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Brewdog: Should you invest?

Introduction

BrewDog the Scottish brewer are raising capital by a crowd-funding. This is their 5 th crowd-
funding exercise in the UK and is referred to as Equity for Punks V, or EFPV). The offer of shares
closes on 15 January 2018 (there is a possibility of extending this).

The offer is available to residents of 29 countries. At time of writing there are almost 65k investors,
including almost 18k investing in EFP V (fifth round). Majority are in UK but Sweden is
approaching 2k investors and Norway has more than 1k.

I have been considering investing again in this round having invested in the EFP IV round. A
couple of my friends asked for my views about the value of investing, and it is easier to write these
down than to explain to each person.

An investment comes with freebies and discounts in both the BrewDog bars and online store. This
report considers the shares on offer only from and investment perspective.

If you are considering investing, you should read the prospectus published at brewdog.com.

The target is to raise £10m. At the issue price of £23.75 per share the company would be valued at
£1.7bn.

With equity markets being fully to overpriced (certainly not cheap) and yields of fixed interest
markets being so low, it is difficult to find attractive investments for your capital. The value of
stock picking has arguably never been higher.

Brewdog is not listed so you will not be able to sell your shares at any time. Every year a trading
window is opened. However only existing shareholders can trade between each other which limits
liquidity. The two founders who together own 46.5% of the shares have indicated that a listing can
be expected in between 2 and 5 years time. They are cognisant that listing too early could give
away future growth to new shareholders at the expense of existing shareholders. Indeed this would
have happened if they had listed 2 or three years ago.

You should therefore only invest if you can be in it for the medium to long term.

Disclaimer.

The views expressed are my own. All the facts and information contained herein are as discovered
by me from public sources and are represented on a best efforts basis. There has been no peer
review of checking of the information gathered or my interpretation thereof. If anything in this
write up is crucial to a decision by you to invest or not, please verify that information independently
for yourself. I take no responsibility for your actions which may be influenced by me.

I do own some Brewdog shares so in this respect I am not independent. Nevertheless what Ive done
is look at a new investment and have attempted to be totally dispassionate so that I make the right
decision about whether to commit more funds or not. I have no connection with Brewdog (other
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than the shares) or anyone at Brewdog.

I'm not a stockbroker or investment advisor. I have been investing in stocks and shares for 35 years.
I have been invested in BrewDog since early 2016 (EFP IV), and topped up in the trading window
in late 2016. I have been a consumer of their products for a little longer.

Conclusions

A brief summary of my conclusions is set out below. The rest of the report sets out more detail as to
how I came to these conclusions.

1. Brewdog is an excellent company with strong track record of growth. They have grown
from a start-up in a garage in 2007 to sales of about £110m in 2017, a period of only 10
years. Recent growth rates have been in excess of 50% pa.
2. They have an excellent product, very strong top management with great marketing flair.
3. They have grown mainly in the UK but have a good footprint in Continental Europe too.
The latter is being given more focus now.
4. They are investing in the US, with their second brewery based there and which came into
operation in late 2017. With the very high quality product and strong marketing abilities it is
difficult to imagine that the US initiative will fail (many companies have ventured into the
US unsuccessfully). The question is more what size business can they build and will this be
slow or quite quick.
5. They also have expansion plans for Asia and Australia.
6. The main risk in my opinion is key-man risk. The founders are the real force behind the
business. Over time this can be reduced by building a good senior team.
7. I estimate a share price of something in the region of £35 to £70 in 5 years time; from the
issue price of £23.75. This is my subjective 10th percentile - 90th percentile range, with my
best central estimate (50 th percentile) being £60. This would represent an increase of 152%
or an annual compound rate of return of 20.4%.
8. If the nascent spirits enterprise, Lone Wolf, grows anywhere near as fast as Brewdog has,
that could easily add a further £5 to £11 to the share price. I've not added anything for Lone
Wolf (in the numbers in 7 above) on the basis that it is very new and may initially not
produce meaningful sales. Note that Lone Wolf can and will leverage the Brewdog bars as a
platform for sales and marketing.
9. Overall my opinion is that whilst the price of £23.75 puts a chunky value on Brewdog, the
expected growth more than justifies this value (UK still has lots of potential, Europe, US,
Asia, hotel/s, online sales, and the new spirits company). I think you would have to look
long and hard for a better investment. You are not likely to multiply your money by 10 or 20
times (like some of the earlier investors), however there is less risk now as the quality of the
operation is clearer. Over 10 or 20 years, who knows what might happen.

