By Rupert Taylor on Tuesday 2 June 2015
Here at AltFi we feel happy to be on the right side of a new wave of more equitable finance. We want to support small and exciting businesses - particularly those that are prepared to innovate and take risks. Brewdog appears to be exactly that sort of company. Whilst the product is not new the approach undoubtedly is. And not only are they producing a high quality product but they have also had the courage to navigate the regulatory landscape to launch their own equity crowd-funding raise – without the help of a platform – and not for the first time. On top of that the company is growing at an impressive rate. So far, so good. The trouble is that when we did some work on the detail of this raise the company begins to look rather less like the brewing equivalent of man’s best friend…
In this latest Crowdview column I want to explain that whilst Brewdog may prove to be an excellent business it looks to me like an extremely poor investment. In so doing I hope to highlight some of the key features that investors should avoid in any equity crowd fund raise.
Before we get into the detail of the valuation lets be clear about one thing – Brewdog is a very exciting business with an impressive growth trajectory and seemingly impressive growth prospects. The product appears to be significantly differentiated and to have significant support from beer drinking customers. On top of that the business has an undeniable flair for marketing and PR. The trouble is that when making an investment it is very important to distinguish between a good business and an attractive investment. Essentially this comes down to differentiating between two things – the ‘story’ and the valuation. Brewdog has a great story. But the chances of making a healthy return as that story evolves are limited thanks to an extremely high valuation. Think of it like a horse race. The Derby favorite may make a compelling case. But at odds worse than evens one has to begin to question the logic in making a bet – uncertainties always remain. The business world is at least as uncertain so however attractive an investment story may seem it must compensate you for the risk that things could change.
It is not easy to discern the valuation of Brewdog - there is not even a valuation section in the prospectus. The picture is further complicated by two classes of shares and planned division of the existing B shares. Added to this it is not immediately clear how many A-shares are in issue. At one point the document suggests that the new B shares in issue will represent 21% of the company share capital “at the date of this document”. However the document subsequently reveals that following resolutions to be proposed at the forthcoming AGM the number of A shares in issue will be significantly enlarged. To be fair the information is all there – but it is not clearly represented – certainly not when considering its obvious appeal to its customers as prospective investors.
The net result of all this is that the new B shares on offer for £25,000,010 will represent 8.19% of the company’s enlarged share capital. This implies a valuation for the entire company of approximately £305 million which in turn equates to a dizzying multiple 10.3x 2014 revenues or 115x 2014 profit after tax. For context UK small cap stocks trade on an average multiple of 17x profits [Numis UK smaller companies index]. Adnams, the small, and admittedly less sexy, but long established Suffolk based brewer, trades on just 8.4x profits. £32m of valuation for £66m of revenues looks interesting versus £305 of Brewdog valuation accompanied by just £29m of revenues. Admittedly Brewdog is growing faster. In the year to 2014 revenues grew at around 60% and profit by 53%. If that growth rate can be sustained, then it would take between 6 and 7 years until Brewdog is on a similar multiple to Adnams i.e. the multiple it could expect to trade on once it has matured – but that assumes it can sustain the growth rate – and in the meantime Adnams shareholders will have been sharing in 6 more years of significant profits…
Represented another way equity investors are buying the hope of a share of profits in the future paid as dividends. It is notable that Brewdog does not have a dividend policy – i.e. they have not yet stated any commitment to share any of the expected profit with equity investors. However lets assume that all of Brewdog’s earnings could be paid out as dividend so giving us an indication of the stream of cash flows that we are buying into. In which case Brewdog offers an earnings yield of 0.86% i.e. that is what the profits look like represented as a yield. Now that number is growing – it will be 1.3% a year from now assuming the 2014 growth rate can be continued. But bear in mind the same number for Adnams is 11.9% this year.
And remember this yield may never be paid out to investors and it is for equity risk i.e. if anything goes wrong share-holders can expect to be wiped out first and have no security over any assets. When taking high risk an investor should expect a higher return as compensation – that compensation is notably absent here.
In short, the story at Brewdog is fantastic. But the ‘odds’, or for those who don’t like betting vernacular, the implied probability of success, are not generous – this company needs to deliver perfectly to have any chance of offering a return to investors.
