The Boston Beer Company BAB026

(A) Jim Koch, president and founder of the Boston Beer Company, of Boston, Massachusetts,
prepared his thoughts before a meeting with the company’s investment bankers in early
November, 1995. On August 24, 1995, Boston Beer, the maker of Samuel Adams brand beer
and the beer industry’s leading craft brewer, had filed a registration statement with the U.S.
Securities and Exchange Commission (SEC) for an initial public stock offering that aimed to
raise between $26 million and $34 million.

Koch could not restrict his optimism for the IPO’s success, given the stock market’s
recent appetite for new beer issues and the market’s overwhelming subscription response to
Boston Beer’s proposed stock. Competitors Redhook Ale Brewery and Pete’s Brewing Company
had each conducted very successful IPOs in the previous three months. The two beer stocks
went public at $17 and $18 per share, respectively, and had since maintained share prices in the
mid-$20s. Koch’s thoughts centered on the price at which Boston Beer should go public. The
company’s bankers initially had set a price range of $10 to $15 per share. Koch wanted to be
sure that the share price established by the bankers reflected the appropriate market value of his
company.

The Craft Brewing Industry

In the early 1900’s, over two thousand breweries, most of which served local markets,
operated throughout the United States. The advent of Prohibition, however, forced the closing of
most of these breweries. The post-Prohibition period marked the beginning of a long
consolidation of the beer industry during which the few brewers that reopened after Prohibition
sought to take advantage of economies of scale in production, distribution, and advertising.
These brewers used low-cost ingredients to mass-produce milder and lighter beer. They used
preservatives to maintain the taste of the beer over a longer shelf life. The consolidation of
breweries and these practices initiated a convergence of brewers’ products to relatively
undistinctive premium pilsners and lagers. 1 By 1995, the three largest brewers, Anheuser-Busch,

Adolph Coors Co., and Miller Brewing Co., shipped over 75 percent of the beer in the United
States.

The re-emergence of the craft breweries segment in the 1990s was directly related to a
decline in mass-produced beer consumption during the period. An increase in health and safety
consciousness among beer drinkers caused consumers to drink less beer, while a rise in affluence
focused them on more distinctive and flavorful brews. Imported beers from Canada, Germany,
Holland, and Mexico initially satisfied this niche. Consumers thus learned to distinguish the
flavor of a beer, which eased them through a transition from promotion-based to taste-based
purchases. The imports, however, were vulnerable to competition from domestic craft brewers.
Craft brewers, which specialized in producing full-flavored ales, stouts, and amber-colored beers
from superior hops, malted barley, yeast, and water, did not utilize ingredients such as rice, corn,
and stabilizers to dilute and preserve their beer for mass production and consumption. Long
shipping times for imports which compromised freshness, coupled with high transportation costs,
allowed craft brewers to invade the market segment previously dominated by imported beers.

The craft beer segment was comprised of four distinct categories, including regional
specialty brewers, microbrewers, contract brewers, and brewpubs. Exhibit 1 depicts the
breakdown of these four segments and the growth in number of barrels shipped from 1985 to
1994. Craft brewers that produced between 15,000 and 1,000,000 barrels of beer per year were
classified as regional specialty brewers. Distribution for this type of craft brewer, which
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The Boston Beer Company BAB026
(A)
currently included 30 breweries, was typically limited to the region in which it was produced.
However, several larger regional specialty breweries, such as Redhook Ale Brewery, had begun
national distribution. Regional specialty brewers produced 29 percent of the total barrels shipped
for craft brewers in 1994, up 70 percent from 1993. Craft brewers that produced less than 15,000
barrels per year were classified as microbrewers. Contract brewing companies marketed and sold
under their own labels craft beers that had been produced other brewers. By utilizing the excess
capacity of existing brewers, contract brewers avoided the high capital expense of developing
and owning production facilities, often maintaining lower production and distribution costs than
regional specialty brewers. The Boston Beer Company and Pete’s Brewing Company were two
of approximately 100 contract brewers in the United States. This segment represented 42 percent
of the total volume of craft brewers and had grown 57 percent in 1994. Brewpubs were
breweries that brewed and sold or served their beer at the same location and were generally
considered a restaurant concept.

