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The Oakes Weekly

Strictly business...
Oakes Weekly September 26, 2002      
Written by Oakes

Vancouver, CANADA -

<P>It was a busy week in terms of brewing business news. I'm not an expert in the brewing industry so I may get a fact or two wrong, and I have to preface this column by stating that my theories are pure speculation and not based on any hard facts or inside tips - I'm just floating possibilities here!

<P>The first was the announcement that Big Rock Brewery is reorganizing itself into an income trust. In essence, shares of Big Rock Brewery are being converted into shares of Big Rock Income Trust. Now, income trusts are an investment vehicle best suited for businesses with stable cash flows (in fact, they carry a "stability rating", which is a volatility measure used in a manner not unlike credit ratings for debt issues). The most prevalent of these are Real Estate Investment Trusts, which obviously receive a very stable cash flow as long as they have tenants. As breweries go, Big Rock does appear to have a stable business. They are the Anchor Brewing of Canada in that regard. But breweries are also subject to seasonal fluctuations in their business. Not only that, but the cash outflows are somewhat less than predictable, especially for a firm like Big Rock, who are stuck in something of a transitional phase in their business - dominant regional in Alberta, and approaching national status overall. There will be changes in the Big Rock business model in the near future in order to help them follow Sleeman to the next level, and it is interesting that some of these changes were alluded to in the press release. The problem is that some of these changes do not appear to mesh well with the proposed reorganization. But I will attempt to unravel this for you, and explain what it all means to the average Canadian beer drinker.

<P>Chairman Ed McNally claims the move is to reward long-term investors, who until now had only the potential for capital gains as a reward on their investment. If that were the case, why not just declare a dividend? That's what every other brewery does when it wants to distribute some cash to its investors. Dividends are also not as big a drain on operating cash flow as income trusts are, which leaves the company more capacity to absorb seasonal cash flow fluctuations and to have cash on hand for growth.

<P>So why are they really moving to an income trust structure? Expansion. And this is what gets me worried. Income trusts are sexy, stocks are not. In Canada, we've seen precious few equity issues of late, and the only real successes have been with high-profile firms or preferred issues. Income trusts, on the other hand, are very popular with weary investors. Everybody and their dog, from A & W to the makers of no-name pet foods have issued income trusts in the past year or so, and usually have no trouble raising the capital they need. Big Rock may have enough cash on hand to purchase the likes of tiny Bear Brewing, but the reason they need to raise capital is because they have much bigger ambitions. Hence the move to a structure in which raising capital is easier in the present investment climate.

<P>So what does all this mean for the casual beer drinker? Big Rock will come to market with a secondary offering either next spring or fall, once they're ready to start putting their plans in motion. Flush with cash, they will go on a shopping spree and, like Sleeman did a few years ago, will rapidly rise to the status of national brewer. Already there are a couple of smaller Ontario facilities on the market, but I think Big Rock has bigger fish in mind. If they wanted to pick up a struggling 15000hl brewery, they could do it without the trouble of tapping the capital markets. Big Rock plans to expand their lager range (conveniently forgetting what brought them to the dance in the first place) and get into the alcopop business (I guess recent expensive flops from the likes of liquor heavyweights Sauza, Skyy and Stolichnaya didn't make the radar screen out in Calgary). For this, their plans will have to include a regional-sized facility. I have no inside track on which ones they've got their eyes on, but there aren't that many in this country.

<P>The push into lagers, like their underwhelming Köld (is it just me, or is the mis-use of umlauts tired as hell?) and alcopops is a gamble, one that could backfire badly when the company is forced to cough up most of its cash flow to its trustholders rather than ramp up marketing expenses, which I personally think they'll need to do to get to the next level. I hope they are not planning to use their secondary offering to cover an operating cost like marketing expenses. I guess if John Sleeman did it, it stands to reason that Big Rock can do it, too, but the later you are to the party, the less likely you are to get the best slice of pizza. Either way, though, the brewing business in Canada is going to be shaken up in 2003, with Big Rock leading the charge.

<P>Another bit of news was the launch by Labatt's of Alexander Keith's Celebration Ale. For those who don't know, Alexander Keith's IPA is (in addition to slandering both IPAs and Alexander Keith) a swill lager (and it is a lager, folks, that comes from reliable sources at the brewery) that Interbrew has taken from regional status in the Maritimes to national status in recent years. Now, in the Maritimes, Keith's is regular old domestic beer. Elsewhere in Canada, it trades as a premium brand. So while the brand has been extended in Nova Scotia years ago to include the likes of Keith's Light and Keith's Dry, such products would only denigrate the name that Interbrew is trying to build for this brand. So along comes Celebration Ale.

<P>The ad copy claims that this is dry-hopped, and while I found no evidence of that, it is certainly hoppier and better-balanced than just about anything else Labatt's produces. To me, the introduction of Celebration Ale is the first step in a strategy. The idea came from Moosehead, who last year introduced Clancy's Harvest Ale, a companion to their premium Clancy's Amber (okay, the odds of any Labatt's staffer admitting this are nil, but it seems awfully convenient). Keith's has a strong brand, which has quickly taken hold in Ontario with the help of thousands of ex-pat Nova Scotians (they tried the same thing with Kokanee but there aren't a lot of ex-pat British Columbians out here to propel that brand anywhere). Interbrew, along with Guinness, is one of the few companies in the world to take premium beer to the mass market. With the Canadian beer wars between Blue and Canadian looking more and more like the no-win trench warfare of WWI, Interbrew is looking elsewhere for domestic growth.

