Over the last decade there have been hundreds of transactions in the beer distribution space. The impetus for consolidation has come from the top-down strategy of the breweries and the bottom-up ambition of distributors. Like a great many things before the onset of the financial crisis, the underlying strategies compelling distributor consolidation and deal pricing made better sense then.
During the last 10 years, major changes have occurred in the financial reporting process. The movement of financial reporting from a system of almost purely historical cost to one more focused on market value is now well established. In 2001 and 2002, the Financial Accounting Standards Board (FASB) enacted new rules concerning the manner in which business combinations must be accounted for. At that time, the use of the “pooling-of-interests” method was abandoned in favor of the “purchase method.” The purpose for the change was multi-faceted, but the overriding goal was to promote a more relevant accounting representation of the economics of a given transaction and its composition, namely the value of the intangible assets acquired in a transaction. To the degree a buyer in a merger paid consideration in excess of the net tangible asset value of the seller (inventory, fleet, and warehouse), such excess is required to be booked as specific intangible assets, whether definite-lived or indefinite-lived in nature, with the residual amount recorded as goodwill. For beer distributors, the value of “brand distribution rights” generally falls into the category of an indefinite-lived intangible asset. The exercise of assigning fair value to the assets acquired in an acquisition is referred to as purchase price allocation, the process for which is defined under Statement of Financial Accounting Standard (SFAS) 141R. Based on surveys of financial data published by the National Beer Wholesalers Association and Risk Management Associates, the average beer distributor has approximately one-quarter to one-third of its total assets booked as a “distribution rights” intangible.
Prompted by tightening credit and compounded by disconnects between buyers and sellers on deal valuations, consolidation has slowed and deal flow will likely remain modest as distributors digest emerging news concerning brewery strategies on distribution. Given the gloomy economic outlook and increased uncertainty in the market today, the carrying value of “distribution rights” could require restatement. Under SFAS 142, the carrying value of an indefinite-lived intangible asset or goodwill cannot exceed its “fair value.” Carrying values must be subjected to periodic tests for impairment. Should such distribution rights fall short of fair value as defined under SFAS 142, then the asset is considered impaired and must be written down to its fair value. Just as fair market value has a specific meaning under the tax code, fair value has specific meaning for financial reporting purposes and is defined in SFAS 157, Fair Value Measurements. The nuances of the numerous FASB pronouncements applicable to beer distributors is beyond the scope of this article; however, since distribution rights often represent the majority of value acquired in a transaction, SFAS 142 is a particularly relevant and timely pronouncement.
Auditors are increasingly requiring their clients to obtain an independent valuation analysis to determine if the carrying values of intangible assets are free of impairment. Keep in mind that SFAS 142 does not require the restatement of the carrying value unless the asset is determined to be impaired (again, worth less to a market participant than reflected in the financial statements). For beer distributors, fair value accounting procedures have become compulsory and likely represent an opportunity for distributors to reform their thinking about the valuations that should govern future strategic decisions, as well as influence shareholder expectations.
If your distributorship has grown via acquisition and the legacy of those deals resides on your balance sheet as a large distribution rights asset, the value of that asset may be impaired. The reality is that numerous advisors in the deal market are on the record proclaiming that the rules of thumb have changed and the financial realities of the market represent lower cash flow multiples. Lenders echo this new reality with less favorable credit terms and with requirements that buyers bring equity to their deals. Those distributors paying big multiples for territory and brand rights who have not markedly improved the margins, market share, and/or operations of their predecessors likely face the challenge of testing these assets for impairment. Beer distributors are main street players in their regional economies and communities. However, Wall Street realities and accounting requirements are knocking at the door.
This is not to say that most transactions in the beer distribution space were bad deals or lacked a sound economic rationale. Most beer distributors are savvy operators and who relied upon the financial feedback of their breweries concerning territory and brand acquisitions. Like many business platforms in the world today, the rules are simply different, or least more stringent, than before. The nature of change in so many markets is exactly the purpose behind enhanced financial disclosure and reporting rules. Many distributors could care less what the financial statements say, particularly as a result of accounting rules that may lack a certain operative and intuitive sense. However, auditors have a keen interest in compliance with the pronouncements that govern the accounting function, not to mention the financial opinions that lenders rely on. Shareholders also need to understand and reconcile the economics of past transactions.
Mercer Capital has a combination of industry, valuation, and financial reporting expertise that is uncommon in the beer distribution space today. Distributors face rising scrutiny with lenders and auditors because historical valuation metrics simply do not translate to today’s transaction environment. Last, but certainly not least, is a challenging world of expectations for many distributors and owners who could face strategic attrition and/or outright termination as brewery strategies surface and evolve. In this environment, what is the fair value today of yesterday’s transactions and how can this new reality be turned into the power of information for better reasoned decisions tomorrow? For a confidential assessment of your strategic and financial reporting needs, call me at 901.685.2120.