Related Diversification Constellation and Ballast Point

Constellation Brands is an alcoholic beverage company, traded under the symbol STZ on the New York Stock Exchange. The company had revenues of just over $6 billion in the 2014 fiscal year and a net income of $839 million (MSN Moneycentral, 2015). While revenues were up significantly over the prior year, profits were down by more than 50%. Until recently, Constellation was an importer/marketer of alcoholic beverages, but the company has recently entered into the production side of the business. As an example, Constellation has built its beer business as the importer of mainstream global brands such as Corona, Tsingtao and several smaller Mexican brands. The company did not own any beer production facilities, but recently announced the purchase of Ballast Point, a microbrewery in San Diego (Kaplan, 2015). This purchases official makes Constellation a brewing company for the first time. The deal is reported to be in the $1 billion range, a large number in light of the valuation on Ballast Point closer to $150 million when it filed an S-1 for an IPO in October, 2015 (Ballast Point Form S-1, 2015). Net asset value of Ballast Point was only $17.9 million according to the S-1. With such a high cost, there needs to be a strong strategic fit for Constellation, something that will be explored in this paper.

Rationale for Acquisitions

When a company acquires another business, it must inherently pay more than the market value of that company. This is because without a premium, there is no incentive for the existing owners of a business to sell to any one particular buyer. Thus, the buyer has to pay a premium. In this instance, a company that was set to have an IPO in 2016 somewhere in the $150 million range was purchased at a phenomenal premium over market value, an estimated 6.67 times the project IPO value, and 109 times the acquired company's 2015 net income and 70 times EBITDA. Another recent industry acquisition was that of Lagunitas, also for around $1 billion, but Lagunitas was the 8th-largest craft brewer by volume in the U.S., where Ballast Point was the 31st-largest (Brewer's Association, 2015).

To justify the premium, the acquiring company must be able to extract more value from the purchased entity than that company could extract on its own. The underlying principle here is that the sum of the parts is going to be worth more than the two parts would be individually. Thus, the acquiring firm must have assets, competencies and attributes that will add value to the acquired entity, in sufficient quantity as to justify the premium paid. The reality is that most deals fail to deliver the sorts of synergies that justify the premium (Bain, 2015). The steeper the premium, the less likely the company is going to extract those synergies.

Constellation's Business

Constellation is primarily an importer and marketer. The company entered into production in the wine business in the 2000s by purchasing a number of wineries. Constellation is now the world's largest winemaker, owning brands such as Robert Mondavi, Jackson-Triggs, Rex Goliath, Clos du Bois, Kim Crawford and several others (Constellation Annual Report 2015). The company also has some spirit holdings, mainly secondary brands such as SVEDKA Vodka and Black Velvet Canadian Whisky.

The company's beer business is based almost entirely in the United States. It does not produce its major beer brands, but rather owns the U.S. rights to those brands. Most of them are from Grupo Modelo, which is owned by Anheuser-Busch InBev. AB InBev was compelled to vacate Modelo brands in the U.S. as part of an antitrust agreement (U.S. Department of Justice, 2013). Constellation is thus the #3 player in the U.S. beer business by market share, primarily on the strength of the Modelo brands and Tsingtao. These products are positioned as imported beers, with Corona and Tsingtao positioned as premium imports. This positioning is essentially a price point, and other Mexican brands fill different price points within the company's portfolio. Constellation has nationwide distribution of these beers.

Constellation can derive value for any of its holdings through its sales and distribution channels. Corona is ubiquitous, and many of the company's wine products also have saturation-level distribution. This is one of the main assets that Constellation can use to extract value from the Ballast Point acquisition. Constellation, prior to this acquisition, had never owned a microbrewery before, or even distributed one. Craft beer is now a major niche in the U.S. brewing industry, with an 11% share in 2014 by volume and 19.3% by dollars. The imported beer industry, in which Constellation competes, has a 14.9% share by volume, which likely equates to around a similar dollar share as craft beer, given that most imported trade at premium prices to domestic (Brewer's Association, 2015, 2). Imported beer grew at 6.9% by volume, but craft beer grew at 17.6% by volume.

Ballast Point

Ballast Point is a rapidly-growing microbrewery in San Diego. According to the company's S-1, the company brewed 122,890 barrels of beer in 2014, an increase of 72.8% over the prior year. This represents a 0.5% share of the national craft beer market. The company has already installed what it believes is capacity to handle expected growth for the next few years, so that would have been built into the purchase price -- Constellation paid for a brewery much bigger than the current output suggests. Revenue in the first half of 2015 was more than double revenue for the same period in 2014, and the 2014 fiscal year saw revenue double that of 2013. This growth, however, should not be considered sustainable. The company's S-1 notes that most of its growth comes from the Sculpin brand, and its extensions. These are highly-regarded beers, with Sculpin rated in the 100th percentile of all beers globally on Ratebeer.com, and Grapefruit Sculpin ranked in the 99th. In contrast, the highest-regarded among Constellation's import brands is Negro Modelo, in the 18th percentile. This highlights just how different Ballast Point is with respect to Constellation's current business -- still alcohol, but a very different category, one in which the company has never competed. Ballast Point also has a craft distillery business as well.

Analysis

The key factor to Constellation's diversification into the craft beer segment will be its distribution networks. The rapid growth of Ballast Point, according to the S-1, is based mostly on California. Constellation will give the brand access to all 50 U.S. states, plus 100 other countries around the world where Constellation sells its products. The company has experience marketing premium beer -- the positioning of Corona in 100 countries around the world. If it can successfully apply its distribution network and sales expertise to the Ballast Point brand, it may yet recoup the premium paid.