JB on Everything Craft


April 7, 2014

Dear Client:

There are a lot of hot issues surrounding the hot craft space these days: Franchise law, shelf space, SKU proliferation, marijuana, the BA definition, etc. On Friday we caught up craft veteran JB Shireman of First Beverage Group (and formerly of New Belgium Brewing Co.) to talk about some of these issues for our latest BeerNet Radio podcast. Here is an excerpt:

BBD: Overall, what is your take on the start to this year's beer business?

JB: As expected and predicted by my 'far smarter-than-me' co-workers and peers, the domestic industry has continued to struggle and craft-style products have continued to accelerate across all types of beverage from NA's to beer to spirits. The variety-seeking consumer who desires local, storied and artisan brands has helped all "craft-style" categories gain momentum across many types of CPG's. We feel we are now far past the tipping point on this. The acceleration of craft beer last year attests to this. We predict this will continue for some time with domestic lagers, certain imports and wines being the most vulnerable to share loss.

BBD: We ran a piece earlier this week on craft brewer valuations and you sent me a rude text saying you felt like it was missing some key components. Can you elaborate?

JB: It was a good exercise from a numerical point of view but valuation, and actually transacting, in this business is much more complex than just multiplying EBITDA by 12 or 13 or whatever. Simply put, something is worth what someone is willing to pay based on how much current and future value they see in it.

As some examples, what is worth 15x earnings to one company could well be worth zero to another based on wholesaler alignment alone. People may spend enormous amounts of money on cap ex that a trade buyer doesn't want or need. If someone is running very close to capacity and efficiently utilizing their assets, the balance sheet may look very strong. However, to a financial buyer this could be a negative, as they may pay a premium on the cash flow only to have to invest millions more to expand into new geography. How much a trade buyer can increase distribution or "scale up" a certain brand depends on many things: who the trade buyer is; their scale; and other similar type products they may already have in their portfolio. Someone with an ESOP [like New Belgium] in place could be devalued by certain buyers simply due to the cost associated with unwinding it if they chose to. Revenue per barrel will vary wildly based on pricing, portfolio and mix. These are just five or six things off the top of my head that could greatly affect transactional values on any of the breweries you projected. I guess the cardinal point is, if you are going to do a valuation of your brewery, hire someone who really knows and understands this space.

BBD: Like you?

JB: I didn't say that.... but I do believe we know as much about the space as anyone.

BBD: What about shelf space and the threat of SKU-mageddon?

JB: We have known each other a long time, Harry and as you know, I am a terribly simple person.

BBD: Some would say a simpleton.....

JB: Well, whatever. But what I say is, why not just add more space? Grocery stores, on average are larger than in the past. Look at the aisles for chips, yogurt, juices, even milk and water. Most all of that space has expanded fairly rapidly over the past five years. Retailers that listen to their consumers and understand the power of well-branded products will see the opportunity over the next decade and make smart accommodations to capitalize on them. Craft beer still offers a superior return per linear foot than many other items.

BBD: At the beginning of this year, First Beverage Group closed what I think was the biggest transaction in craft to date with Duvel Moortgat's acquisition of Boulevard. They just released their 100 Day report. Any comments on that deal or others that may be pending?

JB: Yes for sure. On the Duvel-Ommegang-Boulevard partnership, it is our sense it is going very well. We stay in touch with a number of people there and all the parties we speak with seem happy with how it is progressing. I personally believe the combined entities are going to do some very interesting things together. The company houses a supremely talented group of people with great brands, lots of heritage and serious global credibility in the high end. That's a pretty sweet combination in today's world.

On other craft deals, as you know, our industry and indeed all beverage in general, has never been more competitive and will likely continue along this path for some time. I see many breweries asking themselves, "Am in for the long haul, say another 5 to 10 years, or do I want to monetize all or part of my investment and hard work now?" We think this is the right question to be asking and we see more and more people looking to actualize part or all of their investment now. Having said that, this is a very personal business and these are highly emotional decisions, two things that can complicate any situation. That has made it a lot harder to get some of these things accomplished. That and distribution issues. I think the single largest mistake we see happening with craft breweries these days are those rolling out new geographies with little or no thought into how it serves a mid to long term company strategy. In some cases, and it seems largely unbeknownst to the breweries, they are severely hindering their liquidity options in the future and in certain cases, outright removing some.

Lastly, there will be more deals but we feel the near term sweet spot window is smaller than most think and shrinking with every transaction.

BBD: You are a long time Coloradoan, what is your take on marijuana legalization?

JB: I am sorry, can you repeat the question? I've been having issues with my short term memory.

