Summary

This article discusses M&A activity in the spirits industry and how it applies to Becle (BCCLF). I previously reviewed the company’s operations and the raw material shortage it is facing.

Spirits Industry M&A Activity

The spirits industry is a fragmented industry. In 2016, the top 10 spirit companies have less than 20% market share. In 2015, in the United States alone, there were roughly 1,300 craft distilleries, of which 92% sold 5,258 cases or less. Due to the costs of building a distribution network and marketing a product, smaller distillers have difficulty increasing their sales past a certain level. 80% of the craft distillers have revenue less than USD1 million. A larger company can acquire successful smaller brands and push the smaller brands product through its existing distribution channel, and back it with a marketing budget to exponentially grow the brand’s sales.

In addition to fragmentation, the alcoholic beverage industry is mature, with global growth of 3% not much higher than world GDP growth. Slow growth usually leads to consolidation to improve efficiency and profitability. A mature, fragmented industry with economies of scale is an industry ripe for consolidation. Cheap debt further decreases the cost of acquisitions and increases multiples paid.

Acquisitions multiples can give us an idea of how industry executives value companies and can be used to value other companies in the industry. Within the tequila industry, there have been a few transactions with available valuation data.

The latest tequila acquisition was Bacardi’s acquisition of Patron for USD 5.1 billion in January 2018. The acquisition valued Patron at 7.5 times sales, 25.5 times EBITDA, and USD 1,962 per nine-liter case. In June 2017, Diageo (DEO) acquired Casamigos for USD 1 billion. Diageo valued Casamigos at 20 times sales and USD 8,000-11,000 per case, depending on the final payout. In November 2014, Diageo swapped its Irish whiskey brand Bushmills with Becle for Don Julio, a premium tequila brand. The acquisition valued the Don Julio at 7.7 times sales and USD 800 per case. Brown-Forman (BF.B) acquired El Jimador for USD 648 per case. Constellation Brands (STZ) acquired Casa Noble for USD 3,300 per case. Finally, Pernod Ricard (PDRDF) acquired Avion Spirits in 2014 for USD 5,700 per case. A valuation benchmark in the spirits industry is USD 1,000 per nine-liter case.

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Given the maturity of the overall spirits industry, acquirers are willing to pay higher multiples for companies in faster-growing segments. The tequila industry is one of the faster-growing industries with expected growth of mid-single digits as penetration grows in the rest of the world. There is also a trend toward premium tequilas. Since 2014, the overall tequila market grew by 22%, but premium segments and above grew at 64%. Looking at the acquisitions above, El Jimador is more geared toward the value segment. According to Tequila Matchmaker, El Jimador uses a diffuser in the production of its products. Large corporations use diffusers to efficiently mass-produce lower-quality products. Diffusers lower costs by cutting in half the amount of agave required to produce tequila. Premium products that compete on quality over price tend to use a more traditional process, as quality trumps production costs. Casamigos, Don Julio, Patron, and Avion Spirits are all premium brands.

Valuing Becle

In 2019, Becle sold 10.9 million nine-liter cases. Within the United States, 30% of Becle’s tequila volume is 100% agave tequila and 70% is 51% tequila or value tequila. In Mexico, 75% of tequila volume is 100% agave tequila and 25% is 51% tequila. The company did not provide information on the rest of the world, but the breakdown is probably similar to that of the United States. In Mexico, tequila is a well-known drink and consumers tend to drink a higher-quality product. Outside of Mexico, consumers are not as aware of tequila and are more likely to buy entry-level drinks rather than expensive premium drinks. Using the assumptions above, an estimated 7.5 million cases were 51% agave and 3.3 million cases were 100% agave tequila.

Using a volume-based valuation, Becle is valued under three different scenarios. Under the base case, 51% tequila volume is valued at USD 700 per nine-liter case. 100% tequila volume is valued at USD 1,500 per nine-liter case. Other alcoholic beverages are valued at USD 1,000 per nine-liter case, and non-alcoholic beverages add an additional 15% on top of the value of the tequila businesses and the other alcoholic beverage businesses. The 15% is close to the other non-alcoholic beverages percentage of total sales. The bear-case fair value per share is MXN66.86, 53% above the current share price.

