For years, I proposed in Seeking Alpha pieces that there was significant value inherent in Craft Brew Alliance (NASDAQ:BREW) shares owing to the U.S. market success and international opportunity for Craft Brew Alliance’s (hereafter CBA) KONA brand. Anheuser-Busch (NYSE:BUD) (hereafter ABI) saw this opportunity and approached CBA to buy the company in August 2016, the 8-K for which is available here.
The deal established a three-year period ending 8/23/19, during which ABI had the option to buy CBA. Until the very end of the three-year potential buyout term, I argued ABI would in fact exercise its right to buy CBA for the minimum of $24.50 per share. My belief was that the ownership of the KONA brand for worldwide distribution was worth that price. The $24.50 price represented a 2.5X mainly domestic sales, which was not out of line with industry valuations, and the international business expansion was a bonus.
From my perspective, KONA represented an extremely valuable asset play inside a clearly stumbling company which had demonstrated no discipline in reigning in excessive SG&A spending. The brand was an ideal candidate for a large brewer to market the KONA brand aggressively, and it represented one of the few brands that had proven an ability to cross national and cultural boundaries and thrive.
In the end, ABI let that buyout option lapse, only to re-appear a mere 7 weeks later offering a considerably slimmed down $16.50. It was a gut punch to shareholders and “partners” of over twenty five years and an especially bitter blow, given the significant out of stock issues CBA products faced (discussed by management on multiple earnings conference calls) in FY19. Nobody actually knows how well the KONA brand would have performed in FY19 in the absence of the out of stock issues, factors that clearly would have affected the valuation of the brand.
The Hawaiian AntiTrust Problem & An Arguably Imperfect Solution
The Department of Justice (DOJ) has been reviewing the merger agreement for just over six months. On June 10th, shareholders got a glimpse of what perhaps has been holding up the deal. In a joint filing, CBA and ABI agreed to sell off the KONA brand and Hawaiian-based operations to a third party venture capital firm, signalling there must have been some antitrust concern with the combined market share of ABI with KONA in Hawaii. The press release is available here.
I see several potential issues with the proposed solution.
- ABI and CBA jointly selected a venture capital firm, PV Brewing Partners (PV), partially owned by a former AB president who, one would anticipate, made a significant amount of money when InBev bought out AB. I would assume that the DOJ is concerned with their being true competition for both shelf space and tap handles in Hawaii. Since both companies will use the ABI wholly owned Hawaiian distributor, and a significant investor in PV is a former AB President, is this arrangement really be seen as maximizing and enhancing competition? Are these two entities more likely to compete against each other or against significantly smaller competitors for grocery slots and tap handles in Hawaii? Out of the virtually thousands of venture capital firms out there, and given this is an antitrust issue, I am surprised by the choice. It brings to mind past DOJ challenges and settlements with ABI regarding ABI distributor agreements where ABI sought to determine who could purchase independent distributorships so only ABI approved entities could own them. Given AB’s prior willingness to walk away from a deal, could this in fact be intended to draw additional DOJ antitrust scrutiny and provide ABI the ability to drop its appeal, thereby terminating the merger?
- Price. The brand new state-of-the-art KONA brewery was announced in 2015 and was originally scheduled to be completed in 2016. CBA has had a hard time meeting timelines on this project. Apparently, it was finally on track to be completed late this summer, but now, COVID-19 has apparently altered (understandably) that timeline. CBA shareholders will have spent $23-25MM on this state-of-the-art brewery, including over $17MM in FY20 alone. PV stands to get this brewery, the original brewery and two pubs. At closing, PV will be required to pay $5MM, and then, an additional $11MM is due when the brewery is complete and certain production milestones have been achieved. Again, and fully understanding that Hawaiian tourism is off over 90%, is this the best VC deal ABI & CBA could have struck, or does this appear to be a “sweetheart” deal to a former AB president?
- These key KONA assets are pledged to Bank of America (BofA) as collateral for over $50MM in loans. This VC deal shows BofA that this significant group of assets is worth $5MM at the closing of the transaction. Obviously, if the transaction closes, this is not a problem – it is the “if” that is at issue. In a Seeking Alpha blog post recently, I outlined the Bank of America (BofA) loan covenants facing CBA at the end of Q2 and on July 1st. I am certain many banks are currently renegotiating loan covenants and terms, but this VC deal poses a problem of a different sort. The Hawaiian operations and brands are key collateral for the over $50MM outstanding CBA indebtedness. BofA just learned that these assets and the KONA brand in Hawaii are worth $5MM now (at deal close) and potentially up to $16MM at some point in the future. Given the state of CBA’s business, one has to wonder how BofA is assessing this as CBA becomes increasingly leveraged and debt covenants are renegotiated.