Background

The salient details are set out in the prospectus. If you are serious about the company you can also
visit a Brewdog bar if there is one near you. Take a look at the website too, particularly the online
shop as this is what customers use.
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I set out some of the highlights from the prospectus here, very briefly as well as some of my
personal thoughts and analyses, including numbers and and comparisons to other brewers. I have
included some BrewDog (“BD”) information that is not from the prospectus; gleaned from the
website shareholder forum, or the investor Q&A's, for example.

The Company and the market

Started 10 years ago in the garage of the mother of one of the founders.

Their first crowd-funding EFP I was in 2010. They are now approaching £50m raised through
crowd-funding which I believe is a global record.

Sales for 2017 are estimated at £110m, up 53% on 2016. The average annual compound increase in
sales has been 54.9% over the last 3 years, 59.7% over the last 5 years and 65.0% over the last 7
years.

They are the only company to appear in the (UK) Sunday Times Fast Track 100 list for six
consecutive years (fastest growing companies in the UK).

They are the largest craft brewer in Europe and the fastest growing in the world.

Sales are still mainly in the UK (81% for 2016). However Europe is growing. Sales to Europe were
constrained in 2016 due to capacity issues and the UK was prioritised. They have 30 bars in the UK,
14 in Continental Europe, 1 in Sao Paulo and 1 in Columbus, USA. The bars sell BD beers as well
as curated “guest” beers.

With capacity issues now sorted, BD is putting some focus back on Europe. This is a vey large beer
market, however craft accounts for only 2%. This represents and opportunity to increase the craft
market, as BD have done very successfully in the UK. The bars are good for gaining exposure.
These were the only outlets for their beer initially in the UK but their products are now available in
all the main supermarkets and at many restaurants and hotels. Indeed BD now accounts for 1.5% of
all of the UK off-sales and 44% of craft category off-sales.

The US is a large market with a well developed craft market accounting for 12% of total sales. In
2016 US total beers sales at retail amounted to $108bn of which the craft category was $23bn. BD
have commenced production in the US and have a bar on the same site as the brewery, with 2 more
bars in the area under construction. They have started on a craft-beer themed hotel as well,
expected to open in 2018. This will be good from a marketing perspective. The plan is to grow
their US business as best they can. A crowd funding in the US did not go to plan and only raised
$7m. This was for shares in the US subsidiary; the subsidiary is 2% owned by individuals and 98%
by the UK holding company. It is not too surprising that the US crowd-funding did not go well as
no trading had commenced in the US at the time. I'm sure there will be further windows for the US.
In the UK the shareholders (Equity Punks as they are called) are loyal ambassadors for the company
who buy the products and take their friends and families to the bars. This will probably be
replicated in the US, targeting specific areas initially as springboards for a national presence further
down the road.

Despite only entering the US market late in 2017, they managed to pick up a bronze medal at the
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Great American Beer Festival.

They currently have 2 breweries; one in Ellon, Scotland and one in Columbus, Ohio which was
opened in the latter part of 2017. Capacities are 1m HL and 0.64m HL respectively giving a
combined capacity of 1.64m HL. They are currently investing in Ellon to increase capacity and are
also developing a sour beer facility there. They are planning to build breweries in Asia and Australia
and have stated that within 2 year they will be the only craft brewer with production facilities in
Europe, the US and Asia. Although sales in China are still small, in 2015 they grew by 91%
followed by 117% in 2016 to reach 1.6% of global sales.

The company looks after their staff. Ten percent of all future profits go to staff on an equal share
basis (i.e. not based on seniority, everyone gets the same share). I find the staff very friendly,
helpful knowledgable. Unlike most businesses, the staff actually seem to enjoy their work.

Globally beer sales have been falling in developed markets but rising in developing markets.
However the craft (and premium and super-premium) segment has been growing rapidly.

BD is a nice “clean” company which has grown organically rather than through acquisitions and in
a way that is true to and focussed on the vision of the founders. The mainstream beer market has
been consolidating so many companies are dealing with takeovers which add quite some strain.
They also have diverse and outdated infrastructure. BD's main challenges have been coping with
rapid growth and funding this growth. These strains have not compromised the company which has
a very clear vision regarding having a top quality product range and looking after their people.

