What happened?
Premium wine, spirits, and beer distributor Constellation Brands (STZ 0.64%) set the alcoholic beverage industry buzzing Monday when it announced an agreement to acquire craft beer specialist Ballast Point Brewing & Spirits for the princely sum of approximately $1.0 billion. Constellation will fund the purchase of the San Diego-based brewer using a combination of cash and debt.
Ballast Point provides a portfolio of 40 different types of beer to Constellation, which recently entered the front ranks of beer purveyors with its $5.2 billion acquisition of Anheuser Busch Inbev SA's (BUD +1.73%) Mexican beer portfolio in 2013.
In its press release, Constellation disclosed that Ballast Point will book sales of $115 million this calendar year. The purchase values Ballast Point at an EBITDA multiple in the mid to high teens against projected 2016 earnings.
Does it matter?
The acquisition lays bare what an intensely growth-oriented and competitive category the craft beer industry has become. Constellation's management apparently felt pressure to snare a label that could grow freely within Constellation's system. This is a strategy that non-alcoholic beverage giant Coca-Cola (KO 0.30%) has become quite proficient at: buying smaller brands with great potential and scaling their revenue using its own superior marketing and distribution muscle.
While the strategic rationale makes sense, the huge price tag is open to question. From one perspective, the acquisition can be thought of as fairly priced. Since Constellation purchased the Mexican beer brands portfolio, its stock has skyrocketed more than 150%, and the company now sells for 15 times fiscal 2015 EBITDA on the open market. That's in the ballpark of the formula Constellation is using to value Ballast Point.
But if you look at how efficiently Constellation used roughly $4.5 billion of borrowings to break into the beer business and expand production capacity, management has undoubtedly overpaid for Ballast Point -- delicious beers like Ballast's "Sculpin IPA" notwithstanding.
The Mexican beer acquisition debt has enabled a surge in Constellation's earnings per share, from $2.04 in fiscal 2013, to a projected range of $4.73-$4.93 for fiscal 2016. Even at the low end of the range, Constellation will have generated a return of approximately $0.60 per share for every $1 billion of debt by the end of the current fiscal 2016 year.
In contrast, the Ballast Point deal, which will likely be financed mostly with debt, will be earnings-neutral in 2016, and will add only $0.05 to $0.06 in earnings per share in 2017. That's a drastically lower return for so much leverage. Moody's Investors Service didn't appreciate the idea of new debt without substantial near-term earnings compensation. The credit ratings agency left Constellation's "Ba1" rating intact, but issued a note on Monday calling the transaction "credit negative."
Of course, Constellation excels at marketing and growing high-end brands, so over the long term, the deal should grow in value. But company executives may have failed to exercise their usual acquisition discipline. And this has implications not just for earnings but for future purchases. Suppose you owned the next minuscule-but-stellar craft beer brewery Constellation approaches. After seeing this transaction, would you demand anything less than a trophy price?
