Las Vegas last week. Since 1986 Ippolito/Christon hasrepresented only distributors in negotiations or disputes over the value of brand rights.We will not represent suppliers at distributors’ expense. However, distributors need toexplore opportunities that add value to their business in this changing environment.Despite the rhetoric, few distributors question the underlying concepts once theyunderstand the rationale. The discussion of “skin” is all about building better long-termpartnerships and growing profitable brands. Below we comment further on the mainpoints of this concept. Anyone who wants a copy of our original article may contact usas noted at the end of this commentary.
1. Marketing Contribution vs. Sale of Brand Rights – First, and foremost, we are notadvocating outright sale of distribution rights by a brewer to a distributor, thoughin some circumstances it is an option. Sale of distribution rights in connectionwith the initial appointment of a distributor may work for a proven brandcontemplating entry into new markets. However, we do not believe it is the bestway for a distributor to put skin in the game. The purchase of rights may createsome legal issues involving general franchise laws and intellectual propertyclaims. Advantageous tax treatment also favors guaranteed marketingcontributions vs. outright purchase of brand rights by the distributor who puts realskin in the game.
2. Adding Volume & Value to the Enterprise – In our view, a better way to put “skinin the game” is for the distributor and brewer to enter into a long-term marketingcommitment that assures building the brands long-term. We are advising ourdistributor clients that even though the required level of upfront guaranteedcommitment may be greater than what is traditional in order to secure a desiredbrand, our calculations show that the higher levels of investment will produceabove average returns on investment, thereby adding value to the distributor’stotal enterprise.
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3. Legality & State Beverage Statutes – “Skin” in the form of significant marketinginvestment or outright purchase is legal according to our legal sources, notprohibited in any state of which we are aware. In fact, we were reminded severaltimes at the Convention that it’s already being done in many instances. Much ofthe legal debate seems off point, like trying to fit a round peg in a square hole.The state statutes were designed to prevent brewers from investing in andowning/controlling distributors. “Skin” is a situation where the distributor ismaking an investment in the brewer’s brands, not the other way around.
4. For and Against “Skin” – For years non-AB distributors have been putting skin inthe game to secure new brands, understanding the value of making upfrontinvestments for future profits and market position. Just look at the Reyesbusiness model. Now, there is increasing competition among distributors for newbrands as AB distributors are not constrained by exclusivity and 100% share ofmind. Many AB distributors with a short or non-existent book of craft brands arebeginning to realize that putting more “skin” in the game may be the mosteffective way to compete.
5. Golden Cases – Ippolito/Christon’s distributor clients understand that theincremental volume of a new craft brand (whether proven or unproven) has ahigher value per case than core brands because they add little risk whilecontributing significant value. The value comes from the fact that the incrementalcases generated by the new brand involve very little additional direct operatingexpenses after the initial upfront heavy investment period.
6. Capital Intensive – Is a distributor’s upfront investment in support of craft brandscapital intensive? The answer is “no,” it is marketing and profit intensive. In aproperly negotiated and structured relationship where “skin” applies, thedistributor makes significant tax-deductible marketing investments for the first 3-4years of a new product introduction, followed by a high level of profits in futureyears as the initial marketing investment is scaled back to normal levels. Bycontrast brewing beer is capital intensive, requiring significant permanentinvestment in hard assets and posing a problem to many craft brewers whocannot meet levels of current and projected demand. How many craft brewersrecently have pulled out of numerous markets for this reason and in the processpotentially “poisoned the well?” It would be far better if distributors made aninvestment in the brands which could be structured to enable the brewer toreinvest the money into additional capacity.
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7. Establishing New Partnerships – In 2010, The Coca-Cola Company andPepsiCo, Inc. each acquired their largest bottlers in a vertical consolidation of thesoft drink industry. As a condition of approving the transfer of Dr Pepper brandrights, Dr Pepper Snapple Group negotiated upfront payments totaling $715million from Coke and $900 million from PepsiCo, plus a 20-year contractualmarketing commitment by both transferees. This is real “skin” committed by twosophisticated marketers for “establishing the foundation of a new relationship”with a supplier. In the final analysis, durable relationships in the beveragefranchise business result from mutually beneficial economic results for the partiesinvolved.