The craft segment of the domestic beer industry represented an explosive niche in an
otherwise lethargic industry. In 1994, the overall U.S. beer industry totaled $5 billion in
revenues, and analysts forecast flat growth of 0 to 1 percent compounded annually through the
year 2000. The number of craft brewers, however, had escalated to over 750, 165 of which
opened in 1994. Beer industry analysts estimated that craft brewers, which represented 1.4
percent of the domestic beer market in 1994, up from 0.9 percent in 1993, would expand to 5
percent by the end of the decade.

Despite their relatively minor market share of the total beer industry, the success of craft
breweries had created pressure for change throughout the beer industry, including a proliferation
of new, small breweries throughout the United States. In addition, national brewers had

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introduced fuller-flavored beers to compete with craft brewers’ products. Consequently, the
market for premium quality beer had become highly competitive and the success of a craft
brewer was now contingent on its ability to continuously introduce new products and compete on
price, while maintaining the neighborhood character that originally made it successful.

History of the Boston Beer Company

Boston Beer Company was founded in 1984 by Jim Koch and Rhonda Kallman. Koch
started the company using his great-great-grandfather’s recipe for a hearty, full-flavored beer.
Koch had a successful career working as a management consultant with the Boston Consulting
Group, but wanted to brew and distribute his family’s recipe. He believed that a domestic
microbrewery could capitalize on the vulnerabilities of imported beers by making a consistently
high quality product whose marketing emphasized local character. When Boston Beer began
distributing its Samuel Adams brand beer in 1985, there were few craft brewers. These
breweries tended to produce beers of erratic quality and taste, due to the handcrafted process, and
virtually none of them distributed their beer outside of local territory.

A critical element of Koch’s plan for Boston Beer was the company’s use of established
brewers’ production facilities. Koch hired the Pittsburgh Brewing Company, a thirty-year-old
brewer with state-of-the-art equipment, to brew his beer. Establishing Boston Beer as a contract
brewer allowed Koch two distinct benefits. First, he was able to start the company with only
$240,000 of initial capital, $100,000 from his own savings and $140,000 from friends and
family. This amount was far short of the $10 million capital investment required to build or buy
a brewing facility. Second, outsourcing production freed Koch to focus on selling his product
and, most importantly, on organizing a distribution network not only in New England, but also in
the metropolitan areas of Washington, D.C., New York, Illinois, and California.

Boston Beer’s marketing approach stressed the product’s premium ingredients and quality
brewing process and attacked the imported beers by appealing to consumers’ sense of patriotism.
Koch was successful in educating beer drinkers on the flavor, ingredients, and characteristics of
good beer, establishing Samuel Adams beer as an alternative to imports. The beer earned
recognition within the beer industry as well. Samuel Adams Boston Lager, the company’s
flagship beer, received six gold medals and was voted “Best Beer in America” in 1985, 1986,
1987, and 1989 at the annual Great American Beer Festival in Denver, Colorado. Additionally,
in January 1990, Time magazine rated it the best beer of the decade.

Boston Beer Company, 1995

In ten years, Boston Beer had grown from a seven thousand-barrel microbrewer to the
largest craft brewer in the United States. Exhibit 2 summarizes Boston Beer Company’s volume
growth over the last five years in comparison to other leading craft brewers. There was little
doubt that the 45-year-old Koch was the driving force behind Boston Beer and almost every
aspect of the company reflected his fingerprint. Koch’s initial vision of a market-driven
microbrewery with a wide distribution for its beers had essentially pioneered the way in which
contemporary craft brewers practiced business. Boston Beer distributed its products in 50 states,
the District of Columbia, Puerto Rico, and seven other countries. The company employed a sales
force of over 120 direct salespeople, the same as the domestic sales force of the beer industry
giant, Anheuser-Busch, a company that shipped 88 million barrels of beer in 1994 compared to
Boston Beer’s 714,000 barrels.

