FSA RelativeValuation

THEBOSTONBEERCOMPANY,INC.PROF.A.KANAGARAJ

Usingrelativevaluation,thefairvalueofBostonBeerCompanyequityis$312million. First2comparablepublicfirmsforBBCwerechosen.BecausePetesBrewingCompanyandRedhookAle Brewery are two other players in the USA Craft Beer industry, they were good comparables for BBC. While Petes valuegeneration strategy and asset structure are more similar to BBC, with less physical production assets and more investment in sales and brand marketing, its growth rate is enormous in comparison,soitwouldmakesensetouseagrowthadjustedmultiplewhenusingPetetohelpusvalue BBC.Ontheotherhand,RedhooksgrowthrateislowerthanthatofBBC.Furtherdifferencesstemfrom its small size and its heavy investment in internal production facilities. Nonetheless, Redhook is BBCs competitoranditsequityvaluereflectsthemarketsentimentsinthecraftbeerindustry,soitisuseful asanotherbenchmarkwhenvaluingBBC. Petes PEG was 0.9 while Redhooks PEG was 0.88. Since these values are already so close to one another,wesimplyassumedanaverageandused0.89asthePEGofBBC.Multiplyingthisvalueagainst BBCsgrowthresultsinaP/Eratioofaround50.MultiplyingthatagainstBBCstotalexpectedearnings for1995givesusanapproximate1995yearendequityvalueof$312million.
Petes Brewing Company Redhook Ale Brewery Boston Beer Company

P/E Ratio on 11/20/95 CAGRforsalesgrowthfrom9094 PEGratio 9monthsearnings 12monthsearningsscaled Valueofequity SharesOutstanding Pricepershare($) Sales1990(1000sbarrels) Sales1991(1000sbarrels) Sales1992(1000sbarrels) Sales1993(1000sbarrels) Sales1994(1000sbarrels)

100 111.47% 89.71 9 15 29 69 180

36 40.68% 88.50

24 34 50 74 94

49.77 55.86% 89.10 4702000 6269333.33 312027805.25 20813379 14.99 121 174 294 475 714

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Itisimportanttonotesomeassumptionsthathavebeenmadeupuntilthispoint: TofindthePEGmultiple, theaverage compoundannual growthratefor the 4yearsspanning 1990to1994wereused. In addition, these growth rates are derived from growth in barrel volume of sales for each company,sincethesenumbersgobackfurtherintimethandollarsales. Anaveragegrowthrateratherthanthemostrecentyearsgrowthratewasusedtoeliminate potentialerrorscomingfrommarketshorttermfluctuations,wedecidedthata4yeargrowth rate would be a more reliable indicator of firms growth rates as of November 20, 1995 and beyond. BBCs1995earningswouldtotal$6.3millionbyyearend,whichisalinearscalingofthefirms $4.7millionearningsfromthefirstthreequartersoftheyear. Itisassumedthefirmwouldmake1/3ofthisamountinthelastquarterof1995.Sincethe$4.7 millionitselfisunaudited,theremaybesomeerrorinusingit,andthaterrorcouldbemagnified by our extrapolation, but we believe that our assumption was fair in the absence of other predictiveinformation. Thevaluedriversofthecraftbeerindustryareearnings,sales,growthpotentialcapturedbythe PEGratio. UsingthePEGmultiple,adjustmentisdoneforvariousdifferencessuchassizeofearningsand growthrate. However,therearestilldifferencessuchaseffectsofleverage,whichwerenotaddressed. There is also the inherent assumption that traded companies are always fairly priced by the market, which does not always hold. If investors are overly optimistic about the craft beer industry,PetesandRedhookmaybothbeoverpriced. While the P/E ratio is universally applicable, it misses out on a key indicator that is growth. Especially since Petes, Redhook, and BBC have somewhat different cost structures, their profitability varies greatly despite their potential. Craft brewers operate in a fastgrowing industry, and since valuation is futurelooking, growth should be adjusted for using the PEG ratio. BUNNYSETHI,2010PGP089,SECTIOND Page2

FSA DCFValuation

THEBOSTONBEERCOMPANY,INC.PROF.A.KANAGARAJ

Thekeyassumptionswemadeandthecalculationmethodsweusedarelistedasfollows: BBCsannualsalesgrowthratesfrom1992to1994are63.55%,60.14%and48.84%respectively. The unaudited income statement suggests that sales growth may slow down further. Hence, althoughthemarketgrowthispositiveinthenearfuture,itisexpectedthatBBCsnetsaleswill slowdownandeventuallyreachamaturestage,wherethecompanymaintainsGDPgrowth rategoingforward.ItisassumedthatBBCssalesgrowthwilldeclinelinearlyfrom45%to5%in tenyearsandentermaturestageafterwards.Thegrowthratesinnetsalesforthenextten years (including 1995) are therefore projected as: 45%, 41%, 37%, 33%, 29%, 25%, 21%, 17%, 13%and9%.Aftertenyears,thegrowthratewillremainsteadyataround5%,whichisthesum ofrealGDPgrowthrateatthattime(2.5%)andtheinflationrateof2.8% Inthepastfiveyears,costofgoodssoldasapercentageofnetsaleshasbeenquitesteady.An averagerateof44.7%isused.Grossprofitisthenestimatedas55.3%ofnetsales. It is also reasonable to assume that advertising, promotional and selling expenses are proportionaltonetsalessinceBBChasbeenadoptinganintensivesalesandmarketingstrategy to build up its market. The same linear variable assumption applies to general and administrativeexpensesbecausethecompanywillhavetocontinuouslyrecruitemployeesand increase management efforts to sustain the sales growth. Therefore, those expenses are combinedintoonecategorytotaloperatingexpense.Althoughindividualexpensesmayvary indifferentyears,theoveralloperatingexpenseratetendstobesteadyoveryears.Inthelast three years, on average, total operating expenses accounted for 48.1% of net sales. Other income/expense (net) is insignificant in size (less than 0.1%) and therefore left out in the financialprojection.Taxrateforthecompanyis35%onaverage. FreeCashFlowswerecalculatedasFCF=EBIT*(1Tax)+Depreciation/AmortizationIncreasein WorkingCapitalCapitalExpenditures. DepreciationandAmortizationcostisassumedtobeavariablecostproportionaltonetsales. Theaveragedepreciationandamortizationcostis0.7%ofnetsalesfrom1992to1994.Capital expendituresincludesthereplacementandadditiontocapitalassetsandshouldbeproportional to depreciation and amortization cost. Using data from the past three years, capital expenditures are estimated as 230% of Depreciation and Amortization, or 1.61% of net sales. ChangeinWorkingCapitalcanvarysignificantlyoveryearsinthecaseofBBCandisestimated BUNNYSETHI,2010PGP089,SECTIOND Page3

