Brewdog want to sell you great beer. But they have little interest in delivering you a financial return on your investment.
Whilst the use of such colourful language is a first on AltFi, and not a first that we are very comfortable with, we wanted to explore the recent proclamation of record breaking crowdfunded brewer Brewdog. They titled their recent comments thus…
In doing so the company have in fact delivered…
As always when appraising Brewdog I cannot disguise my admiration for a huge amount of what they are doing. The proclamation they have made is in response to a recent wave of consolidation in the craft beer sector. Specifically a wave of acquisitions of small independents by big multi-national brewing conglomerates. Brewdog passionately, and entirely correctly, point out that all the signs suggest that these brands will never be the same again. The result of this is that connoisseur beer consumers will lose out as the product on offer diminishes in quality. In response to this Brewdog have made a commitment to remain independent. In fact they have gone as far as amending their articles of association such that any proposed take-over by “a monolithic purveyor of bland industrial beer” can be rejected by the board.
All of this should be music to the ears of Brewdog’s customers. They can be confident that a new owner, who may be more powerfully motivated by profit than by the customer experience, will not compromise the quality product that they enjoy. Indeed they can look forward to the ongoing independence of their favorite purveyor of beer that should assure them of the continued quality of the product as well as a continuation of the uniquely maverick company culture which so effectively fuels the brand.
The problem is that all of this is diametrically opposed to the interests of shareholders. Before we explore why, we should first remind ourselves how Brewdog has been funded. Showing impressive initiative the company launched their own £50m equity crowdfund raise. As explored in a previous Crowdview this raise has been explicitly targeted at the company’s beer drinking customers and includes a range of discounts and other incentives. Given their explicit appeal to their own customer base their prospectus was, in my view, unreasonably opaque. To investors who were able to do the analysis, and identify some well hidden but extremely important clauses, they would have identified an extremely ambitious valuation of £305m. This for a company with reported revenues of just £30m in 2014.
Brewdog’s recent proclamation, and associated amendment to their articles, should make concerning reading for their shareholders for two reasons. Firstly it removes one of the possible, arguably the most possible, opportunity for investors to make a return on their investment. Secondly it highlights the increasing competitive threats in the craft beer segment.
So let’s start with the removal of the obvious exit. As a reminder Brewdog shares are not tradeable and have no dividend policy. As such one of the most realistic prospects of the investor making a return is via a sale of the company. This opportunity has now been removed. Horrifyingly final say on this decision has been claimed by the board at the expense of their shareholders. This completely contravenes all notions of good governance which are based on the principal that the board is appointed to run the company in the interests of shareholders. Ordinarily all critical decisions such as whether to accept or reject a take-over approach are decided via consultation with the shareholders – usually in the form of a shareholder vote. But not at Brewdog. Shareholders will henceforth have no say in this critically important matter.
This does not preclude the investors making a return. The company could continue to grow strongly to the point where it is in a position to IPO. This would offer the original crowdfunding investors an opportunity to exit on the quoted market. However as we will go on to explore there are other factors that make this route highly uncertain.
And so to the competitive landscape. Brewdog’s impassioned blog post lists a series of independent craft brewers who have changed, to the detriment of consumers, after a recent acquisition. This list in itself highlights a number of alarming issues for investors. Firstly the sheer number of craft brewers on the list highlights the huge competition developing in this segment. There is no disputing the reality that more competition results in a poorer profit outlook for Brewdog. In simple terms it means more companies chasing the segment resulting in a lower share for all participants and/or a more aggressive pricing environment. This in turn will likely result in one, other, or both of less revenues and lower margins. Two factors could mitigate this reality. First the segment could grow at the expense of bland multi-national beer. This is possible but unlikely to be of a scale sufficient to improve the likelihood that shareholders make a profit. Second Brewdog could gain share within the segment. Brewdog would argue that as many of these craft brewers compromise their independence craft beer drinkers will desert them. However the reality of this is likely to fall well short of any theory. The reason big brewers have become very big is because distribution is critical. And scale brings unequivocal advantages to distribution. Big brewers can more efficiently reach more sales outlets. If a craft beer aficionado finds himself in a bar he or she likely buys whichever craft beer is on offer even if the brand in question has compromised its craft origins and principles. He or she is unlikely to walk up the street, or to the next village / town / city, to find a pub selling a craft beer brand that is true to its principles. Not to mention the fact that the multi national brewers distribution cost advantages probably allow them to undercut the ‘genuine’ craft brand.
Equally alarming to an investor is the realization that this consolidation door may close. Multi-nationals might not be in the market for craft brewers forever. And whilst they are Brewdog is refusing to put itself up for sale. That guarantees that there will be a range of craft brands, blessed with the powerful distribution of their new multi-national owners, out there to compete. And if Brewdog ever do have an epiphany, possibly forced by unpleasant circumstances, and decide that the best route to maximizing shareholder value is a trade sale, the thirst to acquire craft brands may have already been quenched.
Shareholder value? Ah yes. That central tenet of what investors with a financial motivation should want management to seek to deliver. What further compounds the problem for Brewdog investors is that they have invested at an extreme valuation. As such to achieve a return they need the company to deliver not far short of perfect execution. This requires that management are mindful of profitability, and are open to all opportunities to maximize shareholder value. And that brings us to the crux of the issue. It is perfectly reasonable, indeed admirable, for Brewdog to have such passion in delivering the best possible product to their customers. But this aim cannot be reconciled with maximizing returns to investors. And the problem is made all the more intractable when your investors have bought into a stretched valuation. If Brewdog had been explicit that the business would not be run to maximize value to shareholders then they should have set a valuation to match. Rather than the 10x revenue multiple, they could have gone for something more modest. Effectively the bargain would be…
’You guys fund our growth. It will allow us to sell you more of the kind of beer that you enjoy. We aren’t going to worry much about maximizing profits or delivering you a return, but to compensate you for that you can buy in on the cheap’.
Instead, with small quoted peers trading on around 0.5x sales, rather than choose a reasonable valuation, they chose a horrifically expensive one. Not 1x sales. Not 10x. But 30x 2014 sales. i.e. 60x the valuation of small quoted peers!
Now if Brewdog had not built an investor base of customers then the cynical could make the case that they have pulled off something quite clever. An extremely Machiavellian capitalist could argue that if their investor had been a faceless fund then they had raised the finance to allow them to make exceptional beer for their customers without ever having to incur the inconvenience of delivering value to investors. The fund would come to be disappointed but more fool them. But the added issue here is that their fundraise has been explicitly targeted at their customers. This leaves Brewdog vulnerable to upsetting both constituencies. Now perhaps these customers have such loyalty to the brand and product that they are not concerned that their investment might never deliver a return. But it is also possible that this experiment in combining customers with investors, and so clearly favoring the interests of the former over the latter, results in a realisation amongst even the most pickled Brewdog fan. As investors they have been ripped off! As AltFi Investor has been at pains to remind the crowd – if an equity investment does not succeed it normally means that worse than not seeing a return, the investor will lose their entire stake. Could this realisation give even the most ardent Brewdog customer/investor a headache?
The simple reality is that the interests of consumers and shareholders are rarely aligned. In this case they are diametrically opposed. Whilst Brewdog’s customers can celebrate the stand that Brewdog are taking for craft beer their investors should reappraise the likelihood of their investment ever delivering a return. In fact those investor/customers ought to ensure they make the most of their discounts. Cheers!