8. Shifting Balance of Economic Power – In recent years, core brands have been indecline whereas craft brewers represent the growing segment of the industry. Aspointed out in Vegas by the former CEO of Walmart, “You didn't have markets[then] where you have a 4% decrease in the national brands with all the upsidebeing in the smaller brands." Craig Purser, NBWA president, reiterated at lastweek’s Vegas convention the dictum of transforming “brand dependent beerwholesalers into independent brand building distribution companies.” Throughthe three-tier system, distributors control access to the marketplace. Thechallenge for distributors is to reasonably estimate the economic value andbenefit of making significant investments upfront when competing for newbrands, whether in the form of marketing commitments (the preferred alternative)or the outright purchase of distribution rights. As observed last by GaryEttelman, Esq. “…proper structure is the key to accomplishing any goal withminimal risk.”
Andy Christon, PresidentIppolito Christon & Co.
2825 Lewis Speedway, Suite 104St. Augustine, FL 32084
(904) [email protected]
Ippolito Christon & Co. (904) 460-0735
Ippolito Christon & Co.
Providing Business Valuation & Transaction Services Since 1986
THE ROAD TO MARKET March 1, 2011
There has been significant speculation recently in the beverage industry trade press about future mergers or combinations of the major beer and soft drink suppliers, as well as the possibility of large distributors vertically integrating or partnering with major suppliers. During 2010, PepsiCo acquired 100% control of its two largest franchised bottlers, PBG and Pepsi Americas, paying $7.8 billion for the remaining interests it did not already own. Prior to the acquisitions, Pepsi owned 33% and 43%, respectively, of its two largest franchised bottlers. The Coca-Cola Company then announced the proposed purchase of CCE’s North American operations, its largest bottler (which was already 34% owned by Coke), for $12 billion (mostly by assuming a large portion of CCE’s existing debt). Coke’s deal closed in October 2010. Combined with the formation of ABInBev and MillerCoors, the beverage industry has changed dramatically in the past two years. As a result, the value of intangible distribution rights has been re-affirmed and the strategic role of the “exclusive” beverage distributor has escalated. Access to the Marketplace Pepsi now owns an estimated 80% of its North American distribution network and Coke controls an estimated 86% of its distribution system (including direct sales through Coca-Cola’s fountain syrup jobber system, which may account for a third of the 86% estimate). As a result, the recent billion dollar mega-bottler acquisitions will allow Pepsi and Coke to cut costs, be more flexible on pricing, and offer mega-retailers better and more uniform deals. These two leading brand owners now have greater freedom to go to market via 1) central warehouse delivery (a serious prohibition in an all exclusive franchise system) or 2) the traditional direct store delivery method. They also have direct control over any other beverage suppliers who want to access their respective distribution systems. Over the past decade new beverage products have proliferated and some key mega-retailer customers have demanded centralized warehouse delivery of franchised beverages. Nonetheless, we continue to believe that the DSD
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method remains superior for delivering beverage products to consumers at the lowest cost. For this reason, we think that PepsiCo re-vamped its distribution for Gatorade away from central warehouse delivery, to its franchised bottler system. Also, in this new environment, competing smaller brand owners seeking to “piggy back” on the established major domestic distribution networks most likely will incur additional costs (like royalty payments) and other hurdles in order to gain access to the marketplace. The vertical consolidations by the major domestic beer and soft drink suppliers will allow the mega brand owners to profit from future attempts by other brand owners to gain access to the marketplace through their systems. In the U.S., independent distributors with exclusive and perpetual rights to sell and distribute trademarked brands historically have represented a brand owner’s sole access to the marketplace. For decades this road to market has been an efficient means of distribution for beverages of all makes. The lead franchisors now are in a position to capitalize on the indispensable position of the exclusive distributor in the beverage marketplace, possibly at the expense of the smaller beverage companies and craft brewers seeking to expand their own distribution to retailers. In recent years, traditional domestic beer and carbonated soft drink volume has been soft. Craft beer and non-traditional or so-called “alternative beverages” produced by small companies have accounted for most of the beverage industry’s growth. The road to market for many of these new and innovative products was made possible by “piggy backing” on the established beverage distribution systems that have been in place for generations. Therefore, by acquiring the vast majority of their respective distribution systems, the lead brand owners (a) increase their options to acquire future growth by buying out a competing brand owner seeking distribution, (b) protect their existing market position and portfolio of brands with retailers, and (c) create new challenges for the smaller beverage companies and craft brewers. The changing dynamics of beverage distribution and the battle over managing and gaining access to the marketplace increasingly will guide strategic decisions for the dominant mega brewers, the smaller beverage brand owners, craft brewers, and distributors. Due to soft drink companies buying bottlers and brewers attempting to increase their ownership of distributors, “access to the marketplace” is a major challenge for many operators and, by far, the most valuable asset for every beverage company competing in the marketplace in the foreseeable future.
