Beverage

The Beverage Industry: This One’s on the House!

By Ken Freeland Bob Gabruk Kim Laidlaw Jonathan Levine Matt Michaels Greg Schramm May 4, 1998

I. Corporate Governance Analysis Balance of Power Of the six beverage companies we have chosen for our valuation, only Molson (which is managed by CEO E. James Arnett) is not family operated. For example, Brown-Forman is run by Owsley Brown II and Anheuser-Busch is overseen by August A. Busch III, the CEO for the past 21 years. Excluding Anheuser-Busch, the managing families also own a significant portion of their companies’ publicly traded stock. Moreover, incumbent management maintains its power primarily through their boards of directors. Generally, the composition of the boards of directors include a Fortune 500 CEO and at least one member of the originating family. Many directors are insiders (current executives, former executives, or family members) or have close ties to the controlling families. Robert Mondavi and Brown-Forman provide representative examples of the board compositions of our companies. Of the eight members of the directors of Robert Mondavi, four are employees and members of the Mondavi family, and they own a combined 48% of the outstanding shares. The remaining four directors hold very little stock in comparison, only 3.8% of the outstanding shares, and have no discernable connection to the company. One is the CEO of Netscape and on the board since 1996, while another is the CEO of Medical Data Company (on the board since 1989). The board of Brown-Forman is comprised of four insiders and five outsiders. Of the four insiders, three are related to the CEO and have been on the board for more than 26 years. The fourth is the Vice-Chairman of Brown-Forman and has been on the board for 27 years. The remaining five board members are or have been senior executives at other firms. They include the former CEO of British-American Tobacco Company Ltd. and the former CEO of Kraft General Foods.

Manifestations The CEO’s of the companies we analyzed all receive generous compensation packages, although Coors offers a considerably less lucrative package of approximately $300,000. Owsley Brown II (CEO of Brown-Forman) earned more than $1,900,000 ($657,000 salary, $523,000 bonus, $605,000 in stock options and $114,000 in stock gains) last year, while August A. Busch III received more than $8.6 million in compensation, including stock options. Robert Mondavi earned more than $400,000 in salary, $75,000 in other benefits and options to buy 50,000 shares of stock at an exercise price of $28.50. E. James Arnett’s compensation included a pro-rated salary of $263,500 (he was named CEO on May 9, 1997), a bonus of $190,000, $3,500 in other compensation and 50,000 stock options. The financial situation surrounding Nick Caporella, the CEO of National Beverage Corporation (NBC), is interesting. He was compensated via his management company, which received $3,854,000 in fees from NBC last year. These fees also included payments to another employee supplied Caporella’s management company.

Managerial Performance As shown below, the stocks of the companies we studied performed well over the past few years, with the exception of Molson. The best performers were Mondavi and National Beverage Corporation, the only two companies that do not derive the most of their revenues from the very competitive brewing business. Mondavi, which has only been public since 1994, and National Beverage Corporation posted average rates of returns of 50% and 30%, respectively. STOCK PERFORMANCE (1993 – 1997) – Rate of Return (ROR) Year 1993 1994 1995 1996 1997 5-year Cumulative 5-year Annual Average **4-year numbers

Anheuser Busch -16% 4% 31% 22% 10% 53% 9%

BrownForman 6% 5% 20% 25% 21% 101% 15%

Adolph Coors -2% 3% 32% -14% 75% 102% 15%

Molson Co. Ltd. 0% -30% 15% -7% 20% -10% -2%

Robert Mondavi N/A 19% 140% 32% 34% 406%** 50%**

Nat'l Beverage Corporation 11% 8% -10% 235% 13% 273% 30%

Stockholder Reaction The voting shares of the companies we analyzed are mostly family owned; therefore, the marginal investors have very little power with respect to corporate management. For example, only common shareholders of National Beverage Corporation have voting rights and CEO owns almost all the common stock (77.17%). Also, only Class “B” common shareholders of Molson stock have voting rights, and the Molson family owns nearly 50% of these shares. Voting rights for Mondavi shares is a little more complex in that both Class “A” and Class “B” shareholders having voting privileges. However, Class “A” shareholders are entitled to one vote for each share of Class A common stock they own, while Class B shareholders are entitled to ten votes for each share of Class B common stock that they own. Class B common stock is held almost exclusively by the Mondavi family.

Firm and Financial Markets Half of the six companies are followed extensively by research analysts (e.g. nineteen and nine analysts follow Anheuser-Busch and Coors, respectively). This extensive coverage should ensure accurate information exchange between these companies and their investors. Two of our companies, Molson and National Beverage Corporation, are not followed to any significant extent, perhaps due to the lack of trading volume (see Section II). Company Anheuser-Busch Brown-Forman Adolph Coors Molson Co. Ltd. Robert Mondavi National Beverage Corp.

Number of Analysts 19 5 9 1 7 0

Firms and Society With the exception of NBC, all of the companies manufacture and distribute alcoholic beverages. For this reason, they are often targets of public criticism. However, most of the

companies have reputations for being good corporate citizens. For example, Molson has earned a good reputation due to its involvement in AIDS-related benefits and charities in Canada. In addition, Molson created the Molson Companies Donation Fund. In Fiscal 1997, the Fund donated $1,285,928 to a variety of charities, including the United Way, public education programs, community centers, Youth groups and environmental concerns. In addition, Molson owns the Montreal Canadian NHL hockey team, which has one of the most storied histories in all of professional sports. This certainly adds to the popularity of the Molson name in Canada. Anheuser-Busch has also worked hard to build a positive reputation within society. For example, the company initiated “Family Talk about Drinking”, a consumer awareness program aimed at preventing underage drinking through education between parents and their children. So far, more than 2 million parents and educators have received “Parent Talk” materials. The company also sent 5 million cans of drinking water to flood victims in 1997 and protects endangered species at its Busch Gardens’ theme parks throughout the country. The remainder of our companies also provide community services but to a far lesser degree.

II.

Stockholder Analysis

Composition Anheuser-Busch: Although there are more than 64,000 shareholders (including some foreign investors), 61.2% of the stock is held by institutional investors. Insiders own approximately 20% of the stock, with Nationsbanc – who has a representative on the Board of Directors – having a claim on 3.85%. Barclays Bank PLC, Putnam Management, and Barrow Handley each own approximately 2% of the outstanding stock. Brown-Forman: There are 3,156 voting shareholders and 5,054 non-voting shareholders. Seven insiders (all family members) claim 70.9% of the stock in the company. National Asset Management owns 23% of the Class B common stock, much more than that of the next largest institutional investor, T. Rowe Price, which owns 5.24%. Barclays, David Babson & Company each hold slightly more than 4%. Coors: The family holds all voting stock in a trust for the family and 54% of the non-voting shares in different trusts. They are the only insiders of the company and exert virtually complete control. Institutional investors hold 41% of the remaining outstanding non-voting shares. Molson: Members of the Molson family own nearly 50% of the voting shares (Class B common stock). Of the remaining shares outstanding, institutional investors hold 32.41%, of which 9% is held by the Ontario Municipal Employees Retirement Fund. Mondavi: The Mondavi family owns most of the Class B Common Stock, which contain the majority control of voting rights. Of the Class A Common Stock outstanding, there are 78 institutional holders of the stock, representing more than 86% of the outstanding shares. Capital Guardian owns nearly 9.13% of the stock, while Fidelity Management and Wellington Management each own more than 8% of the stock. The marginal Mondavi stockholders are likely to be domestic institutional investors.

