New CBA, A-B Agreement Includes Potential Acquisition

FILED AUGUST 24, 2016

Dear Client:

Craft Brew Alliance brass revealed all the financial details of a new and enhanced commercial agreement with Anheuser-Busch InBev on an analyst call last night. CBA chief Andy Thomas walked listeners through the "four pillars" of the deal and tallied up the "quantifiable financial benefits" of each.

But most interesting to BBD were "guardrails" outlined in the event that A-B were to make a play for CBA. They read like a prenup, particularly as it almost seems like ABI and CBA are engaged to be married, after having shacked up for awhile (if that's how you view A-B's years-long 32% stake in CBA).

Ed. note: It will really help to read the initial bones of the new commercial agreement first, which we covered in yesterday's CBD (see CBD 08-23-2016).

WHAT DOES THE FUTURE HOLD? ABI and CBA both agree that, for the time being, collaborative independence is best for both parties. However, the two realize that that may not be the case further on down the road. So Andy said they've put "some guardrails" in place and "a framework for options that could develop."

Both parties feel they "should have more skin in the game" over the next three years and "some level of protection for their share and stakeholders in the event that their individual interests diverge," Andy said.

ABI ON THE HOOK UNLESS... So ABI has committed to three key agreements over the next three years and is obligated to carry them out unless they make a qualifying offer and CBA rejects it.

Those agreements include an extended master distribution deal, plus a new contract arrangement for CBA to brew 300,000 barrels worth at A-B facilities, as well as a new international distribution deal; more below.

A QUALIFYING OFFER COMES INTO PLAY. "A qualifying offer is defined as an offer to acquire CBA for a minimum price of $22 per share during the first 12 months of the agreement," Andy said. The minimum bumps up to $23.25 per share if ABI makes an offer in the second year of the agreement. If ABI decides to make an offer in the "third year of the agreement or after" it would be looking at minimum of $24.50 per share.

If CBA turns down a qualifying offer or shifts control to someone other than ABI in the next three years, then ABI could "reconsider" any of the new agreements.

A $20 MILLION INCENTIVE IN PLAY. Here's where things start reading like a prenup: If ABI doesn't extend a qualifying offer by 2019, then CBA would be entitled to a $20 million dollar international incentive (more below) and ABI would be stuck with these new agreements.

For ABI's protection, it has the right to terminate the international distribution agreement if CBA were to reject the qualifying offer, in which case CBA would also forfeit the $20 million international incentive payment.

Further, CBA could continue to operate independently or undergo a change in control if no qualifying offer is extended by 2019. In either event ABI would still be required to respect to the terms of all agreements.

So the first quantifiable financial benefit for CBA is then a $20 million international incentive payment payable in 2019 "or the less easy to quantify benefit of knowing that any offer" made by ABI must meet the aforementioned minimums. Technical, we know.

AMENDING THE MDA. Another pillar of the new commercial arrangement is the amended master distributor agreement. Under this agreement, ABI will remain CBA's master distributor through 2028 and distribution fees will stay put at 25 cents per case through that entire stretch. CBA faced a "fee cliff," which would've tripled the cost to 75 cents, when the old deal expired in 2018.

$6 MILL OF SAVINGS. "Assuming volumes in excess of today's approximately 11 million equivalent cases, this amendment represents an estimated savings to CBA of nearly $6 million per year beginning in 2019 and escalating with volume growth through 2028," Andy said. So there's quantifiable financial benefit number two (or whatever order you want to count it) for CBA.

WHY WOULD ABI AGREE TO THAT? Starting in 2019, Andy said, CBA has committed itself "to a reinvestment of half of these savings into the Kona Plus strategy in key strategic markets."

ANOTHER $3 MILL SAVINGS IN CONTRACT BREWS. The next pillar deals with the contract brewing agreement, which gives CBA the opportunity to brew up to 300,000 barrels within ABI's network "at a cost savings of no less than $10 per barrel on an aggregate basis as compared to CBA's current cost basis." CBA stands to save $3 million per year once this agreement is "fully operationalized," bringing us to quantifiable financial benefit number three.

Andy said they've already started to "identify brewers and breweries involved" and "anticipate up to 18 months before commencing to realize the full-annualized benefit."

Additionally, both CBA and ABI have committed to exploring further supply chain synergies.

MORE ON THAT INTRICATE INTERNATIONAL DEAL. The last pillar is the new international distributor agreement. CBA has awarded ABI with the exclusive right to distribute its portfolio in all countries not currently covered by existing agreements with its current export partner, Craft Can Travel.

INTERNATIONAL ROYALTY STRUCTURE. "CBA will manage the exported products from the US and ABI will pay CBA an international distribution royalty fee between $30-$40 per barrel in addition to ABI's payment of production and material costs as well as reimbursement of CBA's out of pocket shipping and export costs," said Andy.

BUT FIXED PAYMENTS COME FIRST. Knowing these are uncharted waters, Andy said they've "agreed to a series of fixed incremental international payments through 2018 before moving to the straight per barrel royalty structure in 2019."

CBA will receive a fixed international payment above and beyond the normal proceeds from their ABI related international business of $3 million in 2016; $5 million for 2017; and $6 million dollars for 2018. As an added incentive for international volume development, ABI will pay CBA a further $20 million international incentive payment in 2019. And there ladies and gentleman is quantifiable financial benefit number four.

GREG KOCH: TOO LATE TO GET INTO THE BEER BUSINESS

What's this? Greg Koch is starting to make a lot of business sense. In fact, the co-founder of Stone Brewing thought it was too late to start a craft brewery back in 1996 when they started.

Greg told Fox News that when he started, he didn't anticipate getting much outside San Diego, much less going global. "I didn't think it was a ghost of a possibility. I honestly believed we were starting too late to ever make a mark. It was our passion to be a part of the craft brewing revolution."

DON'T START A BREWERY. Imagine starting a brewery now. "I would counsel someone not to get into the business today … Boom times are historically not a good time to start a business. Right now we're in a boom time. If you're able to pull back and look at this soberly, you can see the patterns in just about everything. When do you want to buy real estate, in a boom time? Of course not, you want to buy in a lean time."

30k BREWERS IN U.S.? The Brewers Association's Julia Herz disagrees, saying we could support 30k super-local breweries according to history back in the late 1800s. "If you had the same number of breweries per person, we could support more than 30,000. I call it Craft Beer 3.0. The big boys (mega-brewers) want in and are presenting their brands as craft beer and buying up craft brewers."

(Ed. Note: Of course, per capita consumption of alcohol, particularly of beer before Prohibition made cocktails popular, was much higher back then).

MORE ON STONE'S TRUE CRAFT. Stone's True Craft Initiative, the fund Stone helped create to invest in up-and-coming breweries, is not about helping startups. Says Greg: "We're focused on brewers making 25,000 barrels or more." That's about the smartest thing I've heard from a brewery exec all summer.

Until tomorrow, Harry

"To know the road ahead, ask those coming back."
- Chinese Proverb

2017 BEER SUMMIT EARLY BIRD PRICING - The Beer Industry Summit will be held at the Hotel del Coronado in San Diego Jan 29-30, 2017. Stay an extra day and get special discount pricing to attend the Wine & Spirits Daily Summit on January 31. Register and learn more here.

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