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Through vertical distributor acquisitions, major soft drink companies and mega brewers achieve the following immediate benefits:
manage pricing promotion and brand “investment” decisions get closer to the consumer to understand trends improve their ability to react to consumer trends more quickly,
changing out shelves/inventory and adjusting pricing accordingly reduce # of people (i.e., sales people, distributor management team) ...
don't need a brand owner salesman calling on a distributor reduce the level of franchisor-franchisee interaction and “politics” (i.e.,
reduced need to deal with family issues or sensitivity of distributor relations)
reduce barriers for direct shipment to mega-retailers and chains. Beverage Distribution Alternatives The lead suppliers’ current shift to (a) acquiring distribution assets and (b) influencing access to the marketplace may set limits for some market players – direct and indirect competitors as well as bottler/distributor “partners.” However, the good news for smaller beverage companies is that vertical integrations should not automatically restrict the availability and distribution of alternative beverages. When considering the total refreshment beverage market of alcoholic and non-alcoholic beverages, the majority of markets throughout the U.S. will have at least the following four major distribution networks available to brand owners – Pepsi, Coke, ABInBev, and MillerCoors. The four major beverage distribution networks now in place will continue to compete aggressively (with comparable assets and financial resources) to offer beverages to retail customers and consumers nationwide. Additional beverage distribution resources also will be available through expanding mega-retailer delivery systems, and by food wholesalers like McLane Company. Thus, existing and emerging beverage segments such as craft beer will enjoy significant competition for their brands and numerous choices for distribution of their brands, especially among independently-owned distributors seeking to expand their portfolios beyond the products offered by their principal franchisor. Furthermore, in light of the heavy capital investment in distribution, it would come as no surprise to us if Pepsi or Coke were to ”re-franchise” its entire U.S. distribution system in three to five years “to create the next generation of high return opportunities.” The re-birth of franchised distribution three to five years from now could be similar to current Coke and Pepsi systems outside the U.S. distribution systems owned and operated by large, independent bottlers (though
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ideally without public ownership of bottlers that may conflict with the interests of the franchisor). Through the future “re-franchising” and sale of bottling facilities and/or franchise territories it owns, Coke and Pepsi could write new distributor agreements with its new business partners and raise a large amount of capital when needed. This is what Coke did in 1986 when it gave birth to CCE. The soft drink leaders would be in a position to choose whether or not to participate via equity investments in new, large, privately-owned U.S. anchor bottlers who would be more closely aligned with (a) the demands of a diverse marketplace increasingly dominated by mega-retailers, and (b) the interests of the franchisor. As an alternative, distribution rights for the smaller up-and-down the street accounts could be re-assigned to independent local distributors for maximum penetration and retailer service. Value of “Golden Cases” Interestingly, Dr Pepper Snapple Group (“DPS”), the third-ranking brand owner in the soft drink industry, actually strengthened its access to the marketplace as a result of the 2010 Pepsi and Coke mega-bottler acquisitions. As it turned out, the two mega-bottlers that Pepsi sought to acquire also were licensed franchisees of DPS for a small but significant percentage of their total volume. If DPS were to disapprove the transfer of its brands to the buyer, the loss of the incremental profit contribution to PepsiCo