National Beverage Corporation: Institutional investors own 4.7% of the stock, while insiders hold 78.4%. The insiders include Nick A. Caporella, Joseph G. Caporella (Executive VP, Corporate Secretary and Director), Samuel C. Hathorn (Director), S. Lee King (Director) and George R. Bracken (VP and Treasurer). * See the following table for a detailed breakout of major stockholders. Company (Ticker) Number of Shares Anheuser-Busch (BUD) Nationsbanc 18,730,000 BZW Barclays Bank 13,086,000 Putnam Mgmt. 10,846,000 Barrow Handley 10,430,000 Fayez Sarofim 8,829,000 Brown-Forman (BF/B) National Asset Mgmt. 9,165,000 T Rowe Price 2,089,000 BZW Barclays Bank 1,778,000 David L. Babson & Co. 1,668,000 State Street Corp. 900,309 Coors (ACCOB) Coors Family 18,978,000 BZW Barclays Bank 1,361,000 State Street Bank 785,604 Bankers Trust 716,888 NY State Teachers 649,700 Molson (MOL/B) Molson Family 4,953,000 Ontario Mun. Empl. 1,156,000 La Caisse 435,344 Cundill & Associates 24,000 Toronto Dominion 6,200 Mondavi (MOND) Capital Guardian 729,300 Fidelity Mgmt. 687,500 Wellington Mgmt. 659,920 Capital Research & Mgmt. 566,700 Mass Financial 341,900 National Beverage Corporation (FIZ) Nick Caporella 14,267,000 Dimensional Fund 307,960 BZW Barclays Bank 302,330 O'Shaughnessy Capital 133,503 Vanguard Group 71,840

% of Outstanding 3.85% 2.69% 2.23% 2.14% 1.82% 23.00% 5.24% 4.46% 4.18% 2.26% 54.19% 3.89% 2.24% 2.05% 1.86% 38.55% 9.00% 3.39% 0.19% 0.05% 9.13% 8.61% 8.27% 7.10% 4.28% 77.17% 1.67% 1.64% 0.72% 0.39%

Stock Listings With the exception of Molson and Brown-Forman, the companies are only listed on U.S. stock exchanges. Molson is listed in Canada on the Montreal, Toronto and Vancouver Stock Exchanges, while Brown-Forman’s non-voting stock is traded on the London Stock Exchange and the New York Stock Exchange (NYSE). Coors and Mondavi are traded on the NASDAQ, Anheuser-Busch is traded on the NYSE and National Beverage Corp. is traded on the American Stock Exchange (AMEX). The table below presents the average daily trading volume for the companies. Anheuser-Busch is by far the heaviest traded company, while Molson and National Beverage Corporation are the least traded. The data come at no surprise since Anheuser-Busch has the most shares outstanding and, on percentage basis, the least number of shares that are family owned. Moreover, the Molson and National Beverage Corporation are smaller companies with most of the outstanding shares owned by the managing families. AVERAGE DAILY TRADING VOLUME (1996 – 1997)

Trading Volume

Anheuser Busch 927,799

BrownForman 52,410

Adolph Coors 225,417

Molson Co. Ltd. 8393

Robert Mondavi 54,421

Nat'l Beverage Corporation 8947

III.

Risk & Return

A Top-Down Beta Estimate In analyzing the risk and return factors for the beverage industry (both alcohol and nonalcohol) we first looked at past performance. While the industry itself has entered a mature growth phase, international opportunities are still prevalent. In the U.S., growth in alcohol consumption is projected to grow at only 1%, whereas in countries such as England and Japan, there are still tremendous growth potential. The stock prices and earnings for most of the companies have grown steadily over the past five years. Four of the companies’ betas are under 1, hovering around 0.7, signaling a stable, less volatile stock price relative to the market (refer to graph below). The company that caught our attention was Mondavi, a wine-retailer that continues to experience high growth. Mondavi has a levered beta of 1.52 and an unlevered beta of 1.3, which are considerably higher than the industry averages of 0.67 and 0.59, respectively. Mondavi resides in the premium wine category, which has a significantly different risk profile than the rest of the alcoholic beverage industry.

Unlevered Betas 1.4 1.2 1 0.8 0.6 0.4 0.2

Br

ow

na l

i

at N

on

io

da v

n ol

so M

n-

Fo

us

rm

ch

rs se rB he u

An

ol ph

C

oo

et R Ad

M

l ai

t in

m

en

oh ol te rta En

-A

lc

l N

on

co ho Al

an

0

Since the Mondavi is relatively young and actively reinvesting to grow in this market, the company carries unique risk characteristics. Therefore, we used the regression beta for Mondavi throughout our calculations. To calculate the Jensen’s Alpha, we used a monthly risk-free rate of 0.45%, which we annualized to determine excess annual returns for all five firms relative to the market. Adolph Coors Slope Intercept Jensen's α, monthly(%) Jensen's α, annually(%) R-Squared(%)

0.67 0.44 0.28 3.51 7.00

Anheuser Busch 0.63 0.24 0.07 0.84 21.00

BrownForman 0.51 0.49 0.25 2.98 10.00

Molson

0.83 -0.89 -0.98 -11.09 27.00

Mondavi

1.56 0.52 0.78 9.36 16.00

National Beverage Corp -0.17 3.61 3.07 36.84 0.00

The analysis suggests that most companies have performed better than expected. For example, Mondavi and National Beverage Corporation have both had significantly better than expected returns; National Beverage exceeded expectations by more than 36% over the past five years. The only company to return worse than expected is Molson, which under-performed the market average by 11%. Although it may be an anomaly specific to these six companies, we note that there seems to be a correlation between how well, or poorly, a firm performed to the amount of market specific risk it holds. Molson had the highest R-Squared (0.27), but also the lowest Jensen’s Alpha, suggesting poor past performance. Based on this analysis, it is not surprising that Anheuser-Busch had the second highest R-Squared (0.20), and the second lowest Jensen’s Alpha. However, when looking at National Beverage, we find that it has no risk due to market factors (R Squared = 0) and the highest excess return. These findings suggest that the higher the firm is subjected to market risk, the lower the excess annualized return. Thus, there is a negative correlation between the two.

A Bottom-Up Beta Estimate For most of the companies, we found that the top down beta carried too much noise (a high standard error). Therefore, we calculated and applied a bottom up beta for all firms except Mondavi. To estimate a bottom-up beta, some firms were separated into their respective business divisions. The tables below present the various business sectors that some of our companies are evolved in. For example, Anheuser-Busch is involved in entertainment activities that include amusement parks. Brown-Forman actually is involved in household good sales, and Molson’s businesses include alcoholic beverages and retail. Subsequently, the overall unlevered betas for these companies were calculated from a weighted average of the business betas. Companies with Different Businesses (All $ values in millions) Anheuser-Busch Business Alcohol Beverages Entertainment Firm

Estimated Unlevered Division Weight Value Beta $21,933.6 0.59 80% $5,483.4 0.57 20% $27,417.0 100%

Weight Beta

Estimated Unlevered Division Weight Value Beta $3,060.7 0.59 73% $1,132.0 0.67 27% $4,192.7 100%

Weight Beta

0.47 0.11 0.59

Brown-Forman Business Alcohol Beverages Household Goods Firm

0.43 0.19 0.62

Molson Business Alcohol Beverages Entertainment Retailing Firm

Estimated Unlevered Division Weight Weight Beta Value Beta $807.9 0.59 58% 0.34 $118.4 0.57 9% 0.05 $459.7 0.74 33% 0.24 $1,393.0 100% 0.63

Coors, National Beverage, and Mondavi are involved solely in the beverage industry, so their betas are calculated directly from their respective beverage betas. To lever up the betas of our companies, we determined their market values of debt and equity with the following formulas:

Market Value of Equity = Pstock * Shares where Pstock = Stock Price Shares = Number of Shares Outstanding and Market Value of Debt = Expint* PVA(i,n) + BV of Debt * PV(i,n) where Expint = Interest Expense PVA = Present Value of Annuity Factor PV = Present Value Factor i = Cost of Borrowing n = Average Maturity of Debt The results are shown below.

