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 ...view middle of the document...
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%.[1]
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 =...