2014 Profit Multiple
UK small cap index
On top of these unattractive odds an investor’s prospects are also hampered by a lack of disclosure. As well as not committing to a dividend policy the company has also failed to offer any forecasts. That means that the prospects of future profits can only be discerned by extrapolating the past. This is unlikely to give an accurate picture as even a detailed look at the historic trends leaves the investor needing to make far too many assumptions to allow an accurate assessment. Given that neither profits nor cash are growing as fast as revenues there is a lot more that could be gained with the assistance of management’s view of future trends. In the absence of much to go on one issue I would immediately highlight would be margins. They have not expanded between 2013 and 2014. But on top of that I would like to know more about the expected impact of shareholder discounts. Brewdog now boasts 14,777 small shareholders – a number which will presumably grow. These shareholders are entitled to discounts of anywhere between 5% and 20%. If these 14,777 shareholders all drink the UK national average alcohol units (11.5 per week) in Brewdog beer that amounts to an estimated 6 bottles each. If I guess an average selling price of £3 (on trade and off-trade) that amounts to a spend of £936 per annum. Multiplied by 14,777 that amounts to nearly £14m of revenues. That amounts to nearly half of 2014 revenue. Effectively this means that revenues equal to half of last years total revenues are about to become low margin sales. A 5-20% price discount is a significant hit on a gross margin of c.38% and a net margin of c.13%. Admittedly they are gaining brand ambassadors in the process – but I would want to have a better understanding of the saving in terms of customer acquisition costs in the context of the pricing that is being given away.
New share class
At least as important a concern as valuation is the share class on offer. As an investor in Brewdog you have to recognize that you have a different class of equity to management. If all future decisions are made with an equitable approach to shareholders in mind then this distinction could amount to nothing. However they might not be. This means that the B shares carry significant extra risk. In time the B shares could end up with a different claim over dividends, different voting rights, and could suffer dilution that doesn’t apply to the A shares. On top of that all together the B shares represent just 8.19% of the issued share capital so they do not have sufficient voting influence to block any resolution that is not in their favor. Investors should always favor issues in which they get to own the same shares as management – an alignment of interests is the best way to ensure fair treatment.
Conclusion - Warning signs
Perhaps the most important lesson that I have learnt in my investment career is that one should never imagine that you can predict the future. This is why it is so important to make investments at attractive odds. The odds on offer at Brewdog are unequivocally poor. As a result I will not be investing any of my money into Brewdog. Arguably if you are an enthusiastic consumer of their beer you could gain some form of return from product discounts but I would not expect anything in the way of capital gains. The prospectus does not contain anything like enough information to be able to predict with any certainty that the growth rate of Brewdog can be maintained to justify the valuation. Frankly, even if disclosure was improved, I doubt I would be able to make the probability of success feel anything like the probability implied by the valuation. On top of the extremely optimistic valuation the Brewdog offering also includes two further warning signs that should discourage any equity investor. Firstly it requires you to have faith that your share-class does not in time become inferior to managements share class. And secondly it suffers from a lack of disclosure. Alongside a document that makes it hard to discern the correct valuation, even going so far as to make the number of shares in issue unclear, I would proceed with caution.
In fact Brewdog represents a lot of what is good and bad about equity crowd funding. It is admirable that they are offering equity to their customers. Equally I have no issue with them not using a platform to facilitate the raise. However I would want any sort of brave new world that I subscribe to to offer transparent disclosure, respect for and protection of shareholder rights, and attractive valuations that compensate for risk - all of these ingredients are cause for concern here. On top of that I struggle with the evangelical tone to the pitch. I personally do not see how an attempt to re-invent the established model can successfully criticize the existing corporate world by taking a fully liveried helicopter from Scotland to scatter taxidermy fat cats over the city of London. Tesco was recently accused of hubris as it was forced to relinquish some corporate jet assets. In fact as a shareholder in Tesco I could see that there may be some justification in spending my money on an exclusive means of travelling. Not so in this case especially when the capital raise they are seeking to advertise seems to offer shareholders a far inferior deal to the established order. The ‘fat cats’ in the city, admittedly with the assistance of watchful regulators, and established institutions, have designed a market where equities are freely traded, shareholder rights and transparent disclosure are enforced, and valuations are modest. This particular dog looks to me more like a wolf – in fact I would be far happier to take my chance amongst the fat cats…