Market Value of Equity Market Value of Debt Total Market Value

Adolph Anheuser Coors Busch $1,186.0 $22,966.0 $273.9 $4,450.0 $1,459.9 $27,416.0

BrownForman $3,879.0 $313.7 $4,192.7

Molson

Mondavi

$1502.3 $341.3 $1,843.6

$622.9 $164.9 $787.8

National Beverage $191.8 $60.9 $252.7

From the market values of equity and debt, we computed the debt and equity ratios, which are plotted in the following chart.

Debt and Equity Ratios 120.00% 100.00% 80.00% Debt Ratio

60.00% 40.00% 20.00% 0.00%

N

A

lc

oh ol on -A lc E oh nt er ol ta in m en t A do Re ta lp il h A nh C oo eu rs se rB B us ro ch w nFo rm an M ol so n M on da vi N at io na l

Equity Ratio

To determine the cost of equity, we used a riskfree rate of 6% and a risk premium of 5.5% with the following equation: Expected Return = Rf + Beta*Rp where Rf = Riskfree Rate Rp = Risk Premium

Consistent with the top-down beta calculations, Mondavi is again the only company that lies above the industry average for cost of equity. Their cost of equity is 14.36%, while the industry average remains below double digits at 9.36%. Business Alcohol Non- Alcohol Entertainment Retail Adolph Coors Anheuser-Busch Brown-Forman Molson Mondavi National

Unlev. Beta 0.59 0.73 0.57 0.66 0.58 0.59 0.61 0.63 1.3 0.73

D/E Ratio 22.00% 37.00% 61.00% 71.00% 23.09% 19.38% 8.09% 22.72% 26.47% 31.75%

Levered Beta 0.67 0.9 0.8 0.74 0.67 0.66 0.64 0.83 1.52 0.88

Riskfree Rate 6.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00%

Risk Premium 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50%

Cost of Equity 10.35% 11.67% 11.01% 9.26% 9.73% 9.63% 9.52% 9.28% 14.36% 10.84%

Cost of Debt and Cost of Capital To estimate the cost of debt for the different companies, we first ascertained the current ratings of the companies. If the company was not rated, we used its interest coverage ratio to determine a synthetic bond rating and a corresponding spread. We based cost of debt calculations on a long-term Treasury bond rate of 6%, and added the respective spreads for each company to this rate. To calculate the after-tax cost of debt, we used the following formula: After-Tax Cost of Debt = (LT bond rate + Spread)(1-tax rate) The marginal tax rates for each company depended on where they conducted business, and added percentage points to the statutory tax rate of 35%. For example, Anheuser-Busch conducts business primarily in the U.S., yet must also look at any tax issues in other countries. Therefore, we used a 40% tax rate in determining the after-tax cost of debt for Anheuser-Busch. On the other hand, Adolph Coors has less international penetration than Anheuser-Busch, and thus a marginal tax rate of 35% is more appropriate for determining their after-tax cost of debt. To calculate the cost of capital, we used a weighted-average of the cost of equity and after-tax cost of debt, as shown in the following formula:

Cost of Capital = Cost of Equity(Equity Ratio) + A-T Cost of Debt(Debt Ratio) The cost of equity, after-tax cost of debt, and cost of capital are given below both in tabular and graphical form. Business

Equity Ratio 83.72% 88.91% 69.17% 85.61% 84.50% 85.00% 92.52% 81.38% 81.00% 76.00%

Alcohol Non- Alcohol Entertainment Retail Adolph Coors Anheuser-Busch Brown-Forman Molson Mondavi* National

Cost of Equity 10.35% 11.67% 11.01% 16.35% 9.73% 9.63% 9.52% 9.28% 14.36% 10.84%

Debt Ratio 16.28% 11.09% 30.83% 14.39% 15.50% 15.00% 7.48% 18.62% 19.00% 24.00%

A-T Cost of Debt 4.28% 5.30% 3.93% 4.43% 4.88% 4.20% 4.42% 4.07% 4.80% 4.71%

Cost of Capital 9.36% 10.96% 8.82% 9.26% 9.39% 8.86% 9.32% 9.35% 12.36% 9.37%

*We computed a bottom-up beta for Mondavi although a top-down beta was used here after.

Cost of Equity / Cost of Capital 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

Cost of Equity

lc oh te ol rta in m en t Ad R et o ai An lph l C he o or us s er B Br u ow sch nFo rm an M ol so n M on da vi N at io na l En

-A

on

N

Al

co

ho l

Cost of Capital

After analyzing the previous aspects of the company’s financial situation, it is also not surprising that both Mondavi and Coors have the highest cost of capital. Mondavi is confronted with a high cost of capital due to its very high cost of equity combined with their 81% equity ratio. Their cost of capital is 12.36%, versus an industry average of 9.36%. Consistent with the fact that Adolph Coors has a low rating of BBB, the company has the highest after-tax cost of

debt (4.88%), which is 0.6% higher than the alcoholic beverage industry. Coors also has the second highest cost of capital (9.39%), due in part to the high cost of debt and low debt ratio. However, this cost of capital is in line with the industry average, which suggests that the current BBB rating does not increase their cost of capital by an extreme amount.

Analysis In summary, we have analyzed the companies and calculated the betas from both a top down and a bottom up approach. Based on this analysis, we used bottom up betas since they provide a more accurate picture of firm risk and less noise in the information. The exception was Mondavi, where we used the top-down beta because of its unique risk and return characteristics. Furthermore, we see a wide range in the cost of equities for our companies, from a low of 9.28% for Molson to a high of 14.36% for Mondavi. The wide range persisted in the cost of capital comparisons with a low of 8.86% for Anheuser-Busch and a high of 12.36% for Mondavi. In the next section, we perform a more comprehensive analysis of the hurdle rates that each company needs to achieve, as well as how they have performed over the past few years.

IV.

Measuring Investment Returns

The following table breaks down project characteristics by division. Company Adolph Coors

Division Beer Manufacturing

Anheuser-Busch

Entertainment Theme Parks

Anheuser-Busch

Beer Manufacturing

Brown Forman

Distilled Alcohol Manufacturing

Brown Forman

Crystal Manufacturing

Brown Forman

Luggage Manufacturing

Brown Forman

Wine Manufacturing

Molson

Entertainment/ Theme Parks

Molson

Beer Manufacturing

Molson

Building Materials Retailing

National Beverage

Soft Drink Manufacturing

Robert Mondavi

Wine Manufacturing

• • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •

Project Type Characteristics Long term Dollar denominated Non-cyclical Long term Dollar denominated Cyclical Long term Mixed financing – U.S., Mexico, Japan, and Great Britain Long term US and Canadian dollar denominated Non-cyclical Long term US dollar denominated Cyclical Long term US dollar denominated Cyclical Long term Variable due to weather/ environmental conditions Mixed currencies, Italian, French, Chilean, and US Cyclical Long term Dollar denominated Cyclical Long term Canadian Dollar Denominated Long term Canadian Dollar Denominated Cyclical Long term Domestic Non-Cyclical Long term Variable due to weather/ environmental conditions Cyclical Primarily dollar denominated w/ French and Chilean exposure

Project type characteristics of these companies are predominantly long term. Characteristics vary by division with regards to cyclicality, currency, and unique characteristics. Comparing return on equity (ROE) to the cost of equity and the return on capital (ROC) to the cost of capital shows the effectiveness of project selection. These values are presented in following table and chart.

Company

ROE

Adolph Coors Anheuser-Busch Brown Forman Molson National Beverage Co. Robert Mondavi Alcoholic Bev. Ind. Avg. Soft Drink Ind. Avg.

