Constellation Brands' Acquisition of Ballast Point Analyzed

Introduction

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 fiscal year 2014 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 operated primarily as an importer and marketer of alcoholic beverages, but has since moved into the production side of the business. In beer, for example, Constellation built its portfolio as the importer of mainstream global brands such as Corona, Tsingtao, and several smaller Mexican labels. The company did not own any beer production facilities until it announced the purchase of Ballast Point, a microbrewery based in San Diego (Kaplan, 2015). This purchase officially makes Constellation a brewing company for the first time.

The deal is reported to be approximately $1 billion — a remarkable figure given that Ballast Point's valuation was closer to $150 million when it filed an S-1 for an IPO in October 2015 (Ballast Point Form S-1, 2015). The net asset value of Ballast Point at the time was only $17.9 million according to the S-1. Given such a steep acquisition cost, a strong strategic fit is essential to justify the premium — and that question is the central focus of this paper.

Rationale for Acquisitions

When a company acquires another business, it must inherently pay more than the market value of that company. Without a premium, there is no incentive for existing owners to sell to any one particular buyer. In this instance, a company that was set to IPO in 2016 at roughly $150 million was purchased at an estimated 6.67 times its projected IPO value, 109 times its 2015 net income, and 70 times its EBITDA. For context, another recent industry acquisition — that of Lagunitas, also for around $1 billion — involved the 8th-largest craft brewer by volume in the United States, whereas Ballast Point ranked 31st (Brewer's Association, 2015).

To justify any such premium, the acquiring company must be able to extract more value from the purchased entity than that entity could generate on its own. The underlying principle is that the combined whole will be worth more than the two parts would be separately. Accordingly, the acquiring firm must possess assets, competencies, and capabilities that can add value to the acquired entity in sufficient quantity to justify what was paid. In reality, most deals fail to deliver the kinds of synergies that justify the premium (Bain, 2015). The steeper the premium, the less likely the acquirer is to recoup it through synergy gains.

Constellation's Business

Constellation is primarily an importer and marketer. The company entered production in the wine segment during the 2000s by acquiring a number of wineries, and it is now the world's largest winemaker, with brands including Robert Mondavi, Jackson-Triggs, Rex Goliath, Clos du Bois, and Kim Crawford, among others (Constellation Annual Report, 2015). The company also holds some spirits assets, mainly secondary brands such as SVEDKA Vodka and Black Velvet Canadian Whisky.

Constellation's beer business is concentrated almost entirely in the United States. The company does not produce its major beer brands but instead owns the U.S. rights to them. Most of these brands originate from Grupo Modelo, which is owned by Anheuser-Busch InBev. AB InBev was compelled to divest Modelo brands in the U.S. as part of an antitrust settlement (U.S. Department of Justice, 2013). As a result, Constellation became the third-largest player in the U.S. beer market by share, driven primarily by the Modelo family of brands and Tsingtao. These products are positioned as imported beers, with Corona and Tsingtao occupying the premium import tier, while other Mexican brands fill different price points within the portfolio. Constellation distributes these beers nationwide.

The company's most transferable asset to any new acquisition is its sales and distribution infrastructure. Corona enjoys ubiquitous national presence, and many of Constellation's wine products also achieve saturation-level distribution. This network represents the primary lever through which Constellation can extract value from the Ballast Point acquisition. Prior to this deal, Constellation had never owned or distributed a craft brewery. Craft beer has grown into a major niche within the U.S. brewing industry, capturing an 11% share by volume and 19.3% by dollar value in 2014. Imported beer — Constellation's core segment — held a 14.9% volume share, with a comparable dollar share given premium pricing. Imported beer volume grew at 6.9%, while craft beer volume grew at 17.6% (Brewer's Association, 2015, 2).

Conclusion

It also needs to be aware that since Ballast Point is no longer considered a microbrewery under Constellation's ownership, there is a high risk that consumers will substitute alternate products. Constellation's ability to bring the product to audiences outside of the craft beer niche will be essential to the success of this diversification, but the company's experience in doing just this gives it a fighting chance of getting fair value for this acquisition. The move is a good strategic fit — Constellation needed a presence in the rapidly growing craft beer industry — and if there is a primary drawback, it lies with the valuation rather than the strategic rationale.