A comprehensive discussion and examining of BEAM, INC.’s valuation compared to the acquisition price paid by Suntory Holdings Limited

Introduction
Our assessment of the Suntory purchase price for BEAM begins with a background of the firm and the distilled spirits industry. Next, we will move on to a SWOT analysis of BEAM’s position in the industry before diving into the firm’s valuation via three widely used methods for valuing equities.
Finally, we will evaluate the value received for Suntory shareholders given the $83.50 paid for each share of BEAM’s stock. It is interesting to note that the merger was announced on 1/12/14 and closed while we were doing our research on 4/30/14.
History of the company
BEAM is a spirits company that makes and sells branded distilled spirits. The key products of the company include bourbon whiskey, Scotch whiskey, Canadian whiskey, vodka, cognac, rum, cordials, and ready-to-drink pre-mixed cocktails.
The beginning of BEAM’s history can be traced back to the first barrel of whiskey that Jacob
Beam sold in 1795, he named the small company Jim Beam Bourbon. Other brands that BEAM holds have similar, humble beginnings. In 1815, after five years distilling whiskey in Islay, the Johnstons developed the Laphroaig whiskey. Hiram Walker built a mill and distillery on the Canadian side of the
Detroit River in 1856. After that, in 1863
，
Teacher's Highland Cream became an established spirits brand, and its business expanded rapidly. By the early 1990s, American Brands evolved into a series of businesses, and its annual sales had reached $15 billion. In 1968, American Brands purchased the James
B. Beam Distilling Company. In 1987, James B. Beam Distilling Company purchased National
Distillers, and the company was renamed as Jim Beam Brands Company. In 1994, the company got rid
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of some of the businesses and focused solely on the expanding categories of home and hardware, office products, gold equipment and distilled spirits. In 1997, the company changed its name to Fortune
Brands.
Fortune Brands bought the kitchen and bathroom cabinetmaker Schrock from Electrolux in 1998.
In 1999, the company relocated its headquarters to Lincolnshire, Illinois. After they moved their headquarters, Fortune Brands established a wine and sales and distribution joint venture with Maxxium
Worldwide. In 1999, the company purchased Boone International and NHB Group. Fortune Brands acquired SBR (now Simonton Holdings) in 2006, and was renamed as Beam Global Spirits & Wine, Inc. to reflect its global position. By the end of 2007, Fortune brands sold its US wine businesses to
Constellation Brands. In 2008, Fortune Brands established a new international distribution alliance with the Edingtong Group to expand the company’s business operations across 24 other countries. In 2011,
Beam Global Spirits & Wine acquired the Skinnygirl spirits brand. Pursuant to its business separation plan, the company completed the sale of the Acushnet Company golf business for $1.225 billion in cash.
After the company spun-off into an independent company, Fortune Brands began operating under the new name Beam Inc. BEAM made acquisitions of Pinnacle Vodka and Calico Jack rum brands and certain related assets in June 2012, this practice would strengthen the company’s presence in the vodka category. In September 2012, the company decided to increase its distribution relationship with Suntory, which occupied the majority of the whiskey market in Japan. In January 2013, BEAM sold a collection of brands, including related inventory, to Luxco. BEAM introduced Skinnygirl Mojito, Skinnygirl
Swwet’n Tart Grapefruit Margarita, Skinnygirl White Cherry Vodka and Skinnygirl moscato to its cocktails product line in April 2013. Pinnacle Vodka introduced its new flavor innovation in June 2013 and EFFEN Vodka introduced EFFEN Salted Caramel Vodka, an extension of the brand’s flavors. Also in August 2013, BEAM announced its plans to partner with a third-party logistics provider in the
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establishment of a new 600,000 square foot distribution center in the Frankfurt regional area of
Kentucky.
Industry Analysis
Distilled spirits are fermented and distilled beverage alcohol products excluding wine and beer.
The distilled spirits industry in the United States contributes over $110 billion in total to the economic activity annually, and constitutes around 30% of the total activities of all alcoholic beverages. The industry as a whole employs 1.2 million in the production, distribution and sale of spirits in the United
States. The tax rate of distilled spirits is one of the highest consumer product in the United States, which is more than double of the tax rate of beer and triple that of wine. The top competitors of BEAM are the following: Pernod Ricard SA, Brown-Forman Corporation, Bacardi Limited, Constellation Brands Inc.,
Davide Campari Milano-S.p.A. Remy Cointreau S.A. Heaven Hill Distilleries, Inc. Diageo plc.
Key factors that contribute to the steady growth of the spirits industry include a growing middle classes with disposable income, taste for American heritage, and cocktail culture’s expansion around globe. The Spirits industry is adapting rapidly to make spirits an affordable luxury and increase the diversity of flavors. This serves to captivate existing consumers as well as attract new consumers.
