AB Purchase of CBA Imminent

The Craft Brew Alliance held its annual shareholder meeting Tuesday at the shuttered Widmer pub. Shareholders got to hear about the state of the company and pick up their free beer. Yeah, if you own stock, you get a free case of beer each year. You don't have to drink it.

I've been watching the CBA story for several years. If you've been following along, you probably know we're approaching the contractual deadline by which time Anheuser-Busch must make a qualifying offer to purchase the CBA. The date is August 23.

That timeline is based on a contract (actually several) signed in 2016. The details are fairly well-known. For the unaware, the agreement(s) covered contract brewing, domestic and international distribution. It also set deadlines for outright purchase at a set minimum price per share in successive years, the last of which comes in August at a minimum offer price of $24.50.

When the agreement was announced, many viewed it as a framework for a slow moving buyout. Craft beer was growing steadily. People who owned CBA stock figured to cash in. Investors on the outside, if they were paying attention, saw the chance to make some easy money.

Yet the stock price languished, staying well below the required buyout price. Yesterday, CBA stock closed at $15.33. Simple math. That's $10 less than the required 2019 offer price, which suggests the investment community isn't confident a deal will happen by August. If there was confidence, the stock price would be north of $20.

Why the lack of confidence. For one, the craft beer landscape looks a little sketchy. Established brands are suffering as a sea of newcomers sucks up market share. In the case of the CBA, its former flagship brands, Widmer and Redhook, are in dramatic decline and a drag on profitability. No need to delve into the details. Craft beer doesn't look like a great investment right now.

The CBA remains a buyout target only because of Kona, which continues strong growth in a fragmenting industry. Kona has been carrying the CBA for several years. It's a unicorn brand, seemingly impervious to volatility in the market. Kona lost a bit of momentum in Q1, but appears poised to rebound strongly heading into the busy summer beer season.

Virtually everything the CBA leadership has done in recent times was done to make the company a juicier buyout target for AB. The shuttering of unprofitable pubs looked awkward, but removed overhead and costly benefit packages from the ledger. Closing the Widmer tasting room, where they briefly showcased experimental beers, saved barely any money, but signaled that they were abandoning any effort to rebuild local brand status. And so on.

Those who own CBA stock have been patient. Current and former employees who hold stock quietly hope for a payday. However, those who invested because they perceived that the 2016 agreement set the stage for easy money are getting restless.

Fast forward to yesterday. That's when Boston-based Midwood Capital Management sent a public letter to CBA leadership effectively demanding that they complete a sale to Anheuser-Busch or, failing that, to an unspecified third party investor or company.

This is great stuff. It turns out Midwood Capital loaded up on CBA stock in early 2017 and today sits on about 2 percent of the outstanding shares. Needless to say, they were counting on a financial windfall and aren't happy with the downward trajectory of the stock price. They want action.

What these folks correctly realize is that CBA stock is undervalued on the public market. That's largely due to its grubby appearance. When Wall Street looks at the CBA, it sees the complete package and the complete package doesn't look all that appealing thanks to the dying brands and other drags on profitability.

What Midwood Capital also realizes, correctly it seems, is there is no way shareholder value will be maximized if the CBA stays independent (AB owns just 31 percent). They see the value of Kona, but believe fulfilling that potential will require investment and strategic know-how an independent CBA can't deliver. Again, they're surely right.

With that in mind, Midwood urges the CBA board to accept the qualifying offer if it comes. Further, it wants the board to do whatever it can to encourage AB to make a qualifying offer. If no offer comes, they want quick action to stabilize the stock price and sell the company to another suitor.

Listen, CBA leadership is bent on selling. They can't force a deal, but they want one and have been scheming for several years to make one happen. The idea of staying independent, which they've floated, is a ruse. They know what Midwood knows...that they don't have the horsepower to fully realize Kona's potential. 

For its part, Anheuser-Busch can't afford to pass on this opportunity. Letting Kona fall into the hands of someone else would be a disaster. That's partly because Kona has terrific global potential. But mostly it's because AB would be stuck honoring some pretty unpalatable contractual obligations in a scenario where it didn't own CBA/Kona. Zero chance of that happening.

The clock is ticking, obviously. Buyout details are almost certainly being finalized and a deal will be announced shortly. Expect AB's offer price to exceed the required $24.50 by a dollar or two. They don't want to look cheap. There's no running out the clock on this.

CBA Positioned for Whatever Comes Next: 2018 Report

The Craft Brew Alliance issued its Q4 and overall 2018 financials the other day. There's good news and bad news if you absorb the full report. Mostly, though, the numbers paint a fairly positive picture of the CBA's position moving forward.

The bad news in the report, which I shall get to, apparently cooled investor interest in the CBA. Its stock price opened the week at over $17 and closed Friday just above $15. Investors may be missing the boat. Because there's a chance the CBA will be gobbled up in its entirety by Anheuser-Busch at $24.50 per share by next August.

Much of the CBA's good news relates to Kona, which grew 8 percent for the year, 11 percent during Q4. There's a bit of bad news associated with that growth, which is that Kona made up 63 percent of the CBA's total shipments. It's a little scary to be so dependent on one brand, although Kona is thus far proving itself to be immune from the fragmenting, flattening craft market.