Under the bear case, 51% tequila volume is valued at USD 600 per nine-liter case. 100% tequila volume is valued at USD 1,250 per nine-liter case. Other alcoholic beverages are valued at USD 750 per nine-liter case, and non-alcoholic beverages add an additional 10% on top of the value of the tequila businesses and the other alcoholic beverage businesses. The base-case fair value per share is MXN84.01, 93% above the current share price.

Under the bull case, 51% tequila volume is valued at USD 800 per nine-liter case. 100% tequila volume is valued at USD 1,750 per nine-liter case. Other alcoholic beverages are valued at USD 1,250 per nine-liter case, and non-alcoholic beverages add an additional 20% on top of the value of the tequila businesses and the other alcoholic beverage businesses. The bull-case fair value per share is MXN102.38, 135% above the current share price.

The table above illustrates several acquisitions in the spirits industry and the EV/EBITDA valuation of each deal. The average EBITDA multiple is 22 times, while the median is 17 times. Using an EBITDA multiple, Becle is valued under three scenarios. The bear case uses a 15 multiple on normalized earnings, the base case uses a 20 multiple on normalized earnings, and the bull case uses a 25 multiple on peak earnings. Under the bear case and the base case, the normalized EBITDA margin is 25%, while the peak EBITDA margin is 30%. All scenarios are based on 2019 sales.

Under the bear case, there is 30% downside from the current share price. The base case valuation is 6% below the current share price, and the bull case is 41% above the current share price.

Transaction multiples are a useful valuation tool, but to use it as the sole valuation method is speculative, as there isn’t a 100% chance of a company being acquired. The Beckmann family are the largest shareholders, holding 86.49% of the shares outstanding, and they must want to sell the company. Diageo held discussions with the Beckmann family to acquire the company, but it ended with Diageo getting the Don Julio brand in exchange for the Bushmill brand. There is speculation that Campari moving headquarters will free up capital for acquisitions, and that Becle is a potential target. Looking at the transaction history, Diageo is much more likely to pay a higher premium than Campari. Campari has been fairly disciplined, not paying more than 15 times EBITDA. Diageo paid 20 times sales for Casamigos and 38 times EBITDA for United Spirits. Given Diageo’s willingness to pay high multiples, if the Beckmann family were unable to make a deal with Diageo, it may have difficulty making a deal with the more disciplined Campari.

Given the probability of an acquisition is not 100%, the best way to use a transaction-based valuation methodology is to apply a weight based on your probability of acquisition. The remaining weight should be based on earnings-based valuation.

For Becle, an EBITDA multiple valuation is probably a more appropriate acquisition than a volume-based multiple. A company that acquires Becle is not going to see a tremendous increase in earnings from acquiring the company and pushing its product through its infrastructure, as Becle has global distribution already. There may be some synergies, but Becle’s earnings should be close to the earnings for the acquirer. The acquirer may be able to sell off Becle’s US distribution assets (the 9th largest in the US), but there is not going to be a significant change in earnings to the acquirer. A volume-based valuation is more appropriate for a company whose earnings are depressed and are not an accurate reflection of what the acquirer can earn from the company. There is also a lot more volatility in volume-based valuation.

The probability of Becle continuing as a separate entity whose value is determined by its earnings is 70%. The probability of it being acquired is 30%. The 30% chance of acquisition is split evenly between an EBITDA-based valuation and a volume-based valuation. The methodology behind the earnings-based valuation is illustrated in my initial Becle report.

When adding transaction base valuation, Becle’s base case fair value per share is MXN38.36, 12% below the current share price. The bear case fair value per share is MXN26.35, 40% below the current share price. The bull case fair value per share is MXN46.02, 30% above the current share price.

When transaction multiples are added to a earnings-based valuation, Becle is more attractive, but valuations still do not provide a significant margin of safety.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.