Looking at the forward trends of spirits industry, small distillers grew rapidly, from 92 in 2010 to over
400 in 2014. This reflects consumer interest in heritage, uniqueness and premiumization. In recent periods, there has been increased recognition of science regarding potential health benefits associated with moderate drinking. A CDC study has shown that moderate drinking is one of the four key lifestyle behaviors that help people live longer.
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Business Strategy
BEAM has established a Vision into Action strategy to enhance the competitiveness of the company. The strategy includes: profitably building the core distilled spirits brands to drive sales and earnings growth and enhance returns on a long-term basis; and enhance the brand advantages by creating famous brands, building winning markets and fueling our growth.
To create famous brands, BEAM builds core brand equities, mainly for Power Brands and Rising
Stars. To strengthen brands and their connection with consumers, BEAM invests in television advertising, digital and print media, and local in-store marketing. BEAM also seeks to create profitable growth through product innovation, speed to market, and synergy-driven acquisitions.
To build winning markets through effective distribution and enhancement of power brands,
BEAM communicates and collaborates with key strategy partners, such as Coca-Cola Amatil in
Australia and the Edrington Group in various global markets throughout the world. These alliances complement BEAM’s distribution in other key markets, including the US sales organization and performance-based contracts with partners such as Southern Wine & Spirits in the US and the companyowned distribution in markets such as Germany and India.
BEAM seeks to fuel growth by perfecting its supply chains, designing products to maximize value for consumers, exercising disciplined capital and cost management, and building an effective and efficient organization.
BEAM is also dedicated to enhance shareholder's value by making careful acquisitions and divestitures, joint ventures, alliances, and other strategic initiatives. For the long term, BEAM is reviewing its portfolio of brands and evaluate options to increase shareholder value; the company has not predicted whether or when to use particular strategies based on the results of this review.
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Strengths
BEAM benefits from a very strong product portfolio. As stated, BEAM offers whiskey, tequila,
Scotch whiskey, Canadian whiskey, vodka, cognac, rum, cordials, and ready-to-drink pre-mixed cocktails. The company has further strengthened its product portfolio through a series of acquisitions, including its acquisitions in the fast-growing categories of ready-to-serve cocktails, Irish whiskey and premium vodka. The second factor of strength is strong brand equity that contributes to the revenue growth. BEAM breaks its brand portfolio into Power Brands, Rising Stars, Local Jewels and Value
Creators. Power Brands and Rising Stars are the premium category brands, whereas local jewels and value creators mostly serve the regional markets. To further strengthen the market position of its brands, the company entered into various agreements in the recent past. For instance, BEAM's distribution partnership with Coca-Cola Amatil in Australia positioned the Jim Beam brand as the number one spirit in the largest export market for Bourbon. A third point of strength is their strong advertising and marketing initiatives that help increase sales. BEAM makes considerable investments in advertising and marketing to strengthen its brands and to make a connection with its consumers.
Weaknesses
BEAM excessively depends on the North American market. BEAM derived more than half of its revenues from the North America market. This feature limits its growth opportunities outside the region.
Asides from this geographic concentration, BEAM also has steady customer concentration. BEAM’s top three customers account for 40% of total net sales. High concentration of customers reduces the bargaining power of the company, and if any of the three key customers disappear for any reason, the company will suffer a serious negative effect.
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Opportunities
BEAM is confronted with some important opportunities at this time. The global spirits market has experienced an upward trend the past few years. By 2016, the global spirits market is expected to reach $389.8 billion, an increase of 25% since 2011. By 2016, the market consumption volume is expected to have a volume of 20,189 million liters, an increase of 11.2% since 2011. Besides the spread of spirits market, the wine market is also expanding gradually. By 2017, the global wine market value is expected to reach $318.3 billion, an increase of 18.1% since 2012. There is also a growing market U.S. market for white whiskey that BEAM could capitalize on.
Threats
BEAM also faces several threats. First, intense competition in the spirit industry could threaten
BEAM's market share. BEAM competes with companies in several factors, such as product quality, brand strength, customer service and price. Many of BEAM's competitors are making investments just as BEAM does; they expand their product categories and increase production size, while using smart marketing strategy. BEAM also faces stringent regulations in US and some other countries. For instance, the Alcohol and Tobacco Tax and Trade Bureau of the US Treasury Department regulates the US spirits industry with respect to production, blending, bottling, sales advertising and transportation of industry products. The company also is subject to environment laws and regulations in the US and internationally. In the US, the regulations include the Clean Air Act, the Clean Water Act, and
Superfund, which impose various restrictions on companies. BEAM also faces change in taxes and incentives; companies like BEAM could be affected by any increase in federal, state and local excise taxes, particularly if the tax levels increase substantially relative for beer and wine.