would have reduced value significantly, likely killing the deals. DPS showed the muscle and value of incremental “Golden Cases” by entering into a 20-year renewable “Distribution Agreement” with PepsiCo that gave Pepsi the right to hang on to these “Golden Cases” in perpetuity so long as Pepsi abides by the terms of the Distribution Agreement. Pepsi paid $900 million to DPS for the exclusive perpetual rights to the DPS brands in the exclusive territories of the two mega-bottlers it purchased. In essence, Pepsi paid twice for the DPS franchise rights of the two bottlers…. demonstrating the valuable nature of “Golden Cases” and their calculated worth. In the beer world, craft beers are the “Golden Cases.” DPS gained leverage in this arrangement because it retained termination rights. Also, Pepsi must adhere to DPS performance provisions AND maintain a Chinese wall of confidentiality between its Pepsi and non-Pepsi business. The Pepsi-DPS Distribution Agreement also potentially lays the foundation for similar arrangements in the beer industry, by showing that a competitor may handle another brand owner’s brands on an exclusive, perpetual basis without conflict – an interesting twist in distribution. A similar “Golden Case” agreement and payment by Coke to DPS was made as a result of Coke’s acquisition of CCE.
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Financial and Economic Rationale The cash flow of distributors is stable and predictable. A mega brand owner may be motivated to acquire distributors because it views a distributor as an extension of itself. The stability, predictability, and inter-dependence of brand owner and distributor reflect low business risks. Therefore, significant prices are being offered for the stable, predictable cash flows of distributors because buyers recognize that he low business risks drive a low cost of capital. The blue-ribbon investment bankers who rendered the fairness opinions of value in the two Pepsi mega-bottler deals calculated a cost of capital in the range of 7-8%. This is a very low hurdle rate compared to the risk-adjusted return on investment of most industries in the U.S., and reflects the relatively safe and stable nature of beverage distribution. Paradoxically, investments in the distribution side of the beverage business always have generated a lower return on capital than investments in “pure” franchising (which consists mainly of tax deductible marketing expenditures). This conclusion is supported by the underperformance of PepsiCo’s stock price relative to the S&P 500 in the months following its announcement of the mega-bottler acquisitions. Nonetheless, a franchisor’s pursuit of distribution assets in the well-developed U.S. beverage industry is perfectly rational economic behavior, because the lower returns available from distribution still exceed the 7-8% minimum returns required by the franchisor’s shareholders. In most of the world outside the U.S. (where Coke generates most of its profits) the locally-owned, independent, exclusive franchise system publicly advocated by Coke is in full swing. The “contrary” vertical integration of franchisor and franchisee that we presently are witnessing in the U.S. simply may signify that Coke and Pepsi have run out of high yielding investment opportunities in the “pure” franchising business in this country. However, owning their respective distribution systems for now and therefore having the ability to manage access to the marketplace along with low levels of business risk provides the platform for huge future returns. Furthermore, on-going annual capital expenditure requirements are low compared to the cash flow generated, especially for bolt-on brands or “Golden Cases.” The large brewers are likely taking note. The senior management of the mega beverage companies make strategic decisions based on maximizing “Return on Investment” and “Value Creation” for their shareholders. Therefore, as noted above, 3-5 years from now we very well may see a return to a franchise system in the U.S. built around different market dynamics that create “the next generation of high return opportunities.”