Cost of Equity

6.16% 28.90% 23.54% 2.53% 20.61% 17.50% 11.30% 34%

9.73% 9.63% 9.52% 10.57% 10.84% 14.41% 9.70% 11%

Equity Return Spread -3.57% 19.27% 14.02% -8.04% 9.77% 3.09% 1.60% 23.00%

ROC

5.47% 14.65% 19.78% 1.65% 12.71% 8.90% 9.25% 20.47%

Cost of Capital 9.39% 9.47% 9.32% 9.36% 9.37% 12.36% 8.86% 9.66%

Capital Return Spread -3.92% 5.18% 10.46% -7.71% 3.34% -3.46% 0.39% 10.81%

EquityReturnSpread/CapitalReturnSpread 25.00% EquityReturnSpread 20.00%

CapitalReturnSpread

15.00% 10.00% 5.00% 0.00% Non-alc. Beverage Ind.

Alc. Beverage Ind.

Robert Mondavi

National Beverage

Molson

Brown Forman

Anheuser Busch

-10.00%

Adolph Coors

-5.00%

Based upon these results, it appears that Busch, Brown-Forman, and National Beverage select good projects, but Adolph Coors and Molson choose poor ones. Depending on which perspective we choose – that of an equity investor or that of a firm investor, Robert Mondavi may or may not be selecting good projects. Economic value added applies the equity spread and the capital spread to the book value of the firm. The results of our calculations are represented in the following table.

Company Adolph Coors Anheuser-Busch Brown Forman Molson National Beverage Company Robert Mondavi

Equity EVA (in $MM) ($25.54) $778 $93.93 ($95.16) $5.54 $20.71

Firm EVA (in $MM) ($34) $787.07 $95.81 ($107.42) $6.42 ($13.95)

The EVA analysis mirrors that of ROE and ROC. Robert Mondavi has mixed results based upon the perspective of the investor. Adolph Coors and Molson have made poor project choices. Last, Anheuser-Busch, Brown Forman, and the National Beverage Company are earning returns on their investments more than the capital and equity invested. There are a variety of challenges facing the beer industry going forward, specifically for Coors and Molson. Forecasts for the beer industry are not optimistic, the industry faces stiff price competition and decreasing margins. The companies with the best fundamental performance in this category appear to be Anheuser-Busch and Brown Forman, who are diversified in a variety of different industries including theme parks, crystal and luggage. National Beverages is in a healthy position to take advantage of an anticipated 5% increase in world wide soft drink demand in 1998. Mondavi faces a variety of uncertainties. It is aggressively expanding its operations and is ever more exposed to the vagaries of California weather. The 1997 grape harvest was extremely strong, which threatens to trigger price competition in the premium category of California wines.

V. Capital Structure Choices Current Financing Mix The following is a comparison of the different financing arrangements and their maturities across the various business sectors of our companies. Anheuser-Busch Type of Financing Commercial Paper Medium Term Notes Sinking Fund Debentures Medium Term Notes Long Term Notes Foreign Denominated Notes Long Term Debentures Industrial Revenue Bonds ESOP Other L/T Debt Total

Dollar Amount $591.9M $62.5M $68M $250M $1,200M $675.2M $1,000M $198.4M $282.1M $37.5M $4,365M

Interest Rate on Books 5.5% 5.5%-8.0% 8.5%-8.625% 8.75% 6.75%-7.125% 4.1%-5.1% 6.75%-9% 5.625%-7.4% 8.3% Varied

Maturity Varied 1-3 years 1-20 Years 2 years 4 – 20 years 2-4 years 11-29 years

Varied 8 years

Brown-Forman Type of Financing Commercial Paper Medium Term Notes Long Term Notes Other Notes Total

Dollar Amount $155M $30M $17M $22M $224M

Interest Rate on Books 5.6% 6.82%-7.38% Variable 11.25%

Maturity 1 year 8 years 29 years 2 years 5.75 years

Interest Rate on Books 8.63% - 9.05% 6.76%- 6.95% 4.3%

Maturity 1-3 years 6 & 9 years 17 years Approx. 5 years

Interest Rate on Books 4.88% 7.5% 8.2%-9.1 Prime rate

Maturity 5 year 5 years 6-21 years 99 year lease

Coors Type of Financing Unsecured Medium Term Notes Unsecured Senior Notes Industrial Dev. Bonds Total

Dollar Amount $88M $100M $5M $193M

Molson Type of Financing Construction Loan Term Loan Debentures Land Lease Obligations Other Total

Dollar Amount $117.2M $157.7M $160M $50M $17M $501.9M

Approx. 8 years

National Beverage Corporation Type of Financing Unsecured Notes Unsecured Term Loan Capital leases Total

Dollar Amount $50M $16.6M $.268 $66.9M

Interest Rate on Books 9.95% 1.25% above Libor 8%

Maturity 3 years Current 1-2 years Approx. 1.5 years

Robert Mondavi Type of Financing Fixed Rate Secured Loans Fixed Rate Unsecured Loans Capitalized Lease Obligation Total

Dollar Amount $19.2M $89M $5.9M $114.4M

Interest Rate on Books 6.33%-10% 7.39% - 8.92% 6.96% - 8%

Maturity 1-8 years 2-10 years 5-13 years

Although the total debt balances vary by company within the sector, the composition of the debt is quite similar, with the exception of Anheuser-Busch, which has the most sophisticated debt arrangements of the group. The companies are primarily using a combination of unsecured notes and term loans to provide financing as well as revolving credit agreements.

Trade-offs on Debt versus Equity As shown below, a comparison of the advantages and disadvantages of debt relative to other companies in the industry shows many common characteristics. Factor Tax Benefit Added Discipline of Debt

Bankruptcy Cost Agency Costs Future Flexibility

All Companies See Table below labeled “Tax Rates” All of the companies are family run businesses and therefore have very significant stakes in their respective companies and do not need the discipline that debt provides. All of the companies, except Molson, have family members managing the day-to-day business activities. The Molson family has three members on the board of directors including the Chairman. See Table below labeled “Bankruptcy Costs” The companies are all family run and costs are more likely tracked very closely. Agency risk does not appear to be significant for these companies. This industry is not a high growth industry, but rather a mature industry. The growth has been slow or negative for these companies. All of these companies already have existing beverage facilities and there does not appear to be a significant need to expand further in the near term except Mondavi which is trying to expand its wineries and vinyards. Overall, financing flexibility does not appear to be an overriding factor. All continue to require debt for the continuation of their operations.

Tax Rates Company

Marginal Tax Rate Effective Tax Rate

AnheuserBusch

Brown Forman

Coors

Molson

35%

35%

35%

41.9%

National Beverage Corp. 35%

38.1%

38%

42%

40.7%

37%

Robert Mondavi 35% 39%

Ind. Avg.

38.79%

Bankruptcy Costs Company Anheuser-Busch

Brown Forman

Coors

Molson

National Beverage Robert Mondavi

Bankruptcy Costs Anheuser-Busch has had free cash flow (FCF) of less than $100M, on EBITDA of $2,053, over the last three years. However, they have taken on good projects in the past and their operating income has continued to rise which should help in stabilizing their cash flows. The bankruptcy risk should be fairly low given these factors and the size of the company. Brown-Forman has historically taken on good projects. They have FCF of approximately $50M on EBITDA of $337M. The company has had very consistent earnings as well as cash flows. Additionally they have been able to handle higher levels of debt in the past. The bankruptcy risk should be fairly low given these factors. Coors has taken on bad projects over the last few years. Their FCF has fluctuated and has not been that strong. Their earnings have also fluctuated from ($42M) to $78M over the last 10 years or so. The company has moderate to high bankruptcy cost and should be wary of taking on any new debt. Molson’s net income has been decreasing over the past few years and this, in turn, is reducing their FCF. Nonetheless, they did have a relatively high income balance each of last five years. With an exception of 1996 which is an anomoly. This company has a low risk of bankruptcy. National Beverage has had stable earnings that have ranged from about $18M-$20M over the last five years. Overall, cash flows have been positively stable. This company has a low risk of bankruptcy. Although Mondavi’s earnings have been stable, their FCF’s have continued to erode to a negative position. They should not be taking on any more debt and present a moderate bankruptcy risk.