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Now that we have discussed the background information for BEAM, we will get into answering the question “did Suntory pay too much?” We will use three different valuations in order to arrive at a consensus valuation. If our consensus valuation varies from the purchase price, we will use the residual operating income valuation method to estimate the residual income from operating income needed to justify the Suntory purchase price. But first, we will look at how we arrived at the various discount rates used to calculate present values for our three valuation methods.
Discount Rate Calculation
In order to calculate the weighted average cost of capital for BEAM, we needed to calculate the cost of equity and debt capital for the firm along with an estimated tax rate, and a target weighting for debt and equity. Please see Table 1 for a complete listing of our discount rate calculations. For the cost of equity capital we used a pre-merger announcement beta listed on Morningstar.com. Since BEAM is a consumer goods company the .76 beta is not a surprise as the stocks in this category are usually less volatile than the overall market. For the market risk premium we used 5.0% which is half a percent less than the 5.5% discussed on page 108 of the text. We decided to lower the premium given the decline in rates since the text was written. For the risk free rate we used the 30 year treasuries which were at
3.46%. Taken together a cost of equity of 7.26% was calculated.
For the cost of debt we used the risk free rate plus the required yield on BBB- rated bonds.
BBB- was used because that was the rating assigned to BEAM’s debt. This yielded a 4.36% cost of debt which, when combined with the target weightings from Morningstar and the previously discussed cost of equity, produced a WAAC of 5.81%. At first glance 5.81% seems low but the reader should keep in
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mind the low Beta for BEAM as the reason for the WAAC. If BEAM’s beta is raised to 1.25 the
WACC increases to 7.49% and the cost of equity moves to 9.71%.
Free Cash Flow Valuation
Our first step when starting down the path of arriving at a valuation based on free cash flow was to create projections for BEAM’s balance sheet and income statement through the end of 2018. To begin the process we duplicated the actual statements from the 2011-2013 financials. Please see Table 2 for our projections that related to our free cash flow valuation.
We decided to anchor our balance sheet projections by comparing, on an annual basis, the firm’s total assets to sales. From there we calculated the average balance of each line on the balance sheet to total assets. This way our sales projection drove our projection for total assets which, in turn, allowed us to predict the components of the balance sheet. We predicted a conservative increase in sales of 3.5% for the firm. The forecast is based off of a global spirits growth forecast of 17% from 2010-2015 which averages 3.4% per year (Alcoholic Drink Industry). BEAM’s sales increased 6.4% in 2012 and 3.6% in
2013 so we are comfortable that our forecast is conservative.
For the income statement we calculated 2011-2013 averages for income and expense items below the revenue line as a means of projecting future expenses from our projected sales forecast. From this we arrived at a net income projection that predicts fairly steady increases in net income for BEAM through 2018. Once we arrived at net income we considered various adjustments to arrive at our free cash flow prediction. Highlights of our adjustments include removing gains and losses from discontinued operations as BEAM booked a large gain in 2011 from the divestiture of its golf equipment business. We also added in our prediction for changes in net working capital and; finally, we adjusted the firm’s long-term debt repayments because the firm’s actual current maturities listed in the 10-K are unusually low.
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As can be seen on Table 3, our projections yielded free cash flows that are predicted to increase in 2014 and then decline through the end of 2016 before climbing for the remaining two years through
2018. The changes in direction for free cash flows are the result of swings in net working capital as net working capital is expected to decline in 2014 before steadily increasing each year through 2018.
We calculated the net present value for the predicted free cash flow and included a terminal value that is based on 3.5% growth in perpetuity. Once the present values were summed, we arrived at a
$12.7 billion enterprise value. After deducting the firm’s debt from the enterprise value, we divided by the total shares outstanding to arrive at a per share equity value of $64.56. This value compares nicely to the pre-announcement trading range for BEAM but it is well below the acquisition price of $83.50 per share.
ReOI Valuation
Next we move to our residual earnings of operating income (ReOI) valuation. The first step in this method is to reformulate the balance sheet and income statement. Please see table 4 for our reformulation with an included comparison to the actual financial statements posted by BEAM.
Once we reformulated the 2011-2013 balance sheet and income statement, we next created projections for the reformulated financials through 2018. Table 5 provides the detail needed to examine our projections. The methodology for our projections followed the same basic procedure used for the free cash flow projections. With projected sales as the anchor we calculated the average percentage of assets for operating assets and the other accounts on the balance sheet. This allowed us to arrive at the crucial net operating assets projections listed in Table 5. As previously described, we used the historical expense percentages of sales for our expense predictions on the income statement. Our income statement is modeled after the form listed in exhibit 10.7 on page 306 in the text.