Koch’s commitment to marketing was overshadowed only by his commitment to the

production of fine beer. Each year, he traveled to Germany to hand-select the noble hops that
gave the company’s beers their unique flavor. In 1987, the company invested $3 million in a
research and development facility for new product development. In retrospect, the R&D facility
was key to Boston Beer’s growth and success. The eruption of competition in the craft beer
industry had increased the pressure to introduce new beers to maintain and grow market share.
Boston Beer had utilized the facility to develop new flavors and seasonal beers, and had 14
varieties of beer in the marketplace by 1995.

The company had grown its sales volume by over 200 percent since 1992. In 1994,
Boston Beer established a 26 percent market share in the craft beer industry and its sales volume
was higher than the next six largest domestic craft breweries combined. As shown in Exhibit 3,
it shipped 714,000 barrels of beer for $114.8 million in revenues and generated $4.75 million of
net income in 1994. The company continued its explosive growth through the first 9 months of
1995. Sales volume was 688,000 barrels, a 35 percent increase over the volume for the same
time period in 1994, and revenues were $108,905,000. Industry observers anticipated that
Boston Beer would continue to grow its sales volume at a rate similar to its historical pace
through 1997, and then experience lower growth through the end of the century. The company
expected its profit margins to decline slightly due to competitive pressures on prices, higher
production costs on specialty beers, and increased advertising, promotional, and selling expenses
related to new product introductions. Additionally, Boston Beer planned capital expenditures of
$4.5 million in the last quarter of 1995 and, in 1996, planned to invest another $13 million for
bottling, kegging, packaging, and brewing equipment at its contract brewing facilities. The
company expected to fund approximately $10,300,000 of the expenditures through asset-based
financing arrangements.

Boston Beer had historically financed its working capital requirements and capital
expenditures using cash flow from operations and currently maintained only $1.95 million in
long-term debt. It borrowed $2.2 million at 11.5% in 1988 from the Massachusetts Industrial
Finance Authority to finance engineering and design improvements to its production facilities.
The repayment agreement called for principal payments of $50,000 in 1995, $75,000 in 1996
through 1998, $100,000 in 1999 and 2000, and the balance paid, thereafter. In May 1995, the
company also entered into a $14 million line of credit agreement with Fleet Bank of
Massachusetts. It could borrow at an interest rate equal to the bank’s prime rate, currently
8.75%, but had to pay a fee of 0.15 percent on the unused portion of the line. The company’s
balance sheet before the initial public offering is shown in Exhibit 4.

Use of Proceeds
Boston Beer filed an initial public offering prospectus with the SEC on August 24, 1995.
The company was seeking to raise between $26 million and $34 million (after deducting the
estimated underwriting expenses and related costs) to make capital investments in equipment and
to fund working capital and general corporate purposes.

Boston Beer currently was organized as a limited partnership, which

would be dissolved in November 1995 before the initial public stock offering. As
shown in Exhibit 4, at the time of the dissolution, the company would distribute
$12.5 million to its existing partners by using
$1,552,000 in cash and borrowing $10,948,000 against its line of credit at Fleet
Bank. The IPO proceeds would be used to immediately repay the debt incurred in
dissolving the original partnership. The company was also planning to use $7
million of the proceeds to fund capital expenditures in 1996. The remaining
proceeds were to be used to fund working capital expenses or invested in
investment grade securities. Boston Beer did not intend to issue dividends.

