IPO Pricing for Boston Beer Company Inc.


Case Summary

We address the following key questions regarding Boston Beer Company (BBC) to explore the issues surrounding its Initial Public Offering. First of all, we determine the fair value of BBC to be $211 million based on a DCF valuation of projected future cash flows and explain our key assumptions and potential problems arising from those assumptions. Second, we find BBC’s fair value to be $314 million by relative valuation and discuss how differences in operating strategies might translate into differences in financial ratios. Third, we determine BBC’s IPO price to be $15 per share. Finally, we look at the craft brewer industry as a whole and we find that it may be overvalued by the market.

PART I: DCF Valuation

In our intrinsic valuation approach, Boston Beer Company’s future free cash flows of the next ten years are projected in the spreadsheet. Present value of the company at the end of 1995 is calculated by discounting ten year’s free cash flows and terminal value by weighted average cost of capital. As we can see from the spreadsheet, the company fair value is $210.78 million. Subtracting the debt level of $1.95 million, the equity value is therefore $208.83 million.  

Appendix 1 includes the full valuation model we used. The key assumptions we made and the calculation methods we used are listed as follows:

BBC’s annual sales growth rates from 1992 to 1994 are 63.55%, 60.14% and 48.84% respectively. The unaudited income statement suggests that sales growth may slow down further. Hence, although the market growth is positive in the near future, it is expected that BBC’s net sales will slow down and eventually reach a “mature stage”, where the company maintains GDP growth rate going forward. In our financial projection, we assume that BBC’s sales growth will decline linearly from 45% to 5% in ten years and enter “mature stage” afterwards. The growth rates in net sales for the next ten years (including 1995) are therefore projected as: 45%, 41%, 37%, 33%, 29%, 25%, 21%, 17%, 13% and 9%. After ten years, the growth rate will remain steady at around 5%, which is the sum of real GDP growth rate at that time (2.5%) and the inflation rate of 2.8%.

In the past five years, cost of goods sold as a percentage of net sales has been quite steady. We used an average rate of 44.7%. Gross profit is then estimated as 55.3% of net sales.

We believe it is also reasonable to assume that advertising, promotional and selling expenses are proportional to net sales since BBC has been adopting an intensive sales and marketing strategy to build up its market. The same linear variable assumption applies to general and administrative expenses because the company will have to continuously recruit employees and increase management efforts to sustain the sales growth. Therefore, we combine those expenses into one category -- total operating expense. Although individual expenses may vary in different years, the overall operating expense rate tends to be steady over years. In the last 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 our financial projection.

Although the company as a partnership was not subject to income taxes, it will be taxed after public offering. We believe pro forma income is a more precise measure of value in a forward-looking perspective. For the past five years, the pro forma tax rate for the company is 42% on average.  

Free Cash Flows were calculated as FCF=EBIT*(1-Tax) +Depreciation/Amortization - Increase in Working Capital - Capital Expenditures.

Depreciation and Amortization cost is assumed to be a variable cost proportional to net sales. The average depreciation and amortization cost is 0.7% of net sales from 1992 to 1994. Capital expenditures includes the  replacement and addition to capital assets and should be proportional 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. Change in Working Capital can vary significantly over years in the case of BBC and is estimated by the weighted average rate of change from Dec 1992 to Sept 1995, which comes out to 0.57% of net sales.

With all the free cash flow for the next ten years in place, discount factors are needed in order to calculate present value. BBC’s weighted average cost of capital is used as the discount factor and is calculated as KWACC = (Equity/Value) × KE + (Debt/Value) × KD× (1-Tax)

We assume that the book value of debt equals the market value of debt. As of Sept 30, 1995, short and long term debt totaled $1,950 thousand. Cost of Debt (KD) for BBC is 11.5% with semiannual payments. Compounding it gives an annual rate of KD = (1+11.5%/2)2 = 11.83%.

Partners’ Equity totaled $29,517 thousand, after adjusting for the recapitalization and receipt of estimated net proceeds of the Offering ($12.5 per share) as suggested in case Exhibit 5.

Join now!

Cost of Equity can be estimated by the CAPM model: E (Ri) =Rfi (E (Rm)-Rf). Expected market return, Rm for the US in 1995 was estimated by the US 20-year historical average annual return up to 1994, which is 14.60% using S&P 500 as benchmark Index. The risk free rate is considered the rate of long-term government bonds. In BBC’s case, the government 30-year Treasury notes’ annual rate of 6.26% was applied.

Unlevered Beta for BBC should be close to unlevered beta for Anheuser Busch, as they both operate in the same industry. In 1994 Anheuser Busch had a levered ...

This is a preview of the whole essay