A Qualitative Judgement Based on the above analysis, Brown-Forman and National Beverage appear to have some excess debt capacity and are in a position to take on new debt if necessary. Anheuser-Busch should maintain its debt position since its debt ratio appears to be about right. Robert Mondavi and Coors should be not taking on any new debt, and Coors should begin to reduce its debt due to its high earnings volatility and debt ratio.

VI. Optimal Capital Structure Current Cost of Capital and Financing Mix In Section III, we calculated the market value of equity from the top-down or bottom-up betas and the cost of debt from the estimated bond ratings. We then used a debt ratio weight to calculate the cost of capital. With the exception of Robert Mondavi, the costs of capital fell within a narrow range. Mondavi’s higher hurdle rate is due mainly to company’s higher cost of equity. Company Anheuser-Busch Brown-Forman Coors Molson National Beverage Robert Mondavi

Cost of Capital – Current 8.86% 9.32% 9.39% 9.35% 9.37% 12.36%

Comparison of Optimal Cost of Capital at Various Debt Ratios The table below presents the cost of capital as a function of debt ratio for each company. Cost of Capital Debt Ratio 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

AnheuserBusch 9.24% 8.91% 8.74% 8.85% 9.20% 10.41% 12.11% 13.01% 13.91% 14.81%

BrownForman 9.39% 9.08% 8.90% 8.89% 9.12% 9.70% 10.83% 12.69% 13.59% 14.49%

Coors

Molson

9.25% 11.43% 12.63% 13.83% 15.03% 16.23% 17.43% 18.63% 19.83% 21.03%

9.74% 9.40% 9.16% 9.04% 9.38% 9.59% 11.17% 13.10% 14.05% 15.00%

National Beverage 10.01% 9.67% 9.47% 9.25% 9.45% 9.64% 10.25% 10.32% 12.23% 12.98%

Robert Mondavi 13.15% 12.77% 12.74% 13.08% 15.02% 15.92% 16.82% 17.72% 18.62% 22.31%

The optimal debt ratio varies significantly within the industry. For example, Coors has a 0% optimal debt ratio while at the high end, National Beverage, Molson and Brown-Forman all realize their optimal ratio at 30%. It is unlikely that Coors will move to the 0% ratio, since it currently has outstanding debt that is rated BBB and will need to continue to use debt to help finance the activities of the company, and Coors is unlikely to be willing to give up any control.

(For further information on control of shares by the family, see Section I). Of the remaining companies, only Brown-Forman and Molson currently operate far from their optimal debt ratios.

Firm Value at the Optimal Debt Ratio The following are the formulas for the calculations in the ensuing table: Annual Cost Before = WACC (Before)*Firm Value Annual Cost After = WACC (After)*Firm Value Change in annual Cost = WACC (Before)*Firm Value - WACC (After)*Firm Value (We assumed an implied growth rate of 5% in firm value over time) Increase in firm value = Change in annual Cost*1.05/( WACC (After)-.05) Change in stock price = Increase in firm value/# of shares Outstanding Company Anheuser-Busch Brown Forman Coors Molson National Beverage Robert Mondavi

Annual Cost Before N/A $379.6M $131.8M $177.4M $23.7M N/A

Annual Cost After N/A $365.2M $129.8M $173.2M $23.4M N/A

Change in Annual Cost N/A $14.4M $2.0M $4.2M $0.3M N/A

Increase in Firm Value N/A $388.7M $49.4M $109.4M $7.4M N/A

Change in Stock Price N/A $5.54/share $1.41/share $1.87/share $0.40/share N/A

The above table shows that by moving to the optimal, Brown-Forman, Coors, National Beverage and Molson can all increase their firm value. National Beverage will only be able to increase their firm value by about $13M while Brown Forman will be able to increase their firm value by $389M. Therefore, moving to the optimal has very different effects on each company and, while it makes sense for Brown-Forman, National Beverage, Coors and Molson to move to their optimal, it is unclear whether these companies would since they maintain control through family ownership and probably value flexibility. Since Mondavi and Anheuser-Busch currently operate very close to their optimal debt ratio, we did not calculate new values for these firms.

Operating Income Variability As shown below, normalizing operating income by averaging over the past few years has little effect on the optimal debt ratios, except for Mondavi and Molson. However, since both

Mondavi and Molson have experienced sharp trends in operating income (although in opposite directions) over the past four years, we decided to use the optimal debt ratios calculated in the previous subsection with non-normalized income levels. Company Anheuser-Busch Brown Forman Coors Molson National Beverage Robert Mondavi

New Debt Ratio 20% 30% 0% 30% 30% 90%

Old Debt Ratio 30% 30% 0% 50% 30% 20%

Ratings Constraint Rating constraints are given in the table below. Most of the companies would probably be able to move to their optimal debt ratio without needing to impose a rating constraint. As all of these companies are family operated, they do not need the control afforded by debt. However, the companies may also be willing to finance with greater debt ratios, since they are not as concerned with the other stockholders and may not be concerned with debt ratings. Company Anheuser-Busch Brown Forman Coors Molson National Beverage Robert Mondavi

Optimal Debt Ratio 20% 30% 0% 30% 30% 20%

Optimal Rating BBB BB D BB BBB B

Constrained Rating 20% 30% 0% 30% 30% 10%

Constrained Debt Ratio BBB BB D BB BBB Min. A rating

Industry and Market Analysis Half of the companies have debt to equity ratios that are comparable to the industry average of 22%, with the exceptions of Brown-Forman at 8.09%, Molson at 53.61%, and National Beverage at 31.75%. As there is limited historical information on some of the companies, performing regressions with multiple variables would not provide a statistically significant information. The average debt to equity ratio for the overall marketplace is 24.28%,

which is above that of Coors, Anheuser-Busch, and Brown-Forman but below that of National Beverage, Molson, and Mondavi.

Summary The above analysis indicates that the companies’ optimal debt ratios are insensitive to “outlier years” since the results do not change when normalized incomes are applied (except as noted with Mondavi and Molson). It is unlikely that Coors will change its debt ratio since the potential change in firm value and the need for manager control are relatively small. However, Brown-Forman would be wise to move to the optimal since even with a ratings constraint the company can significantly increase firm value. National Beverage and Molson are also underlevered, however, not to the same degree as Brown-Forman. Thus, we do not anticipate a substantially change in leverage for these firms. Finally, Mondavi and Anheuser-Busch appear to be properly levered and will most likely not change their debt ratios.

VII. Mechanics of Moving to the Optimal Path to the Optimal The following table provides information on how our companies should move towards their optimal debt ratios. Although we provide suggestions on how they should achieve their optimal debt ratio, we anticipate that only Brown-Forman will change its leverage significantly. Company

Actual/Optimal

Threat of Takeover/Bankruptcy Rated BBB. It is a family owned business and it has been profitable for over 10 years. The firm has moderate to high bankruptcy costs. Rated A. It is below its optimal debt level but is not a likely takeover target because of its large size $23 billion and because of the large amount of stock held by insiders. Rated A+. Not at risk of a takeover because of the large amount of stock held by the family 70%.

Adolph Coors

Coors’ current debt ratio is 15.5% and the optimal is 0%.

Anheuser-Busch

Anheuser-Busch’s current debt level is 16% and the optimal is 20%.

Brown-Forman

Brown-Forman’s current debt level is 8% and the optimal is 30%.

Molson

Molson’s current debt level is 22.32% and the optimal is 60%

Rated A+. Not at risk of a takeover because of the family ownership of a large number of shares.