The bad news involves the CBA's problem child brands, Widmer and Redhook. The former declined 20 percent, from 123,300 to 98,700 barrels. The latter lost 24 percent, from 94,200 to 71,200 barrels. Imploding sales of Widmer Hef and Redhook Longhammer IPA and ESB were identified as the primary reason for the decline. The two legacy brands, once strong growth engines, are losing the competitive battle in a market increasingly driven by smaller local breweries.

A few juicy tidbits from the report:

• Despite the continued success of Kona, total CBA shipments, including beer produced under contract at its facilities, declined by 700 barrels, to 747,600 barrels in 2018 versus 2017. Nonetheless, net dollar sales increased 1.3 percent, to $182.2 million, the result of stronger pricing.
• Total net sales were $206.2 million, a 1 percent decrease from 2017, primarily due to a $3.4 million shortfall in contract brewing fees received from Pabst in 2017 that did not recur in 2018. The decrease also reflects lower 2018 pub sales, mainly due to the absence of the Woodinville pub, which was closed at the end of 2017.
• As part of its agreement with AB, the CBA can brew up to 300,000 barrels a year at AB's plant in Fort Collins, Colorado at a net savings of $10 per barrel. They evidently came closer to realizing the $3 million in annual savings that arrangement could have brought in 2018.
• Partially as a result of production shifted to Fort Collins and other AB factories, capacity utilization at CBA facilities declined to 57 percent over the last two years. That's a lot of underutilized tank space and it happened despite the fact that Goose Island beer and Virtue Cider is being produced by the CBA in Portland and Portsmouth.
• Like its parent-apparent, the CBA is fixated on cost cutting and improving gross margins.Through strong revenue and rabid management, it delivered a 2.6 percent increase in total revenue per barrel, which led to a 5.6 percent improvement in beer gross profit and record full-year beer gross margin of 36.8 percent.
• Finally, shipments of the Omission, Square Mile Cider, Appalachian Mountain Brewing, Cisco Brewers, and Wynwood Brewing families grew by a combined 4,700 barrels to 93,200 barrels. That portion of the CBA’s portfolio now accounts for some 13 percent of total shipments.

What the CBA has effectively done by leveraging its arrangement with AB and aggressively tightening up underperforming aspects of its business is improve its position for the future, regardless of whether it becomes a fully-owned subsidiary of Anheuser-Busch. Investors, for the moment, appear to be too fixated on the bad news in the 2018 report to see that the prospects of a buyout at $24.50/share remain quite strong.

CEO Andy Thomas set an aggressive tone in comments made during the conference call, reminding shareholders that the CBA position is strong even if the possible takeover by AB doesn't happen. In the absence of a qualifying offer, he noted that the CBA will be entitled to a $20 million international incentive payment and AB could not terminate any part of the current agreement.

Further, Thomas went on, if AB fails to make a qualifying offer, CBA could continue to operate independently or come under the control of another entity. In either case, AB would be required to honor all agreements, including payment of the $20 million international incentive, continuation of the master distribution agreement at $0.25 a case, continuation of the international distribution agreement and fulfillment of the contract brewing agreement.

It's difficult to fathom the extent to which the current contract, signed in 2016, favors the CBA. What were the folks at AB smoking when they signed a deal that would allow the CBA to be taken over by another entity while Anheuser-Busch is forced to fulfill the terms of the agreement? The likely answer is the people who negotiated the agreement believed the CBA would be purchased during its term. There can be no other explanation.

Of course, the craft beer landscape has changed dramatically since 2016. Competition is fierce and most large craft breweries are suffering. Yet Anheuser-Busch recently reported that the High End (craft line) is its top growth engine, accounting for 30 percent of the company’s worldwide revenue growth and 10 percent of its total revenue in 2018. Why would AB want or need the CBA?

The answer is Kona, which continues to thrive in a flat overall market. Keep in mind that Kona beers, unlike some of craft's more nuanced offerings, can be brewed virtually anywhere, even in a factory brewery. Acquiring Kona, of which AB already owns nearly a third, would cost around $300 million. That's pocket change for a brand that has apparently unlimited potential.

Flies in the ointment are the CBA's declining brands, Widmer and Redhook. Anheuser-Busch, should it make a qualifying offer, will have no interest in salvaging those brands. They might be killed or sold in a buyout. In fact, you have to wonder what would become of CBA properties in Portland and Portsmouth. Those breweries, not as big or efficient as AB's giant factories, might well be closed and sold in the wake of a buyout to recoup some of the investment in Kona.

Inquiring minds keep asking what's so special about Kona. In my mind, there's nothing particularly special about any of the Kona beers. But Kona is a lifestyle brand with a strong connection to a place consumers identify with. It hardly matters that Kona beers have been brewed in Portland and elsewhere on the mainland for years. The brand is Hawaiian.

Honestly, there's a lot not to like about the CBA, an organization whose leaders appear to be fixated on numbers. This company ceased being about craft beer long ago. By cutting costs and leveraging their agreement with Anheuser-Busch to the hilt, executives have positioned the CBA to be bought lock, stock and barrel. The chances of that happening look to be better than 50/50 from here.

Then the fun begins.