In 2017 TSG Investment took a 23% stake which valued the company at £1 billion (Enterprise
Value). This included £100m cash injection into the company for new shares, as well as the
purchase of existing shares mainly from the founders. TSG has backed many brands which have
subsequently performed well, mainly in the US. They also invested in Vitamin Water which is an
international brand.

Management

The quality of the management and leadership is arguably the most important determiner of the
success or otherwise of a company.

I believe BrewDog has exceptionally strong management in the two founders, James Watt and
Martin Dickie. They have that rare combination of being exceptionally strong technically as well as
being very strong marketeers. Both hail from Scotland.

James has an honours degree in Law & Economics, is a qualified deep sea Captain and is one of
Europe's only holders of the title of Master Cicerone (for the Brits, he is also an MBE and was
Great British Entrepreneur of the year in 2014). His marketing abilities are par excellence in my
opinion.

Martin has a first class honours degree in Brewing and Distilling from Heriot Watt University. It is
amazing to listen to him speak about BD's beer. He's also an MBE.

The two seem to complement one another.

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The passion for their craft (brewing mainly) is evident from reading what they have written and
watching them on YouTube. I have also seen them in action at Investor Q&A road shows. They
live and know beer! At both of the Q&A's that I attended, there was a great deal of discussion of
beer and their latest and forthcoming developments. Beers were handed out and tasted and
commented on in detail! I don't think you would see that at Anheuser-Busch or Heineken!

Some of their marketing stunts are legendary. Driving a military tank down Threadneedle Street
past the Bank of England; brewing the strongest beer in the world; brewing a beer called Make
Earth Great Again using ingredients sourced from areas affected by climate change and delivering a
case to the White House.

These guys know beer, are passionate about beer, know how to market themselves and their
company. They have delivered over a period of 10 years building a successful fast growing
company. Whats not to like?

For the numbers section I trawled through some of the main players in the brewing industry, mainly
to get a feel for valuations. It struck me that the annual and other reports, whilst very lengthy, really
did not mention the products (beer) much. Where they did, it was in terms of branding and price
levels, market shares, packaging, not the intrinsic features or qualities of the products.

It seems to me that the big companies in the industry are lead by people who know very little about
beer or their own products. The reams of reporting cover things like remuneration committee
reports, cost savings initiatives, complex business combination issues (buying and selling each
other!) and special projects that seem to have nothing to do with the product. They are also fighting
the reduction in main stream beer sales in the main markets, and trying to find a solutions to the
threats posed by the growth in the craft. The main answer though is to try and buy other craft
brewers and also to “create” craft products through mainly marketing rather than actually up-
skilling their “craft”. In my opinion the big generic brewers are not able to compete with the likes
of Brewdog when it comes to product quality. Don't get me wrong, they make excellent and
consistent beer, but it is actually a different product to the likes of what BD produce (good but
generic and bland). This can only be good news for BD.

There are many really small Craft breweries who make excellent beer, and BD has collaborated
with some of these and sells some of these other companies' products in the Brewdog bars (this
became important when Brewdog could not meet the demand for their own beers!). However most
of these are not in the same class as Brewdog when it comes to scaling-up their small operations.
Brewdog have been very successful in scaling up without losing the intrinsic character of their
beers.

I see BD as unique in being in a position between the giants and the micro brewers; they do quality
in volume. Volume is a relative thing though. In their most established and successful market, the
UK, Brewdog is aiming to produce 1% of all beers drunk by 2020 so are actually still very small.

Some question whether BD can grow volumes and remain essentially craft. This is a tricky
question. My own view is that beer comes in a range of qualities. i.e. rather than classify the market
into craft and non-craft, I would segment as economic, regular, premium and super-premium (note
that BD segment their own between “headliners” and other categories such as “amplified”,
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“seasonal” and “small batch”. BD are in the premium to super-premium bracket. They have been
able to achieve this at volumes far exceeding what the micro-brewers push out. I don't see what is
stopping them from increasing volumes further. In other words I am not convinced that scale and
quality are mutually exclusive. Remember that the big brewers are run by people who do not really
know anything about beer (my opinion) and who are primary concerned with running a mega-
organisation than with brewing beer. This explains the blandness and regularity of their product
more that the fact that they do vast volumes, though undoubtably it must be more difficult when
volumes are so large.