National Beverage

National Beverage’s current debt level is 24% and the optimal is 30%.

Robert Mondavi

Robert Mondavi is currently at their optimal debt ratio 20%.

Rated A- synthetically. Not at risk of a takeover because of the large percentage of shares held by the family. Synthetically rated A-. Not at risk of a takeover because of the large percent of shares that the family owns. The firm has moderate to high bankruptcy costs.

How should it move toward the optimal No new debt or arrangement of debt should be taken. If Coors wants to take on projects it should use equity to finance them. Earning above its cost of capital (8.86%) based on its ROC (14.7%). They are currently at their optimal level and should try to stay there. Earning well above its cost of capital (9.32%) based on ROC (19%). They should use debt to expand and invest over the next 5 years. Eaving problems earning above its cost of capital recently, but if the firm finds good projects it should use debt to pay for them. Above its cost of capital (9.37%) based on ROC (15%). They should use debt to expand and invest over the next 5 years. Currently at their optimal debt ratio 20%.

None of the firms are in serious danger of a takeover due to the large number of shares held by family members or the large size of the firm. Adolph Coors and Robert Mondavi are the

firms with the lowest ratings but are in little risk of bankruptcy. Anheuser-Busch, Brown Forman and National Beverage should continue to expand using debt since they are choosing good projects. They should use debt to take on additional projects because they are all below their optimal debt ratios and they can maximize firm value by approaching the optimal debt ratios.

The Right Financing for Our Firms The following table provides the project cash flow characteristics and types of financing that our firms should use. Business Sector • • •

Project Cash Flow Characteristics Projects are likely to be: long term primarily in dollars; some firms w/ foreign incomes non-cyclical

• •

Beverages (Non-Alc.)

• • •

long term primarily in dollars non-cyclical

• • •

Entertainment

• • • • • • • • •

long term primarily in dollars cyclical medium term primarily in dollars cyclical medium term (tied to store life) primarily in dollars cyclical

• •

Beverages (Alc.)

Home Furnishings Retail-Building Supply

• •

Type of Financing Debt Should be: long term dollar denominated but portions in foreign currency try to link to success of new products introduced long term dollar denominated try to link to success of new products introduced long term dollar and Canadian dollar denominated medium term in dollars

•

in the form of operating leases

•

Most of the projects in these sectors are long term and denominated in dollars. More specifically, the Beverage Sectors have long-term projects that include the introduction of new products and the building of new production facilities. Home Furnishings and Retail-Building Supply have medium term projects and have some operating leases. The duration of the debt in these sectors should match the length of the project.

Influences of Macro-Economic Variables on Firm Value and Operating Income Macro Variable Long Term Interest Rates Regression Coefficients for: (1) Firm Value (2) Operating Income

Real GDP Growth (1) Firm Value (2) Operating Income

Weighted Dollar (1) Firm Value (2) Operating Income

Inflation Rate (1) Firm Value (2) Operating Income

Company/Results of Regression (1) (2) Adolph Coors -10.20 17.80 Anheuser-Busch -1.99 17.30 Brown-Forman 0.68 -3.96 Molson 2.34 1.20 National Beverage 3.80 -7.10 Robert Mondavi 69.00 -11.40 Average 0.6 (-1.07) 2.31 Adolph Coors -8.00 30.50 Anheuser-Busch -9.02 9.30 Brown-Forman 2.23 -6.77 Molson -7.68 10.90 National Beverage 12.50 -11.90 Robert Mondavi 175.00 -31.80 Average 27.5 (-2.00) 0.04 Adolph Coors -1.24 3.94 Anheuser-Busch 0.60 -3.89 Brown-Forman 1.08 0.28 Molson 4.82 -5.22 National Beverage 0.77 4.80 Robert Mondavi 2.90 -0.41 Average 1.49 -0.08

Adolph Coors Anheuser-Busch Brown-Forman Molson National Beverage Robert Mondavi Average

-12.80 14.60 0.20 71.70 -3.87 -1.32 10.40 -9.20 -5.43 -26.20 8.60 5.80 -0.48 9.23 (-3.26)

Implications for Financing Although some of the individual regressions show some signs of longterm duration, on average the combined averages do not show signs of long term duration. It appears as the firms become stable, they should use short-term duration debt. On average, it appears that these firms are non-cyclical. The firm values seem to be influenced by cyclicalities on average, but when Robert Mondavi’s outlier is removed from the average the relationship is far less significant. The effect of the dollar does not seem to have a large effect on these firms. Therefore the majority of the debt should be issued in US dollars, but there is evidence to suggest that some of the debt should be issued in foreign currencies. This should be evaluated on a firm by firm basis. Again, conflicting results reveal that the companies are not consistent but on average the firm’s income seems to be effected by the inflation rate. This indicates that some of the sector’s debt should be issued at floating rates.

Looking at the regressions, a general sense of the types of debt that these firms should use is evident. It appears that the firms should use medium to long duration debt, but as the firm becomes more stable, the duration should decrease. Robert Mondavi is the best example of a firm that should use long-term debt, while Anheuser-Busch should use short-term debt. On average the firms do not appear to be cyclical, with the exception of Robert Mondavi. They also do not appear to be influenced by fluctuations in the dollar. The majority of the debt should be issued in dollars and does not need to be shielded from cyclicalities. The exceptions are Brown-Forman and Robert Mondavi, which have substantial investments internationally and

should issue a portion of their debts in foreign currencies. The firms’ incomes seem to be effected by the inflation rate; thus, some of the debt should be issued with floating interest rates.

Influences of Macro-Economic Variables on Sector Value & Operating Income Macro Variable Long Term Interest Rates Regression Coefficients for: 1) Market Value 2) Operating Income

Results of Regression Beverages (Alc.) -14.6 Beverages (Non-Alc.) 0.65 Entertainment 20.7 Home Furnishings 1.67 Retail-Building Supply 0.27

Real GDP Growth 1) Market Value 2) Operating Income

Beverages (Alc.) Beverages (Non-Alc.) Entertainment Home Furnishings Retail-Building Supply

-6.80 0.90 25.8 3.98 -2.74

Weighted Dollar 1) Market Value 2) Operating Income

Beverages (Alc.) Beverages (Non-Alc.) Entertainment Home Furnishings Retail-Building Supply Beverages (Alc.) Beverages (Non-Alc.) Entertainment Home Furnishings Retail-Building Supply

-1.14 -0.58 -0.17 -0.11 1.18 -67.7 -0.01 30.7 -1.24 1.69

Inflation Rate 1) Market Value 2) Operating Income

6.84 2.56 2.75 10.7 6.73 -20.9 6.39 9.70 23.9 1.61

1.69 0.38 0.57 1.43 -0.56 -14.7 -2.12 -9.05 3.20 -1.50

Implications for Financing Based on industry averages it appears that the duration of debt in the Beverages (Alcoholic) sector is 15 years. All of the other sectors that these firms are in seem to favor short-term durations of debt. The Alcoholic-Beverage sector seems to be influenced by cyclicalities. As the GDP rises the firm value and the income are reduced. The other sectors seem to be sensitive to cyclicalities as well but they tend to move with the GDP growth. This indicates a need for debt that protects from GDP fluctuations or reduced debt levels. Once again the Alcoholic-Beverages sector does not seem to be sensitive to fluctuations in the dollar. The other sectors are also not sensitive to fluctuations in the dollar. In the Alcoholic-Beverages sector the firm value and operating income are strongly influenced by the inflation rate. The relationship however is one such that when inflation increases the income and value decrease. Only the Entertainment sector’s value moves with inflation. This indicates that some of the debt in this industry should be a floating rate.