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Armed with the ReOI calculations for 2014-2018 we calculated the present values for the ReOI and continuing value in Table 6. Much like the free cash flow model, the continuing value is based off of the assumption that ReOI will grow at 3.5% perpetually. We summed the 2013 net operating assets, present value of the ReOI and present value of the continuing value to arrive at an enterprise value.
Once the book value of the net financial obligations was deducted we divided the $11.2 billion equity value by the shares outstanding to arrive at a $67.73 per share valuation. Just as we saw with our free cash flow valuation, the ReOI valuation is in the neighborhood of where the stock was trading preannouncement but well below the Suntory purchase price.
AOIG Valuation
Our abnormal operating income growth (AOIG) valuation is anchored by our prediction for operating income which can be found in the previously discussed Table 5. Please see Table 7 for our complete valuation via the AOIG method. Armed with the operating income and net operating assets from Table 5 we calculated the free cash flow and the predicted income from reinvesting the free cash flow. This allowed us to calculate the AOIG and discount it back to the end of fiscal year 2014. To this we added the 2014 predicted continuing value which, much like our previous calculations, is based off of ReOI growing by our perpetual growth rate of 3.5%. This value mirrors the calculation for continuing value shown in Table 14.4 on page 446 of the text.
We arrived at an enterprise value of $12.7 billion which, after subtracting the book value of net financial obligations, resulted in a per share calculation of $63.72. At the risk of sounding like a broken record, the share price calculated for AOIG is right in the trading range of the stock just prior to the merger announcement but well short of the $83.50 acquisition price.
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Consensus Valuation & Comparison to Purchase Price
After completing per share valuations for all three methods we decided to weight the methods to arrive at a consensus valuation. Since all three methods produced consistent results we weighted each method equally. This gave us a $65.34 per share consensus value. As the following chart shows the value is extremely close to where the market valued the stock prior to the merger announcement.
As the chart shows, BEAM’s 200 day moving exponential moving average (yellow line) was just above
$65 in the days prior to the announcement with the stock trading just above the average. We also noted the very bullish inverse head-and-shoulders pattern which, when combined with the 200 day exponential moving average and the Fibonacci retracement support, foretold a bullish move up in the stock price.
If we compare our consensus value with the acquisition price, we see that Suntory paid a 27.8% premium for their purchase of BEAM. Historically speaking the 27.8% premium is just below the longterm average of 30%; however, during 2013 companies only paid an average of a 19% premium on their acquisitions (Monga, 2013). This leads to several questions. Does Suntory know something the rest of
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the market does not about general conditions? Is Suntory’s management too optimistic regarding their ability to create synergies via a combination with BEAM? Did BEAM’s management, which is widely respected for their stewardship of the firm, negotiate a great deal for their shareholders at the expense of the Suntory shareholders? Or, did the fact that the dollar started moving off of historic lows versus the yen in 2013 make Suntory, a Japanese company, decide it was worth the risk to pay a higher premium since the movement in the USD/Yen will only make an acquisition more expensive if the dollar continues to strengthen? As was widely rumored were there multiple suitors involved in negotiations that ultimately drove up the final acquisition price?
To help us obtain a better perspective we also calculated the projected ReOI needed to justify
Suntory’s acquisition price. As can be seen in Table 8, excluding currency movements, Suntory appears to be planning on being able to force significant increases in ReOI over and above our initial projections.
This fact leads us to conclude that BEAM shareholders received a very good price for their shares. If
Kayne West owned any BEAM shares he is no doubt sending “shout-outs” to BEAM’s management since this deal closed on May 1 st
.
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Works Cited
"10-K: BEAM INC." MarketWatch . N.p., n.d. Web. 06 May 2014.
"Alcoholic Drink Industry: Market Research Reports, Statistics and Analysis." Alcoholic Drink
Industry: Market Research Reports, Statistics and Analysis . N.p., n.d. Web. 05 May 2014.
"Beam Inc." MarketLine . N.p., n.d. Web. 06 May 2014.
"Distilled Spirits Council of the United States." Economic Contributions of the Distilled Spirits Industry. N.p., n.d.
Web. 05 May 2014.
Japan’s Suntory Group to Buy Jim Beam, Makers Mark & More. 2013. Hoochly. N.p.: n.p., n.d. N. pag. Web. 06
May 2014. <http://hoochly.com/japans-suntory-group-buy-jim-beam-makers-mark/>.
Monga, Vipal. "Why Are Takeover Prices Plummeting?" The CFO Report RSS . The Wall Street Journal,
26 Nov. 2013. Web. 05 May 2014.
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