The thoughts of the founders on the issue of craft vs volume are set out in the Appendix, section 3.

There is a very strong alignment of interest between management and ordinary shareholders. They
are major shareholders and in it for the long term. Each 10% increase in the share price represents
about £42m in value to James and £37m to Martin (based on the EFP V issue price of £23.75 per
share). This compares to the big “competitors” where the interests of top management are more
aligned with keeping their jobs and short term share price increases (take their share options, cash in
and run). The tenure of most top managers is short and insecure, so this results in a very short term
focus.

The numbers

To get a handle on the value of listed brewers I gathered the following from publicly available
information (please note my work has not been checked):

*Earnings before Interest, Tax, Depreciation and Amortisation.

** Enterprise Value (EV) is MC plus Debt minus Cash&Equivalents, plus Minority Shareholder Interests. If
a company has significant debt and/or cash, EV is a better measure of the “value” of an enterprise than the
market capitalisation.

Unfortunately I could not find much information on the smaller craft brewers.

The growth rates of the above companies for the latest year(annual revenue):

Heineken: 1.4%
Diageo: 14.9%
Molson Coors: -1.8%
Carlsberg: -0.5%

The growth rates for Brewdog and several other craft brewers are set out in the Appendix.

At first glance the valuation numbers for BrewDog look insane. However it is growing extremely
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fast. It is surprising that that are actually able to show a profit. Usually fast growing companies
make a loss and once they reach a more stable size the profits follow.

The information in the table is from the latest published financial year; in most cases this is the 12m
ending December 2016. This is also the case of BD.

BD revenue for the 6m ending 30 June 2017 was £50.4m , up 61% on the equivalent prior year
period (see prospectus). At a recent investor Q&A road show, James mentioned a figure of £110m
as expected 2017 full year sales. This represents an increase of 53% over 2016. Note that this will
include very little from the US which only commenced trading late in 2017.

Using the estimated 2017 revenue numbers, the EV as a multiple of revenue drops to 15.7x. This is
still very high relative to the other companies, but BD is growing very fast whilst most of the others
are battling to keep volumes from falling.

I've attempted a forecast on what the share price might be in 5 years time. I've done this on the the
following basis:

• Forecast sales 5 years hence (2022). I've considered three scenarios; my best guess, a
pessimistic scenario and an optimistic scenario. The pessimistic scenario represents my
subjective view of the 10th percentile outcome (so I believe there is a 10% chance that things
could turn out worse than this and a 90% chance of a better outcome). The optimistic
scenario represents my 90th percentile view.
• Earnings are difficult to forecast and are likely to be depressed for a fast growing company
like BD. It is earnings that underpin the value of an enterprise, but earnings come from
sales. For a growing company it makes more sense to base a valuation on sales volumes,
with the understanding that earnings will eventually emerge. So I've valued the enterprise
using a multiple of sales approach.
• Once stable, a craft brewer should be more profitability per £ of sales than the big brewers
as there is a price premium. Carlsberg state in their 2016 annual report that their Craft &
Speciality segment accounts for 5% of volume but 10% of revenue. I think BD should be
able to generate earnings of 15% to 20% of revenue once a degree of stability has been
reached. Furthermore a price to earnings ratio of 20 (representing a 5% real yield) seems
reasonable to me. Of course the overall level of stock markets will feed in. I think a PE of 20
for a stable (not growing, not shrinking), quality company represents good long term value
for a market that is not overheated nor depressed.
• A long term PE of 20 combined with 15% to 20% earnings ratio gives an enterprise value
(EV) to revenue multiple of 3 to 4.
• A growing company would justify a higher multiple. For example if a company is expected
to double, you can expect the EV multiple to be a bit less than double.

The three scenarios considered are:

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The US sales %'s used are not meant to be the actual market share as that would depend on wether
sales are through own pubs or retail outlets or online. Furthermore the overall market size will vary
over the period. This is merely a crude attempt to anchor the forecast sales for BD to some sort of
reality.

The EFP V issue price of £23.75 per share represents a MC of £1.7b (EV of similar amount as most
of the BD's value is equity; loans, cash and minorities are small).