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Outlook For Independent Exclusive Distributors & Small Brand Owners Independent exclusive distributors, the small beverage brand owners, and craft brewers will undoubtedly encounter hurdles in a turbulent and uncertain future in the months and years ahead. Nevertheless, so long as there remains a mandate for a dynamic 3-tier system for soft drinks and beer, we conclude the following:
The industry’s margin pool split for independent exclusive distributors will remain intact because the principal brand owners realize that distributors must operate near current gross profit levels to remain competitive and deliver value-added services to large and small retailers.
The independent distribution platform for beverages is an extremely
valuable asset for all brand owners that use it, including small breweries, craft brewers, and small beverage companies, and to risk altering the existing franchise or 3-tier system risks permanently damaging the equity of the brand owners.
The outlook for growth, profitability, and re-investment in the beverage
distribution business remains positive for strategic buyers of exclusive distributors as they continue to squeeze out redundancies through the acquisition of willing sellers.
Brand exclusivity and perpetuity are conveyed to distributors by the
binding distribution agreements that exist between brand owners and exclusive distributors. Well-drafted agreements will support the premium value of beverage distribution rights and strengthen the balanced partnership between a performing distributor and the brand owner.
The smaller beverage brand owners and craft brewers are seeking and
should be afforded relief from some of the state-regulated franchise laws, to enable them to economically divorce themselves from a non-performing distributor. This will encourage greater investment and growth on the supplier side.
Opportunities exist for brand owners and independent beverage
distributors holding exclusive franchise contracts to create enterprise value through strategic partnerships and acquisition of “Golden Cases,” as the beverage industry continues to re-align brands and re-make itself.
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Now is the time for independently owned craft brewers, beverage companies, and distributors to assess strategic options, create new partnerships and alliances, and pursue brand acquisition opportunities to increase overall enterprise value. An exclusive “three-tier” beverage distributorship system, in tune with the demands of consumers and retailers, remains the best business model to create value for distributors in partnership with strong and growing brand owners. Since 1986, Ippolito/Christon has prepared nearly 500 appraisals for the purchase, sale,
and valuation of closely-held businesses in the beverage industry. We also advise clients
on the purchase and sale of beverage businesses and brokered the first beer
distributorship transaction in excess of $100 million three years ago. Ippolito/Christon
is recognized nationally as an expert on the value of intangible beverage distribution
rights.
ANDREW S. CHRISTON, President Ippolito Christon & Co.
2825 Lewis Speedway, Suite 104 St. Augustine, FL 32084
(904) 460-0735 [email protected]
“The Legal Buzz”
SMALL BREWER CARVE-OUTS FROM BEER FRANCHISE LAWS
PART I:
Massachusetts HB 1897: One Step Forward 5 Steps Back
By: Gary Ettelman, Esq.
This is the first of a two-part article dealing with beer franchise laws and the craft beer
industry. Part I will deal with the history of beer franchise laws, how these laws have actually
helped craft brewers to gain a foothold in mainstream distribution channels, and how some
recent attempts to amend these franchise laws by inserting so-called “small brewer” carve-outs
may be devastating to the craft brewery industry. Part II of the article will discuss the need to
develop appropriate amendments to beer franchise statutes to address particular concerns of craft
brewers, why such amendments are good for the industry as a whole, why craft brewers and
distributors have the same interests at stake, and what craft brewers and distributors can do to
achieve a win-win.
Beer Franchise Laws Pave the Way for the Craft Beer Explosion
While craft and micro-brewers are certainly not new to the American beer scene, few will
deny that while still comprising a relatively small portion of the beer industry, craft and micro-
brewers have dominated the minds, if not hearts, of the beer industry over the last several years.
At the distributor level, everyone is looking to add those “Golden Cases” (as popularized by
noted valuation expert Andy Christon). These are high profit brands with little incremental
expense and as a result, revenues translate almost entirely to the bottom line. Meanwhile, at the
brewer level, the top brands which historically looked down their noses at these young upstarts,
have had to sit up and take notice – buying up as many craft brands as they can to diversify their
increasingly stagnant portfolios. Years back, a craft brewer was thrilled to find a distributor –
any distributor – willing to take on their brands. Today, mainstream distributors battle each
other furiously to obtain rights to emerging craft brands. No doubt, the tide has turned in favor
of craft brewers – at least in terms of their ability to get their products to market.