Seriously speaking, taken at the highest level we really don't know what impact this will have on the beverage industry yet. Perhaps watching the trends in CO and WA will tell us something. It is hard to argue with the tax collection issue. The numbers still seem to be under debate but I think it is safe to say that the collection rate so far exceeded even optimistic expectations. Currently, it is still a cash only business and, because it is still illegal on a Federal level, banks can be prosecuted under the RICO Act from participating in the space. Other issues, such as access to legal counsel, are being addressed as well. At a time when our country is struggling financially, education is badly underfunded and most people that wanted to use marijuana were already doing it, legal or otherwise. It is hard to find real fault in that. I haven't seen an enormous rush of people using who weren't before. It's just legal, more highly controlled and taxed now.

Having said that, marijuana can be a dangerous drug, as can alcohol. There was a death in CO over the Spring Break when a 19 year old fell from a balcony after eating a THC edible. Apparently, there were no other intoxicants in his system. This is going to be a tough learning process and perhaps other states will benefit from the learnings here.

Lastly, we don't think it is coincidence that Washington or Colorado were the first two states to fully legalize recreational use and both states have robust craft beer scenes. You don't have to look very deep to find consumer overlap. And perhaps interestingly, both states have been critical swing states in the last two presidential elections.

BBD: What is the next big thing in beer?

JB: Lately, some significant portions of the malt beverage industry has been driven by products that most consumers would not call quote beer. We believe this trend will continue and morph with various other flavors, with a focus on easier drinking and lower alcohol offerings.

On the other end of the spectrum, quote IPA seems to be the new catch all phrase for all kinds of varietals from peach to white to rye...all "IPA". This gives brewers a tremendous amount of latitude to explore, isolate and accentuate various aromas and flavor profiles from certain hops and ingredients while directly tying it to a very robust category. So far, this has worked very well and we look for it to accelerate.

Lastly, I wish you would have asked about beverage instead of beer? I think history has shown us that those who view themselves in isolation of the surrounding world, be it beverage or global politics, find themselves out-of-touch and unable to compete effectively in a world that is changing very quickly. The rate at which spirits can innovate, execute and deliver new drinks straight to the hands of the consumer is much faster than it will ever be for beer just given the nature of the supply chain and on-premise creativity alone. If I were a brewer today competing in a world with a seemingly insatiable appetite for variety, upgrades and newness; I would be paying very close attention to this.

BBD: Any thoughts on the revised BA definition?

JB: I have a tremendous amount of respect for the BA. They do absolutely amazing work and I have very good friends who work there and/or serve on the Board or various committees. Having said that, I personally have always struggled with the definition for a few reasons. First, by creating a definition, you automatically alienate some, which I think loses sight of the larger factor that we need to unite as a whole industry and work better together. Secondly, they are attempting to define something they don't own and never have. "Craft" lives in the mind of the consumer and as anyone who has spent any amount of time with millennials will tell you, the very last thing they want to be told is what to believe, think or feel. Lastly, very few consumers even know what the BA is and many who do could care less about how they choose to define craft beer. I would personally rather see time and energy spent unifying and working more closely with our industry peers to rebuild what's been lost over several years of in-fighting and the globalization and consolidation of our very small world.

BBD: Brooklyn's Steve Hindy certainly got the wholesalers riled up last week with his op-ed in the New York Times. Any thoughts on the latest rhetoric surrounding franchise laws?

JB: As with most things, I can see both sides of the issue. Overall, it is very clear to me that the three-tier system has had an enormously positive impact on craft share growth. For years, and even today, the MillerCoors system was widely accessible to most craft brewers, offering them access to many accounts they simply would have never reached if left to their own devices. The old AB system becoming non-exclusive offered a huge leg up to many breweries in terms of distribution access.

On the supplier side, I can also see that as a craft brewer's business grows and evolves, a distributor choice made ten, or even five, years ago may not be the right one for the future and I feel brands should be able to address that for fair market value compensation. At the very least being able to self-distribute to prove your brand and grow it to a size that a wholesaler is comfortable investing in it, seems like a reasonable proposition to get started.

In some states craft brewers can sell liquor, wine and their own beer in their own pubs on-premise, sell package beer and/or growlers to go off-premise and self-distribute and still they seem to want more. If anything is really going to change, this has to be a reasonable give-and-take process that balances free market enterprise against consumer interests. It is hard to argue that what is good for the goose is not good for the gander. I really like Jim Koch's quote on the three-tier system that said, "we may not all get what we want but we get most of what we need". I think this is spot on. What we definitely do not need is to continue to air these debates in such public forums, turn against one another and further fuel in-fighting. As an industry, I feel we should expect more from ourselves.