Some of the other sectors that the firms are in conflict with the type of debt that should be used in the Beverage Sector. Each firm should evaluate itself and adjust its debt accordingly. These regressions were computed using five data points for each economic variable and produced T-scores that were quite low, indicating that the data did not provide statistically significant results. Each firm should regress of its value and income and compare to the macroeconomic data. In general, the data presented here is a good estimate for the sector, but each firm should be aware of its differences from the sector and make adjustments accordingly.

VIII. Dividend Policy With the exception of Mondavi and the National Beverage Corporation, the companies have historically used a mix of dividends and stock repurchase programs to return cash to their investors. The National Beverage Company initiated its first stock repurchase program in 1997 and has never paid dividends. The tables below summarize the cash returned to shareholders for each of these companies and the corresponding dividend ratios. Company Adolph Coors Dividends ($millions) Stock Repurchase ($millions) Cash to Stock Holders ($millions) Anheuser-Busch Dividends Stock Repurchase Cash to Stock Holders Brown-Forman Dividends Dividends Stock Repurchase Cash to Stock Holders Molson Dividends Stock Repurchase Cash to Stock Holders Nat'l Beverage Co. Dividends Stock Repurchase Cash to Stock Holders Robert Mondavi Dividends Stock Repurchase Cash to Stock Holders Company Adolph Coors Anheuser-Busch Brown Forman Molson National Beverage Company Robert Mondavi Industry Average

1997

1996

1995

1994

1993

18.98 2.95 21.93

19.07 9.94 29.01

19.15 9.94 29.09

19.00 19.00

18.80 18.80

492.60 587.10 1,079.70

485.90 770.12 1,256.02

429.50 393.40 822.90

389.80 389.80

370.00 370.00

73.00 73.00

71.00 71.00

67.36 67.36

73.84 73.84

71.56 71.56

39.18 39.18

35.56 35.56

40.05 40.05

36.82 0.02 36.84

38.22 120.28 158.50

1.20 1.20

-

-

-

-

-

-

-

-

-

Dividend Yield

Dividend Payout

1.62% 2.18% 1.89% 2.81% 0.00% 0.00% 2.50%

68.50% 46.26% 27.00% 180.00% 0.00% 0.00% 39.09%

The dividend yield for the industry is relatively small, which is also reflected in the companies represented here. Anheuser-Busch and Molson pay the most of their earnings in the form of dividends. However, it is clear that Molson is paying out more than it can afford.

Trade-Offs on Dividend Policy The following tables provide detailed discussions of the ramifications of the dividend policies of each company. Stockholder Tax Preferences Company Adolph Coors Anheuser-Busch

Brown-Forman

Molson National Beverage Company Robert Mondavi

Implications Given Coors’s long history of consistent dividends their shareholders clearly have a preference for dividends. Busch’s shareholders are predominantly institutional investors who would not normally desire dividends however their dividend policy has been in place for over ten years and recent shareholders might prefer dividends. The majority of Brown-Forman’s investors are family members, given the consistent history of dividends family members seem to prefer dividends as a source of income. Molson has a long consistent dividend policy the average investor is likely to have a preference for dividend income. The company has not used a consistent dividend policy or stock buyback program implying that its shareholders prefer capital gains. The company has never paid dividends or used dividends it investors are interested in capital gains.

Information Effects and Signaling Incentives Company Adolph Coors Anheuser-Busch

Brown-Forman Molson National Beverage Company Robert Mondavi

Implications Coors should not have to use dividends as a signal to markets in the fashion that it does. Anheuser-Busch is one of the most well followed beer companies in the United States and does not need to rely on dividends for communications with markets. The company uses dividends as a signal unnecessarily; the vast majority of its investors is family members and should not need these signals. Molson is a large well followed firm in Canada and should not need to use dividends as a signal of its health. The insiders who are the majority of National’s investors do not need stock repurchase as a signal from the company. The company has eight analysts following the stock and does not need stock repurchase or dividends to signal markets.

Effects on Flexibility Company Adolph Coors Anheuser-Busch Brown-Forman Molson

National Beverage Company Robert Mondavi

Implications Coors is in a low growth industry, consistent markets share, and has control over its financial needs flexibility is not a high priority. Busch takes on long term projects and has produced consistent earnings over its long history future flexibility is not an important factor. Brown-Forman has highly consistent earnings and exercises a great deal of control over its projects; future flexibility is not meaningful concern. Molson has recently gone through a difficult period where earnings have declined, future flexibility might be a concern however dividend payout is relatively low. Although, National is in a mature slow growth industry, it is a relatively new company and probably values flexibility. Mondavi is attempting to grow quickly taking on a variety of new projects. They have had relatively consistent earnings but variable cashflows. Future flexibility is very important.

Bond Covenants and Rating Agency Concerns Company Adolph Coors Anheuser-Busch Brown-Forman Molson National Beverage Company Robert Mondavi

Implications Coors bond covenants do not pertain to dividends, No restrictive bond covenants, rating is not likely to be concern. No restrictive covenants, rating is not likely to be a concern Neither bond covenants nor rating would be a concern for Molson. No restrictive bond covenants, rating is not likely to be concern. No restrictive bond covenants however, a change in rating is likely to be a concern if a dividend policy is initiated.

The mature nature of the beverage industry, predictable earnings, and long-term projects of these firms suggest that returning cash to investors is a reasonable policy. However, several of these companies have been paying out more in dividends and stock repurchases than their free cash flow to equity. For instance, Anheuser-Busch may be repurchasing stock in order to move to their optimal debt ratio. This suggests that adopting stock repurchase programs might be a more effective means of returning cash to stockholders, particularly to a company such as Molson, which has had decreases in earnings but has been obliged to pay dividends to its shareholders. Many of these firms have been paying dividends consistently for many years, and investors would be upset if the dividend policy were changed, with the exceptions of Mondavi and National Beverage Company. Mondavi has been reinvesting in the firm heavily and has not returned cash to investors, nor has it been able to do so. National Beverage Company has just instituted a repurchase program to return cash to its investors, but still returns only a minimal amount of cash to shareholders.

IX. Dividend Policy: A Framework Free Cash Flow To Equity (FCFE) between 1993 and 1997 The following tables shows the free cash flow to equity and the actual cash to shareholders for each firm over the past five years. Firm Adolph Coors Anheuser-Busch Brown-Forman Molson National Beverage Robert Mondavi Average

Net Income $23.34 $925.60 $264.91 $21.04 $7.17 $21.65 $210.62

(Cap Ex-Depr)*(1-DR) -$29.09 $341.52 $7.69 $87.82 -$1.67 $16.42 $70.45

Chg in WC*(1-DR) -$4.13 $3.94 -$18.30 $13.21 -$1.03 $24.84 $3.09

FCFE -$9.88 $580.14 $275.52 -$79.98 $9.86 -$19.60 $126.01

On average, the firms could have returned $126 million in cash to its stockholders in dividends or stock repurchases.

Average payments to equity between 1993 and 1997 Firm Adolph Coors Anheuser-Busch Brown-Forman Molson National Beverage Robert Mondavi Average

FCFE -$9.88 $580.14 $275.52 -$79.98 $9.86 -$19.60 $126.01

Dividends + Stock Buybacks $18.73 $778.30 $71.35 $62.03 $0.24 $0.00 $155.11

Some of the firms actually returned more to the stockholders in the form of dividends and stock buybacks than they had in free cash flow to equity, and are thus paying more than they can afford. This of course will not continue indefinitely. Over the past few years, Adolph Coors, Molson and Robert Mondavi averaged negative free cash flows to equity. Robert Mondavi did not return any cash to the stockholders, but Molson and Adolph Coors did. Anheuser-Busch paid more to the stockholders than it had in free cash flows. This indicates a strong desire by stockholders in this sector to have cash returned to them.