The $107MM Lawsuit Alleging Breach of Fiduciary Duties
Last week, a shareholder filed a lawsuit against Anheuser-Busch and CBA officers and directors alleging breach of fiduciary duties in the proposed merger. Brewbound covered the story here.
I have read the filing, and it addresses the alleged prioritization of ABI products over CBA products and includes significant discussion of CBA out of stock issues which plagued the company in the year up to the termination of the original merger agreement. The suit calls for class action status and a jury trial.
The impact, if any, on the currently proposed merger cannot be determined, but it is clearly another bump in the road on an already bumpy transaction road.
It also references Midwood Capital’s valuation of the KONA brand alone, which was between $21 and $26 per share.
CBA’s current business is being pressured significantly by COVID-19 which certainly has devastated Q2 results. The cornerstone Hawaiian business is starved of tourists with tourism down 95.0-99.5% for the entirety of the second quarter. Now, half of the states are contemplating rollbacks and additional shutdowns of the on-premise business.
If ABI is willing to conclude this transaction at $16.50 after being forced to give up the Hawaiian business, despite ABI’s ability to terminate merger discussions, and given the severe impacts upon CBA business and its rising debt levels, one has to wonder what CBA really was worth to ABI when it was profitable and KONA was thriving despite significant out of stocks. KONA Hawaii is the very heart of the brand and a valuable, defensible market with significant barriers to entry. Paying $16.50 while giving up this market clearly would indicate that KONA ownership and international distribution was worth a considerable sum to ABI.
Other Data Points & Commentary
Casa de la Cerveza is an ABI company selling beer and variety packs in Chile. I thought it was an important data point when I found it as it signaled that ABI had expanded distribution of KONA products to Chile. Chile was one of three territories awarded to ABI under the original merger agreement. I followed the offerings and “beerpacks” on their website, which is here.
When I first found the website, KONA was available in approximately 3 of the 75+ variety pack product offerings. As the original deal term end was approaching, KONA products had been included in up to 13-15 product assortments and in a 12-pack of just KONA Longboard Lager and Big Wave. The placement was largely at the top of the first page of offerings and often included a scrolling banner offering KONA products.
Recently, I again examined the offerings on this website, and now see that KONA product is only offered in 2 beerpacks and also one offering of a mixed pack of KONA Longboard Lager and Big Wave. All of these offerings are on the bottom half of the second page of offerings, which is clearly a change in visibility of the products on the website.
ABI also never did expand KONA products into its 8,000 Modelorama beer stores in Mexico despite having been awarded the territory now almost 4 years ago.
Is this ABI backing off international distribution of KONA? It is impossible to say, given supply chain disruptions and problems caused by COVID-19 worldwide. I would not use it as proof positive a deal is off, given that, when KONA was extremely well represented, it did not signal the deal was on (which fooled me). It is just a data point. There is considerable presence of other ABI U.S. craft beers in these variety packs, however.
As previously mentioned, I owned BREW shares purely for the KONA asset play and my belief that the brand had significant value both in the U.S. and internationally. Part of the KONA brand evolution now includes KONA Hawaiian Seltzer which has entered several US markets. The explosive growth of hard seltzers is a powerful new trend in the craft segment and clearly could be a significant market competitor in the hard seltzer space with ABI behind it. This alone could support the thesis that, although CBA is significantly impacted by COVID-19 and its markets roiled, having KONA Island Seltzer ready to roll out could be a huge advantage for ABI. ABI would also pick up the Omission Seltzer product, which I personally drove five miles to purchase – three times.
Several fund managers have reached out to acknowledge my work but to also reiterate that we are talking about a meaningless sum of money for ABI. I do acknowledge that but proffer in response that $24.50 was a modest sum on the original deal. A roughly $100MM out of pocket difference for ABI.
I wrote a blog piece a month ago and finally published it on Seeking Alpha this past week. A handful of readers approached me and asked why it was not an SA article, and several suggested it was my best work. This blog post can be seen on SA by searching for my and then clicking on BLOG POSTS.
This piece was motivated by the proposed sale of Hawaii and the shareholder lawsuit.
And a lot like the Tiger King documentary series, I have frequently cringed while watching this deal evolve but, in the end, could not stop watching. Count me as a ‘NO” on the Joe Exotic pardon, but maybe the sentence could be reconsidered. This home confinement has to end!
Disclosure: I am/we are long OPTIONS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: All investors are encouraged to do your own research and due diligence prior to taking a position in the securities mentioned herein. This is provided for informational and entertainment purposes only and although we believe the information contained herein is accurate we do not guarantee this. Do your own analysis. Regarding my ownership, I own both puts and calls and have initiated such positions due to the volatility in BREW shares. I trade these positions.