Well here’s a news flash – if it weren’t for beer franchise laws there is virtually no
chance that there would be a craft beer industry beyond micro-breweries self distributing in local
venues. Here’s why. As any industry historian knows, the genesis of beer franchise statutes
arose from tied houses – where powerful major suppliers dominated and controlled distributors.
Beer franchise laws paved the way for strong, independent distributors being able to operate their
businesses as they saw fit – not as the large supplier demanded. This includes the ability of
distributors to carry competing products, which paved the way for the variety that dominates the
marketplace today. Thus, without beer franchise laws, craft and micro brews could never have
reached the lofty position they presently find themselves in. If there were no beer franchise laws,
would behemoths such as Anheuser-Busch or MillerCoors ever allow their distributors to carry
craft and micro brews? Not bloody likely. The fact is that beer franchise laws were necessary to
even the playing field between the large financially powerful suppliers and the smaller,
financially weaker distributors; and a natural by-product of those laws is an extremely diverse
market.
Craft Brewers Are Different
To a great extent, beer franchise laws have accomplished that which they were designed
to do. Distributors are independent (for the most part); they are free to run their own businesses
as they see fit, which has created opportunity for craft brands to get to market. Furthermore,
secure in the knowledge that their distribution rights (and profits) cannot be stripped without
good cause, distributors are able and willing to invest more in their businesses, to invest in
acquiring other brands and to invest in growing their brands; including emerging craft brands.
Financially stable, long-term distributors develop extensive sales networks, become integral parts
of their communities, create tremendous good will in the brands they sell and are able to pass
their family owned businesses from generation to generation. This is all positive for the beer
industry in general and for emerging craft brewers in particular. Indeed, that is exactly why so
many craft brewers have eagerly embraced the opportunity to be represented by mainstream
distributors.
Nevertheless, it may be argued (and craft brewers do so loudly and passionately) that
distributors occupy a favored position in the three tier system, particularly as compared to craft
brewers. And the truth of the matter is that craft brewers are different from large brewers.
Indeed, the similarity between craft brewers and large brewers seemingly ends with the fact that
both large brewers and craft brewers create and manufacture the liquid which, according to
Benjamin Franklin, is proof that God loves us. No doubt there are some beer geeks that work for
the big guys, but the big guys are far more interested in the bottom line than the product itself.
To be fair, their interest in the liquid is directly related to their bottom line because they know
they have to sell a lot of it. On the other hand with craft guys it is all about the liquid – and it
doesn’t even have to be their liquid! Sure, many are concerned with the bottom line as well, but
with a different focus– not to placate their shareholders, or to buy luxury homes. For many (if
not most) craft brewers it’s about making sure they make enough money to be able to continue
following their passion – making and selling more great beer. And while it cannot be denied that
it is a whole lot easier to get their product to market these days due in large part to the
proliferation of beer franchise laws, neither can it be denied that beer franchise laws can have
dramatically adverse (even fatal) impact on a craft brewer that gets into bed with the wrong
distributor. This has led to many small and craft brewers seeking relief from these franchise
laws.
In attacking beer franchise statutes the typical battle cry is that craft brewers can’t move
their brands from non-performing distributors because to do so would require proof of good
cause for termination, and the financial ability to engage in prolonged and expensive litigation to
do so. As a result, they are trapped with non-performing distributors. No doubt, there are
distributors that have lost interest in a brand, do not even try to sell the brand and, despite the
threat of financial disaster to the craft brewer, refuse to allow the transfer of the brand to a
competitor. Frankly, it is a compelling story; David and Goliath redux. Only now Goliath is the
large distributor threatening the existence of David – the small craft brewer. When that happens,
it’s wrong; plain and simple. Moreover, anecdotes of such instances place distributors in an
exceedingly bad light and capture the imagination of politicians when they are approached to
effect a change in the law. Although I am an unabashed advocate for distributors, I will go on
record saying that a non-performing distributor should not be able to risk the financial
destruction of an emerging craft brewer. There ought to be a way for a craft brewer in financial
distress by reason of a non-performing distributor to divorce that distributor quickly, equitably,
and without the need to break the bank on litigation costs to do it. Properly drafted craft or small
brewer “carve-outs” from beer franchise laws can accomplish that task.