Listen to the entire interview here: http://beernet.libsyn.com/beernet-radio-15-a-talk-with-jb-shireman


In a letter to the editor to the New York Times in response to Steve Hindy's op-ed last week, NBWA chief Craig Purser made the argument that state franchise laws actually "benefit consumers because the laws support an independent system that generates tremendous choice." Because franchise laws protect distributors from arbitrary termination from the big brewers, craft brewers "benefit because they can partner with independent distributors who invest in new brands that they market and sell to retailers across the country." Franchise laws "allow distributors to invest capital and labor in new brands, meeting the needs of today's consumer. These laws support an open, accountable and transparent marketplace where brewers of all sizes can compete and gain access to retailers, large and small. And within the highly competitive beer market, these laws allow for distribution agreements to be terminated for cause."


We also got a flood of response from distributors on this issue as well. Here is a small sampling:

"The red system jailbreak, and resulting competition for craft breweries to be acquired as part of the portfolio among well-capitalized distributors has been a significant contributor to the craft beer's growth. Any craft brewer who says his distribution situation today as compared to 10 years ago is worse either has his head in the sand, or has made very poor business decisions. All this said, I think eventually the craft brewers will get their way. As craft grows, their payroll and local influence will grow, and their legislative clout will. This is a relative certainty."

"It's clear craft brewers like franchise laws for big brewers but not themselves. The BA wants rights/freedoms for its members that would destroy the BA if BI members had those same freedoms. The volume trend difference between crafts and the bigs is nearly 20 pts and craft brewers are feeling aggrieved. Crafts would not have an economically viable route to market if they couldn't piggyback on the scale of large suppliers. They couldn't pay the freight."

"You're correct when you say it's about money, it's always about the money. But the other issue is that the BA and guys like Steve Hindy don't represent the average craft brewer, who love the access that we give their brands to the market. The BA represents the largest of the national craft suppliers that have much more in common with ABI and Miller/Coors than they do with a 10,000bbl. small craft brewer. The huge national craft brewers should just join the BI and leave the representation of the real craft brewers to the smaller guys. I bet a lot of the anti-distributor rhetoric would go away."

"I think you are correct in that this is an issue which reflects a maturing industry and category. Interestingly, wholesaler per unit profitability is dramatically higher than ten years ago (a result of pricing and mix shift) and craft growth has been extraordinary...so both have been served well but with any success comes the eventual tug-of-war over the division of a large and growing pie. Hopefully logic can prevail and the focus shifts more to continuing the growth of said pie vs the results of dividing it. There is certainly a fair plan to be negotiated."

And finally, a distributor altered the famous courtroom speech made by Jack Nicholson's character in A Few Good Men:

"Son, we live in a world that has walls, and those walls have to be guarded by men with guns. Who's gonna do it? You? You, Steve Hindy? I have a greater responsibility than you could possibly fathom. You weep for franchise laws, and you curse the wholesalers. You have that luxury. You have the luxury of not knowing what I know. That franchise laws, probably saved lives. And my existence, while grotesque and incomprehensible to you, saves lives. You don't want the truth because deep down in places you don't talk about at parties, you want me on that wall. You need me on that wall. We use words like freshness, franchise, and execution. We use these words as the backbone of a life spent defending something. You use them as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide, and then questions the manner in which I provide it. I would rather you just said thank you, and went on your way, Otherwise, I suggest you pick up a weapon, and stand a post. Either way, I don't give a damn what you think you are entitled to!"

And now for truly the last word, this comes from an actual craft brewer, a large craft brewer you've heard of:

"Rules like these frame the game that we're all involved in and it's dangerous to change the fundamental operating rules of any system. When you tinker with fundamental operating rules of any system, unintended consequences arise. Humans breathe oxygen, so it makes sense that if there were a little more oxygen in the atmosphere on earth then humans would be better off, right? So in the future a decision is made to increase the oxygen in the atmosphere by 2%. It'll make for a better operating environment, correct? But then the unintended consequences appear and it turns out the forest fires burn 10 times as hot as a result... Even if I didn't like the fact that government interferes in business relationships in this way (to the apparent advantage of one party), a lot of other considerations have been made and other structures built upon these particular rules."


COUNT IDAHO AS THE LATEST state to pass a branch bill.

WE CORRECTED the sell day calendar, thanks for your emails. See you in Denver.

Until tomorrow, Harry

"The secret of being a bore is to tell everything."

---------- Sell Day Calendar ----------
Today's Sell Day: 5
Sell days this month: 22
Sell days this month last year: 22
This month ends on a: Wed.
This month last year ended on a: Tues.
YTD sell days Over/Under: +0


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