Trust in management It appears that the management at these firms take strong interest in the stockholders’ needs because the average payback to stockholders is larger than the free cash flow to equity. The investors in these firms have come to expect cash paybacks to the stockholders and currently some of these firms do not have enough free cash flows to pay them. In the short-term, it appears that the managers of these firms are very committed to the stockholders, which may be due to the family ownership and control of the companies. Stock price performance is another indicator of how much these firms should be trusted. The companies are consistent in their performance in this area, with the exception of Molson – which has incurred annualized returns of –11%. The rest of the firms have above average gains, topped by Mondavi and National Beverage Corporation, which have returned over 30% more to investors than similar firms and the market. The last criterion is the firms’ investment policies. Below is a five year average of each companies’ investment returns (i.e., return on equity, return on stock, and required returns).

Return on Equity and Stock and Required Returns (5-year Average) 60.00% 50.00% 40.00% ROE

30.00%

ROS

20.00%

Required Returns

10.00%

vi

e ev

tM on

er

da

ag

n so ol

ob R

na io at N

er

lB

now Br

er us he An

M

Fo

sc Bu

oo C

ph ol Ad

rm

h

rs

-10.00%

an

0.00%

As you can see from the chart, Brown-Forman, National Beverage and Robert Mondavi all had returns on stock that exceeded their required returns, while only Brown-Forman’s return on equity exceeded its required returns. On average, Adolph Coors and Anheuser-Busch have not achieved their required returns.

Conclusions Adolph Coors, Anheuser-Busch, Molson and Robert Mondavi cannot continue to pay more to equity than they have in free cash flow. Of these companies, Anheuser-Busch is in the least troublesome position due to its size and the relative difference between the cash flow and payments to equity. Anheuser-Busch has earned some flexibility in their dividend policy and should try to reduce their high dividend payout of 46%. Adolph Coors, Molson and Robert Mondavi, on the other hand, are in precarious positions since they have negative free cash flows to equity. Mondavi has not made payments to equity and should not until their growth stabilizes. Coors and Molson are stable firms and need to increase their cash flows to equity if they wish to continue with their current dividend policy. National Beverage and Brown-Forman have demonstrated better performance with respect to free cash flow, and may therefore be more trusted by their stockholders. As a growth firm, National Beverage should continue with its 0% payout policy until growth subsides, and should subsequently set their payout ratio close to the industry average of 39%. Brown-Forman has a consistent dividend policy with a payout ratio of 27%, which is lower than the alcoholic beverage industry average of 39%. Brown-Forman is now a stable firm and should move the payout ratio closer to the industry average. Both National Beverage and Brown-Forman have earned some leeway on their dividend policy due to their high performance with respect to their capital returns on stock.

X. Valuation Model Selection Mondavi, National Beverage Corporation, and Anheuser-Busch We valued Mondavi, National Beverage Corporation, and Anheuser-Busch using a 2stage FCFE discount model since we expect these companies to grow at double-digit rates, but with no substantial change in debt ratio. Although Anheuser-Busch has realized only moderate EBIT growth over the past 5 years, the company has gone through some restructuring and is poised for exceptional growth. Moreover, Mondavi and National Beverage are both relatively small and do not present high barriers to entry, so we expect their exceptional growth period to be limited to approximately 5 years. Anheuser-Busch has brand equity as a barrier to entry, but we feel that the barrier is declining with the heightened popularity of other small and moderately sized alcoholic beverage companies. Thus, we also used a 5-year exceptional growth period for Anheuser-Busch. Brown-Forman We valued Brown-Forman using a stable growth FCFF model since Brown-Forman has low expected growth, and we anticipate a change in debt ratio towards its optimal. Coors and Molson We valued Coors and Molson using a stable growth FCFE model because these companies have low expected growth, and we do not anticipate any significant change in debt ratio.

Estimation of Inputs The inputs are summarized for each firm on the pages following this section.

Valuation A schematic representation of each firm’s valuation is given on the pages following this section. We valued our companies as follows: Anheuser-Busch, Mondavi and National Beverage Corporation: The present value of the free cash flow to equity (per share) is added to the present value of the terminal value (per share) to determine the value of equity per share, which are shown below for Anheuser-Busch, National Beverage Corporation and Mondavi. Value of Equity Per Share for Anheuser-Busch = $52.76 Value of Equity Per Share for National Beverage Corporation = $12.75 Value of Equity Per Share for Mondavi = $44.03 Brown-Forman: The present value of the free cash flow to the firm is used to determine the value of the firm, which is shown below. Value of Brown-Forman = $3056 Million We next subtracted the market value of existing debt of $313 million from this value to arrive at the value of equity. Value of Equity for Brown-Forman = $2743 Million Finally, we arrived at the value of equity per share by dividing by the number of shares: Value of Equity Per Share for Brown-Forman = $39.07 Adolph Coors and Molson: The present value of the free cash flow to equity (per share) is used to determine the value of equity per share, which are shown below for Adolph Coors and Molson. Value of Equity Per Share for Adolph Coors = $29.03 Value of Equity Per Share for Molson = $12.44

Analysis The current and forecasted stock prices are shown graphically below. Our analysis indicates that Anheuser-Busch, Mondavi, and National Beverage Corporation are currently undervalued, while Adolph Coors, Brown-Forman, and Molson are overvalued. On a percentage basis, National Beverage Corporation is most undervalued (by 23% of the current price), and Molson is the most overvalued (by 52% of its current stock price).

Current & Forecasted Stock Prices 60

50

40

30

Current Valuation

20

10 0 National Beverage

Coors

Mondavi

BrownForman

Molson

Anheuser Busch

Sensitivity to Assumptions All of these valuations incorporate subjective parameterization, and the appraisal can be sensitive to these specifications such as the assumed debt ratio changes. For example, the value of Adolph Coors goes from $29.03 per share to $28.43 per share when the debt ratio changes from the current value of 15.5% to the optimal of 0%. However, most of our firms (except

Brown-Forman) are near their optimal debt ratio, so the magnitude of debt change effects is small. The assumed growth rate of the stable growth period has perhaps the most significant effect on the valuations. The results of a growth rate sensitivity analysis are provided below.

Stock Valuation as a Function of Stable Phase Growth Rate $160.00 Stock Valuation

$140.00

Adolph Coors

$120.00

Anheuser Busch

$100.00

Mondavi

$80.00 $60.00

Brown-Forman Molson

$40.00

National Beverage

$20.00 $1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% Growth Rate

From the chart, we see that the stock valuations are quite sensitive to the assumed stable phase growth rate. For example, the valuation of Brown-Forman increases from $39.07 at a growth rate of 5% (as in our previous analysis) to $62.50 at a growth rate of 7%, as compared with the current stock price of $55.25. Moreover, the valuation of Molson jumps from $12.44 at a growth rate of 5% (as in our previous analysis) to $23.76 at a growth rate of 8%, as compared with the current stock price of $25.75. Likewise, the valuations of the other firms can be made consistent with the current stock prices by altering the growth rate assumptions.

Summary of Valuation The previous sensitivity study indicates that valuations are quite sensitive to model input assumptions. By iterating on input parameters, valuations can altered to provide values that

match the current stock price. Obviously, this procedure invalidates the valuation. In our initial valuation, we attempted to use a combination of historical financial data and objective assumptions to forecast future free cash flows, then discounted the case flows by either the cost of equity or cost of capital to determine equity value. Although our valuations are much different than the current stock prices in two cases, we are fully confident in all of our results. For example, our valuation of Molson indicates that its stock price should be approximately 50% of the current value. This is a surprising result, however, we believe that the company has been taking poor projects and, against better judgement, paying dividends far exceeding earnings. Thus, we feel that the current price is well above what is deserved. The other company that we significantly undervalue is Brown-Foreman; a valuation that we found to be quite sensitive to the growth rate assumption. In our best estimate, however, we believe that Brown-Foreman is overpriced at the current stock price. All other valuations are close enough to the current stock prices to conclude that they are reasonably valued in the stock market.