Allowing for 5% dilution of of current shareholders interests (on the assumption that there will be
further new equity issued in the next 5 years), the assumptions above suggest the share price in 5
years time will be:

Optimistic (10th percentile): £72 (compound annual increase of 24.8%)

Best Estimate (50th percentile): £60 (compound annual increase of 20.4%)
Pessimistic (90th percentile): £37 (compound annual increase of 9.3%)

The above is not scientific but is to give an idea of what may materialise. I have not broken the
business down into pubs, off-sales and the hotel; nor sales through the brewdog.com online sales.
By using revenue all aspects of the business are being implicitly picked up, albeit in a crude way.
Also for the US I've used some industry data without analysing the detail behind it (e.g. revenue
from sales in supermarkets vs pubs). Nevertheless it does provide some reality check. In future
years more robust analyses will be able to be carried out if BD supply financial data segregated by
pubs, supermarkets/restaurants/hotels/online and for the hotel.

I have not taken into account the new spirits enterprise, Lone Wolf. This has been in development
for a couple of years and commenced sales in 2017. The target sales for 2018 is £5m. I've tasted
the Gina and Vodka and they are excellent in my opinion. Very good reviews as well (you can
check these out online). The products are already being stocked by Sainsbury's, Tesco and
Morrison’s. There is every indication that this business will also be successful. There is likely to be
greater shareholder dilution of this part of the business though, as there are plans to raise equity
capital separately (yes, you guessed, through crowd-funding). It is quite possible that this business
could be turning over £50m in 5 years time. With higher margins on spirits than beer (and pubs and
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hotels; see the Diageo numbers in the table at the beginning of this section) and the high growth rate
implied by £50m in sales, it is easy to envisage an EV for Lone Wolf of 10 to 20 x sales, i.e. £500m
to £1bn. Even with 20% dilution this would still add £5.50 to £11 to the share price! You may want
to watch out for the Lone Wolf equity raising and get in on that from an early stage.

It is worth noting that dilution occurs only in respect of increase in share price above the future new
issue prices. For example with the EFP V issue, dilution is only in respect of price increases above
the £23.75 issue price. And if the full £10m target is raised, that represents some 0.6% of total
equity, so dilution would be 0.6% of increases in value above £1.7bn. More serious dilution is likely
to occur when listing on an exchange (London Stock Exchange, or one of the US exchanges).
However the listing price would probably be at much higher prices than the current issue price.
Furthermore, the funds raised in such an issue would strengthen the balance sheet and accelerate
expansion plans. It is also possible that a listing would not raise fresh funds but would release some
of the founders shares to the public; no dilution in that case, but also no new funds for the business.

Allen White
London
January 2018

Appendix:

1. US Beer Sales Volumes (source, Brewers Association, Boulder CO)

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2. Growth rates of significant craft brewers (source: a Brewdog presentation).

Note that the right-hand scale is mis-aligned. The bottom line is 100% (i.e. base sales). The lines represent
the total sales as a % of the 2007 starting sales. Brewdog have referenced their source as Beer Marketer's
INSIGHTS, Inc. There is a similar chart in the prospectus.

3. What makes a beer “craft” . The views of the Brewdog founders

In boardrooms across the drinks industry there will be a noticeboards with the word “craft” written on them,
quickly followed by a question mark. Craft beers and spirits might be all the rage, but how do you define
them? Who better to ask than the founders of Brewdog, arguably the most famous craft beer brewers and
now global bar operators, James Watt and Martin Dickie. In this extract from their new book they give their
definition of what they think “craft” really means.

The craft beer phenomenon has become such a big business that it is danger of creating beers, brands,
brewers and distributors that might claim to have craft credentials, but are anything but. Brewdog founders,
James Watt and Martin Dickie, are better placed than anyone to give their definition of what they think still
constitutes craft. It’s even meant writing a book, BrewDog: Craft Beer for the People, to prove their point.
Here’s their definition of craft.

To paraphrase Oscar Wilde, craft beer is the unstoppable pursuit of the indefinable. This modern term that
screams out from bar chalkboards and bottle labels the length of the country must mean something. At first it
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brings to mind rustic workshops with sawdust hanging in beams of afternoon sunlight, or craft stalls with
tables bearing hand-stitched cushions and earrings made from seashells. Isn’t beer just…well, beer?

