Amid Rising M&A, Craft Brewers’ Declarations of Independence

Craft beer is undergoing an M&A boom.

“Transaction multiples are at all-time highs,” says Richard Moreau, partner at Uni-World Capital, which owns Pittsburgh-based Iron City Brewing. He ballparks the range at 12-20x EBITDA.

Nineteen craft beer deals were announced in the U.S. last year at a total value of $13 billion, according to Fortune.

Big beer stalwarts — including Anheuser-Busch InBev, Heineken, and MillerCoors — all grabbed up craft brands. Private equity deals included Full Sail Brewing (acquired by Encore Consumer Capital) and Oskar Blues Brewery (which sold a majority stake to Fireman Capital Partners).

A Desert Oasis

What constitutes craft? The Brewers Association (BA), a trade organization, defines craft brewers as small (producing less than 6 million barrels per year); independent (less than 25% owned by a non-craft brewer); and traditional (producing beers “whose flavor derives from traditional or innovative brewing ingredients”).

The number of these breweries has multiplied rapidly in the last 20 years. According to BA, there were 1,000 craft breweries in the U.S. in 1996; 2,000 in 2011; and over 4,100 as of December 2015 — the largest number since 1873.

“The craft beer space has tremendous tailwinds,” says Pierre LeComte, managing director at TSG Consumer Partners, which completed a minority investment in SweetWater, a top 50 brewery, in 2014. “People are looking for more variety in their beer consumption, and more quality and storytelling in the brands that they purchase. All that plays into the phenomenon that’s been growing over the past 20 years and accelerating over the past 5 years.”

“Craft is an oasis in what was a total desert of beer from prohibition to the 1990s,” says Greg Parker, founder of Iron Horse Brewery, a microbrewery in Washington State. “Almost every brewer in that time period was a race to the bottom — how plain and low-calorie could you make a beer was the name of the game. In craft beer, the name of the game is how much flavor can you pack into a beer.”

Declarations of Independence

When Constellation Brands Inc. announced plans to acquire San Diego-based craft brewery Ballast Point Brewing for $1 billion dollars last November, M&A advisor David Duval immediately shot off an email to his friend Greg Koch.

Koch is the co-founder of Stone Brewing, also based in San Diego and currently the 9th largest craft brewery in the United States. Stone Brewing brought in $185 million in revenue in 2014 and is expanding rapidly, with new breweries now open in Richmond, Virginia and Berlin, Germany.

“I asked him, ‘How will you resist the tempation?’” Duval recalls.

Koch responded with one line: “Because I am strong.”

But Duval wasn’t trying to get Koch to sell.  Just the opposite. “I’ve been pretty vocal about the fact that I would never take a sell-side engagement with a microbrewery, because in order to represent them in the best way possible, I’d have to take them to the big guys. And that’s just something I won’t do,” says Duval, principal at Claiborne Advisors.

For aficionados, craft’s appeal lies largely in its lack of allegiances and offbeat charm.

“There are a group of consumers that love what craft is about — it’s local, independent, part of the community, caring, driven by passion and not profits,” says Parker.

In an op-ed in the San Diego Union-Tribune, Stone Brewing’s Koch emphatically declared his company’s plan to remain independent and “[hold] true to the craft beer ethos.” He writes that “selling our company to Big Beer is not in our future. No matter the size of the check. Period.”

Koch argues, “In purchasing small, ‘local’ brands, Big Beer is able to capitalize on the purchased brand’s reputation, while many consumers are too distracted to pay attention or care… When a craft brewer sells out to Big Beer, not only are they handing over control of their company’s future (irrespective of the requisite ‘We’re Not Changing Anything’ press release), their brand is transformed overnight from being a positive force for growing the craft segment into a tool fighting against the brewers who choose to remain solely dedicated to the craft category.” Corporations are much better equipped to compete on price than craft brewers, making it tougher for independents to stay afloat.

The Challenges of Craft

“There are big challenges for craft,” says Uni-World Capital’s Moreau. “The market is approaching saturation.” Brewing has a relatively low barrier to entry — many breweries are started by former hobbyists — and in today’s crowded marketplace, it can be tough to differentiate. Moreau points to lawsuits over similar beer monikers and to a brand so eager to innovate they used homegrown yeast from their brewmaster’s beard. Regulations, particularly the U.S.’s post-Prohibition three-tier distribution system, present an additional hurdle.

Given these obstacles, current valuations, and the realities of the business lifecycle, it’s unrealistic to think every brewer will resist M&A.

At the least, most breweries looking to scale will need outside capital at some point, says Moreau. “There will always be a few guys that buck the trend, who have better recipes or who are savvier with marketing and distribution,” but for most, bootstrapping their way to national distribution will be tough.

“For guys that want to expand, PE firms bring certain skillsets and can add value at the management level. We have a network of individuals that we use to improve the business on the personnel side as you’re growing, helping with sales planning, sales teams, recruitment and management, performance, all those types of things.”

As a business owner, “You’ve got to choose the right partner. There are lots of guys who can just write the check.” Look for additional value an investor can add based on unique knowledge, relationships, or past transaction history.

For brewers opposed to big strategic acquirers, there remain alternatives for growth. Stone Brewing, which funded the company’s growth entirely on internally-generated cash flow (other than an early round of friends-and-family equity), obtained a bank line to build their two new breweries in Richmond and Virginia.

Other independent brands are merging with one another rather than turn to big beer — Iron Horse Brewery’s Parker points to the February union of Southern Tier and Victory union as one way for “independent brewers to continue… more or less true to form,” while addressing some of the persistent challenges around distribution and scale.

What’s Brewing

“I don’t know how much higher valuations can go,” says Moreau. Plus, there’s only so much room in the market. Those looking to start modest brewpubs at the local level are one thing, he says, but for those looking to go national, “there are only so many brands the store shelves and taps can handle.”

Parker too predicts the craft craze “will not last in its current form. The growth in breweries and the rapid change in the beer landscape is stunning right now… Consumers will always want beer and tasty beer at that but… it would be foolish to assume that the next seven generations are all going to feel that supporting the local business is of primary concern.”

He continues, “I would be surprised if the craft segment doesn’t undergo a massive shift in the next 10 years, and there are quite a few factors that will be influential. I just have no idea which factors are going to be the biggest nor what all of them are.”