The Remedy Should Match the Problem
The problem, however, is that while the concern of craft brewers is a genuine one, it is,
frankly, limited in scope. No one would seriously dispute that by and large, distributors do the
job that they are expected to do, and do it well. The brewer-distributor relationship is a two-way
street and in general commerce flows freely both ways on that street; particularly where suppliers
and brewers work together to build brand equity. So the goal should be to facilitate divorce in
those instances where that relationship is destroyed; the distributor is not performing (or even
attempting to perform) and as a result, the craft brewer is at risk. The goal should not be to
remove craft brewers entirely from the regulations; it should not be to facilitate convenience
terminations or to accommodate the subjective desires of a craft brewer. And it is certainly
should not be the goal of any such amendment to enable large brewers that are able to
manipulate arbitrary definitions of what constitutes a “small brewer” or “craft brewer” so that
large brewers can escape the coverage of a beer franchise statute; which is precisely what is
being attempted in Massachusetts.
How Not to Amend a Franchise Law: Exhibit A - Massachusetts HB 1897
Presently before the legislature in Massachusetts is HB 1897, an Act, according to the
sponsors, “relative to small brewers.” Succinctly stated, that claim is a farce. In fact, what this
proposed bill does is effectively repeal the beer franchise law with respect to every brewer that
does business in the Commonwealth of Massachusetts except for MillerCoors and Anheuser-
Busch. That is because the definition of a “small brewer” under the Act is any supplier whose
world-wide sale does not exceed 6 Million barrels. That is not a typo, 6 Million barrels.
Seriously, if you are selling 6 Million barrels, you are NOT a small brewer. At the 6 Million
barrel threshold, Sam Adam and Yuengling are not only small brewers, but they can double in
size and still be “small brewers”. Believe it or not, even if a brewer sells MORE than 6 Million
barrels it may still qualify as a small brewer under the proposed law if the sales of its products to
a distributor it wishes to terminate does not exceed Twenty Percent (20%) of that distributor’s
total sales. So brands like Heineken, Corona and Guiness, despite huge world-wide volume
would be deemed small brewers in Massacusetts. Indeed, about the only brewers that would not
be small brewers under this statute would be Anheuser-Busch and MillerCoors. Virtually every
other brewer, including some exceedingly large and powerful ones would be considered small
brewers, and as such excused from the requirement of proving good cause to terminate their
distributors. Yet, the true small brewers in the state, the ones that arguably should have some
protection, have argued loudly for the passage of this bill. Talk about throwing the baby out with
the bath water!
Legislation such as Massachusetts HB 1897 is bad for the industry and it is bad for the
craft industry in particular. The last thing that the craft industry should want is a return to the
days when large suppliers that have the clout to monopolize distributor focus had the ability to
terminate their distributors for convenience. Not when emerging craft brands are fighting for
shelf space. Simply stated, the goal of the craft brewer in seeking relief from beer franchise laws
should be to help them compete. The way to achieve such results is by focusing on the narrow
issue which has plagued some craft brewers; the ability to divorce non-performing wholesalers.
In this regard, craft brewers and wholesalers are on the same side of the equation; if an
amendment to a beer franchise law helps a large brewer, you can bet it is bad for distributors and
it is bad for craft-brewers. The solution seems obvious – craft brewers and distributors should
join forces to develop a model amendment to beer franchise laws that addresses the concerns of
craft brewers and distributors, strengthens the critical relationship between craft brewers and
distributors, but does not provide large brewers with the ability to regain their strangle-hold on
distributors.
Gary Ettelman, Esq.
516 227 6300