<P>What I like most about Celebration, though, is that it doesn't pretend to be a microbrew, which is more than I can say for other swillmongers like Sleeman and Brick (Brick Bock excepted, of course). This is a macrobrew with flavour. There are clear malt and hop notes, and even a little bitterness. Regular Keith's drinker will try this. And then they will be on a path. A path to flavour. A path that Interbrew probably hopes leads to Stella, Leffe an Hoegaarden, but which I think might just lead towards Black Oak, Sgt. Major's and, god forbid, American micros (which never sell well here, despite the fact that the few we get are usually beauties). So for that reason I like to see this new direction.

<P>The micro business in Canada has reached yet another doldrums and we need to start converting beer drinkers into beer lovers en mass. Interbrew and Big Rock have the power to do it. I say let them. Don't get me wrong, Big Rock's gamble might not pay off at all, and Keith's Celebration could be a fall fling, or worse yet a total flop. But if these guys do succeed in their objectives, and I should state that both firms do have a good track record at doing just that, then I think every beer lover will benefit, and the scene here could be a lot of fun the next three or four years, which is more than I can say about the past three or four.

<P>In other news, Heineken has been on an acquisition tear of late,
adding the likes of Al-Ahram in Egypt to its portfolio. They also picked up
minority stakes in the dominant breweries in Costa Rica and Nicaragua.
These are hardly monster additions, what with Egypt being a Muslim country
and the Central American market being generally small. Heineken is generally
conservative when it comes to overseas expansion, especially relative to
rivals Interbrew and SAB. But more acquisitions and strategic partnerships are
expected in Africa, where Heineken has enjoyed great success with Nigerian

<P>As a rule, though, the best beer-drinking markets are mature, and the
best growth markets have been well-tapped by multinationals. But, it seems
pointless for Heineken to dip into the petty cash for brewers in tiny
markets unless there is a broader strategy afoot. Look for a series of
moves in Africa first, and if that goes well, Heineken’s stellar balance
sheet will prepare them well for a dramatic move in the much-anticipated
final round of global consolidation later this decade.

<P>In an interesting article in the Financial Times, the ATF is apparently
pulling a 180 degree turn and doing something productive. This, of course, is
tightening the regulation of the so-called “malternatives”. It turns out
that, and this applies to the US only I might add, these beverages are not using enough
malt-based alcohol for the ATF’s liking. The producers of many alcopops wish for their products to be classed as malt beverages for taxation and distribution purposes, but have been blending a
portion of malt-based alcohol with distilled alcohol. Thus, following
the lead of yours truly, the ATF has come to the realization that these drinks are
not even related to beer and should therefore not be taxed and distributed
like beer.

<P>The ATF's proposed solution is to ramp up the amount of malt-based alcohol. They laid out some guidelines and industry players did test batches. Industry sources were quoted in the article as saying “The stuff tasted like
crap. The formulation proposed by the ATF is essentially a category
killer.” In other words, the products would have actual malt character.
In order to restore their beloved loophole, the producers of these fine
beverages would have to invest in heavy-duty microfiltration to “get the malt
notes out of the liquid”. I can only hope that the ATF succeeds in setting
things right with regards to alcopops and that the category and all of its
proponents drop off the face of the earth as soon as humanly possible.

<P>The last piece of news is that Famous Players,
the largest movie theatre chain in Canada, is considering selling beer and
wine. Having enjoyed a pitcher of Terminator Stout at MacMenamin’s
Edgefield many moons ago at their movie theatre, I like the idea. That said, having
seen what kinds of beer Famous Players pours, and for what price, at the bars some new
theatres in Toronto have in their lobbies, I’m pretty sure I won’t be taking
advantage of this new policy, should it go into place.

<P>The thing that gets me though, are comments that I’ve read from poll
respondents in the newspaper regarding the issue. For example, one Jason
van der Valk of Victoria, BC states: “Ridiculous, how are you going to
enforce rules upon drinking and handle any problems that might arise during
a movie? Do we now how large bouncers hanging around tossing intoxicated
individuals?” And another rocket scientist, Toby Cox of Toronto goes on
record with this bit of genius: “Alcohol is fine at a stadium; sports fans
are expected to cheer and make noise anyway. But what is to stop a group of
people from getting completely hammered at the movies and making a ruckus?” I guess Mr. Cox falls into the .001% of Canadians who are not literate, since he never made it to the part where Famous Players executives explained the two beer maximum rule they were setting forth.

<P>How many licensed establishments, Mr. Van der Valk of impeccable
intellect, have bouncers? Nightclubs. Biker bars. So, what, 1%? In my
neighbourhood, I can count on one hand the number of people who make their
living as bouncers. And I live next to the university. Restaurants have no
bouncers, and often not any burly staff members of any description. Yet they
serve alcohol, and never have any problems. How is that? Perhaps
because when you treat people like adults, they will act like adults. When
you treat them like infants, they will act like infants. In other words,
you are no more likely to have problems relating to drunkenness by serving
people a glass of beer or wine with their movie than you are by letting
people into the theatre fresh off of a bottle-of-wine-dinner.

<P>When faced with such total imbecility, it is hard to know where to begin.
Attitudes like these promote drunken excess, not prevent it. This whole
antiquated notion that every person who drinks alcoholic beverages is
predisposed to alcoholic stupor, random crime and general belligerence is
pure, unadulterated stupidity.



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