The Initial Public Offering

Only five domestic brewers’ stocks traded on the market in 1995. These
included Anheuser-Busch, Adolph Coors, Mendocino Brewing, Redhook Ale
Brewery, and Pete’s Brewing Company. The latter two companies took
advantage of the red-hot IPO market in 1995 (see Exhibit 5) to raise
approximately $100 million. Redhook was a regional specialty brewer that had
$16.21 million in sales, $6.24 million in gross profit, $3.44 million in operating
income, and $2.13 million in net income in 1994. The company went public on
August 17, 1995 at a price of $17 per share; its price jumped to a first day high of
$27 per share. Pete’s Brewing, which had $33.62 million in sales, $13.94 million
in gross profit, $603 thousand in operating income, and $551 thousand in net
income in 1994, went public November 6, 1995 at $18 per share, closing at
$25.25. These two transactions are summarized in Exhibit 6.

The process of issuing public stock for the first time begins when a
company engages an investment bank to serve as its lead underwriter. The
investment bank advises the company through the offering process, assists in
preparing documents, and finally, commits to selling the offering’s shares. A
company initiates the formal process by filing a registration statement with the
SEC for approval to sell stock to the public. 2 The registration statement is
comprised of two parts. The first part is a prospectus that contains items such as
audited financial statements, a disclosure of the number of shares being offered
for sale, and management’s discussion of the company’s business, capital
structure, risk factors, and intended use of proceeds from the sale of the shares.
The second part varies depending on the nature of the security, size of the
offering, and the type of company and industry. The SEC generally reviews initial
public offering registration statements and may request (through comment letters)
that issuers amend documents. This process generally lasts between one and six
months; as of mid-October, 1995 Boston Beer had not yet received SEC approval.
 Meanwhile, the lead underwriter organizes a syndicate of investors that
commit to buy or subscribe to specific blocks of shares. During the organization
of the syndicate, the lead underwriter conducts price discovery. The underwriter
estimates a range for the offering price based on the syndicate’s feedback and
current market conditions. Boston Beer Company’s underwriters estimated an
initial price range of $10 to $15 per share in August 1995.

has 20 days to sells its shares of stock. The company meets with its lead
underwriter the day before or morning of the IPO to establish the final offering
price, so that the price best reflects market conditions. The underwriter, because it
facilitates the sale of the shares, typically has significant power in determining the
offering price. Underwriters tend to underprice IPOs, anticipating immediate price
increases that generate gains for syndicate members. Then the stock hits the
market.

A total of 3,984,215 shares were to be offered in Boston Beer’s IPO, of

which the company would issue 2,540,379 shares to raise capital for expansion. In
addition, existing partners would sell 1,443836 shares. The breakdown of shares
being offered is shown in Exhibit 9.

The Market Value

Although Jim Koch originally estimated that an IPO would net the
company between $26 million and $34 million, the company might have a unique
opportunity to raise substantially more money given current market conditions.
The aggregate U.S. stock market was up 37 percent from 1994, and through
September 1995, 225 companies had raised over $13 billion in initial public stock
offerings. Market analysts projected that an additional $12 billion would be raised
during the fourth quarter in 1995, making it the largest quarter ever for IPOs.
Exhibit 5 illustrates the quarterly dollar volume of IPOs from 1993 to 1995. In the
craft brewing industry, Boston Beer rivals, Redhook Ale Brewery and Pete’s
Brewing Company, had recently conducted successful IPOs. Many institutional
and retail investors did not have an opportunity to purchase the stocks during
those initial offerings and were anticipating the offering of Boston Beer’s stock.

Jim Koch was growing anxious as he and his underwriter anticipated the
SEC’s approval of the registration statement. He was wary of the $10 to $15 per
share price range that the investment bankers initially disclosed. There was always
the potential that the IPO could be under-subscribed and therefore pulled from the
market: The company would thus miss an opportunity to raise much-needed
capital. However, he could not keep himself from dreaming about the amount of
money that Boston Beer Company would raise if it sold its stock for a higher
price. The challenge now was for him and the company’s underwriter to
determine the appropriate price for the offering.