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THEBOSTONBEERCOMPANY,INC.PROF.A.KANAGARAJ bytheweightedaveragerateofchangefromDec1992toSept1995,whichcomesoutto0.57% ofnetsales.

BBCsweightedaveragecostofcapitalisusedasthediscountfactorandiscalculatedasKWACC = (Equity/Value)KE+(Debt/Value)KD(1Tax) Bookvalueofdebtequalsthemarketvalueofdebt.AsofSept30,1995,shortandlongterm debt totaled $1,950 thousand. Cost of Debt (KD) for BBC is 11.5% with semiannual payments. CompoundingitgivesanannualrateofKD=(1+11.5%/2)2=11.83%. PartnersEquitytotaled$29,517thousand,afteradjustingfortherecapitalizationandreceiptof estimatednetproceedsoftheOffering($12.5pershare)assuggestedincaseExhibit5. CostofEquitycanbeestimatedbytheCAPMmodel:E(Ri)=Rf+i(E(Rm)Rf).Expectedmarket return,RmfortheUSin1995wasestimatedbytheUS20yearhistoricalaverageannualreturn upto1994,whichis14.60%usingS&P500asbenchmarkIndex.Theriskfreerateisconsidered therateoflongtermgovernmentbonds.InBBCscase,thegovernment30yearTreasurynotes annualrateof6.26%wasapplied. UnleveredBetaforBBCshouldbeclosetounleveredbetaforAnheuserBusch,asthey

bothoperateinthesameindustry.In1994AnheuserBuschhadaleveredbetaof1.0.According to their annual report, its debt had a market value of $3,270 million (assuming market value equalsbookvalue).Itsshareholdersequitywas$4,434millioninbookvalue.Withanaverage P/Bratioof29.69/7.22=4.11,itsmarketvalueofequityistherefore$18,224million.Anheuser Buschstaxrateis39.5%.Adjustedforcapitalstructure,theunleveredbetaofAnheuserBusch andBBCwas0.902. PricingintheCraftBeerIndustry Thecraftbeerindustryasawholeisoverpricedbythemarket.Thereasonsareasfollows. First, the U.S. economy appeared to be doing particularly well in the 1990s and it was called long boom. Investor sentiments tended to be strong and positive towards the manufacturing industries, including the craft beer industry, in this bullish economic environment. Several Wall Street analysts forecastthatsalesvolumeofthecraftbeersegmentcouldtripleinfiveyears.Othersbelievedthatthe BUNNYSETHI,2010PGP089,SECTIOND Page4

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segmentcouldgrowevenmore.Sincestockpricecanbelargelyaffectedbythemarketconfidence,we believethatthepositivemarketsentimentoverheatedthestockprice. Secondly,itisquitedoubtfulthattheannualgrowthrateofsalesinthecraftbeerindustrycouldsustain at40%inthenextdecade.Iftheselargecompaniesloweredpriceorenhancedmarketingforcetostep up competition, the current marketing programs used by relatively small companies in the craft beer segment might not be sufficient to resist the fierce competition. As a result, the annual growth rate would drop significantly. In this sense, we believe that the market was overly optimistic about the growth of the craft beer industry. We should take into account the uncertainty caused by the rivalry amongincumbents. Moreover, the craft beer companies sales strategy also played a role in altering the real price. BBC offered990,000ofthesharesdirectlytoconsumersthroughcouponsattachedtosixpacks.Usingthe coupon,the consumerscouldobtainsharesatalowerpricethanitsIPOprice.Thatofferingwasfully subscribed. Apparently this sales strategy created a link between beer consumption and equity investment,anditattractedlotsofconsumers,nomatteritwasforthepurposeofbeerconsumptionor purely investment or both. Not even to mention how many beer lovers supported the craft beer companiesbyinvestingintheequity.Thepsychologicalfactorsbehindthiscouldalterthewayinvestors perceivedandvaluedthestocksandtheindustry. Anotherpossiblereasonisthatifthebenchmarkorcomparablecompanywasalreadyoverpriced,the valuationofthecompanypreparingforIPOwouldbeoverpricedaswell.Thiserrorcouldhappenone aftertheother.Inthatsense,thewholeindustrycouldbeoverpriced. In summary, the craft beer industry was overpriced due to lots of internal and external factors, even psychologicalfactorscouldinfluenceinvestorsentimentsandobscure thewaypeople evaluatestocks andindustryandmakeinvestmentdecisions.

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