Let’s start with an analogy. Imagine, for a minute, that music is your overriding passion. Entranced by that
first Nirvana/ Miles Davis/Ace of Base track you heard, you were drawn in. From that moment, you wanted
to make music at the expense of everything else. So at home you picked up a guitar or a pair of drumsticks,
or began writing lyrics. And the results were terrible. You couldn’t hit any notes; your voice fumbled rather
than soared. But instead of quitting you kept going. You were bad, but f**k it – you just did it anyway. And
after months or even years of practice at home, you reached a level of skill and confidence where you could
audition to join a band.

So you did.

At first your band also struggled – using new equipment, working together instead of individually made
things hard. It took a while to get everything and everyone in sync. But you kept on, driven by your all-
consuming love of music. Eventually you started to play gigs, even though nobody knew who you were.
Only your parents and close friends showed up – and they only said the right things when you asked for
feedback. But one day people you didn’t know paid money to discover what you were about.

This was the moment you had dreamed of ever since you started out playing at home, alone. Yet the hard
work still continued, with long hours and relatively little reward at the end of each day. It took months or
even years of effort, until you began to notice a difference. Eventually, after your band had logged dozens of
new releases and attended more festivals than you could hope to remember, word of mouth had spread to the
extent where people were handing over enough money for you and your bandmates to begin to earn a modest
living.

You had finally made it.

All swagger, no substance

And then almost overnight, there was a new band everyone was talking about on the TV. They looked the
part, but to you there was something not quite right about them. When they played their instruments, they
were actually miming. They were all swagger; no substance. Genuine music fans could spot the difference a
mile off, but people new to the genre flocked to their music. Even when it turned out that this new band had
been put together by a record label, styled to look and sound like they belonged. All your hard work, long
hours and knockbacks were bypassed in days.

The big money men had arrived and they had brought their impostors with them. Your style of music had
become so successful, they were attempting to commoditse it. While you were in it for the love of music,
they were only interested in the bottom line. Your spirit of creativity and adventure had been piggybacked on
overnight. How would this make you feel?

The craft beer movement is gaining a greater share of the market with each passing year through the passion
and skill of those who wield brewing equipment (as opposed to instruments). From careers honed through
homebrewing to collaborations between like-minded breweries around the world, it is a movement driven by
creativity.

When any creative industry breaks into the mainstream, others take notice. Just as with big record labels and
their manufactured acts, the money men in brewing have cottoned on to the success and hard work of others.
They want a slice of craft beer.

Beware the corporates

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It's the motto that has helped Brewdog set the rules when it comes to craft beer
It’s the motto that has helped Brewdog set the rules when it comes to craft beer
Typically, there are two ways they go about this. Industrial lager brands are now creating fake craft beer that
looks authentic, but on closer inspection mimes the instruments. This so-called “crafty” beer is an affront to
everyone who worked hard to get where they are.

The other tactic to which corporate beer resorts is even more abrupt; they simply take over existing craft
breweries. It’s ambulance-chasing on a grand scale – see who is doing well and adopt chequebook
diplomacy. Screw the people who work for the breweries and buy the name.

No more hoodwinking

It may be oafish, but why is it a problem? Well, for those of us truly passionate about the craft beer sector,
these newcomers devalue the term, as they seek to confuse and hoodwink the beer drinker. The beers are like
band T-shirts worn by people who can’t name an album and the companies are simply snake-oil salesmen.

Everything we and many other craft breweries up and down the country work for is done for the love of
brewing amazing beer, using the best ingredients, in the right way. Craft beer is a point of difference. A
rallying call and a badge of recognition: not something these newcomers should be able to hide behind.

But this is where you come in.

Whether you’re a beer veteran or a virgin, read up a little. Such is the variety of amazing beer out there,
research rewards in kind. Visit your local craft brewer. Follow them on social media (craft brewers usually
handle their own rather than paying a branding agency). Try as many different styles as you can; listen to
recommendations.

So when faced with a new “craft beer” from a “craft brewery” that you haven’t seen before, you can be your
own best judge. Sample it against something similar you know and trust. It won’t take more than a few sips
of each to learn what flashy advertising, big budgets and profiling can’t hide.