Let’s look at the company’s revenues.
Molson Coors Brewing Company - Revenues and Margins, 1994 - 2Q 2011
There are two things to note about this chart. First, the company’s revenues appear to collapse beginning in 2008 and continuing to this year. Second, the company’s margins rocket upward. Someone who has not been following TAP would assume that there has been a major and successful reorganization, with expenses being cut dramatically and far in excess of revenues. This is not the case.
The changes shown in the chart above obscure what has really occurred, which is not a real reorganization but rather accounting changes.
A Primer on Consolidation
When a company is deemed to have control over a subsidiary (usually >50% voting control), the parent company includes all of the subsidiary’s financial data in the parent’s financial reports (this is called “consolidation“). On the income statement, all of the subsidiary’s revenues and expenses are included in the parent’s income statement, and then a line item (importantly, this is below EBIT) is included to subtracts the earnings that are attributable to the portion of the subsidiary not owned by the parent. On the balance sheet, the non-controlling interest is a separate line between ParentCo shareholder Equity and Total Equity.
When a subsidiary is not consolidated, say for ownership that is significant but not controlling (usually 20 – 50% ownership), the “equity method” is used to account for the subsidiary. On the income statement, the parent company’s share of the subsidiary’s net income is recognized as a single line item (rather than separated out as both revenues and expenses).
Why does all this matter? Consider this example. ParentCo owns 51% of SubCo which has $1,000,000 in revenues, $600,000 in total expenses, for net income of $400,000. Since ParentCo has control over SubCo, it consolidates SubCo’s results. ParentCo’s revenues increase by $1,000,000 and expenses increase by $600,000. However, ParentCo’s net income does not rise by $400,000, instead increasing by 0.51*400,000 or $204,000 (this is the result of a line item “Net Income Attributable to Noncontrolling Shareholders” of 0.49*400,000 or $196,000).
In the second year, ParentCo sells 10% of SubCo, thus reducing ParentCo’s ownership from “control” to “significant interest” and so now ParentCo must account for SubCo with the equity method. SubCo has exceptionally stable operations and so in year 2 also has $1,000,000 in revenues and $600,000 in total expenses. For year 2, ParentCo now includes a line item of $204,000. This shows pure profit, as the revenue and expenses used to arrive at this figure are not shown on the income statement.
The result? When a company consolidates its profitable subsidiaries, it reports higher revenues and a lower profit margin as compared to accounting for the same profitable subsidiaries using the equity method.
Back to TAP
As you can guess from my discussion of consolidation, TAP has deconsolidated several subsidiaries over the past few years. This “accounts” (har har) for the apparent decline in revenues and increase in profit margins.
From the company’s recent 10-k:
Effective, July 1, 2008, MCBC and SABMiller formed MillerCoors to combine their respective U.S. and Puerto Rico operations. Each party contributed its business and related operating assets and certain liabilities. The percentage interests in the profits of MillerCoors are 58% for SABMiller and 42% for MCBC. Voting interests are shared 50%-50%, and MCBC and SABMiller have equal board representation within MillerCoors. MCBC and SABMiller have each agreed not to transfer its economic or voting interests in MillerCoors for a period of five years, and certain rights of first refusal apply to any subsequent assignment. Our interest in MillerCoors is accounted for under the equity method of accounting.Translation: That 23% drop in revenues in 2008 was the result of the company deconsolidating its US operations, for only half a year!
The Canada segment also includes our partnership arrangements related to the distribution of beer in Ontario, Brewers’ Retail Inc. (“BRI”), and in the Western provinces, Brewers’ Distributor Ltd. (“BDL”). BRI and BDL are currently accounted for under the equity method of accounting. BRI was consolidated in our financial statements until March 1, 2009, when it was deconsolidated.Translation: That 37% drop in revenues in 2009 was both the first full year of deconsolidating its US operations and the deconsolidation of its Canadian retail operations (high revenues but low margin).
Deconsolidating these subsidiaries had the effect of causing a dramatic reduction in the company’s revenues since the full amount of revenues from these subsidiaries was eliminated. It also had the nice effect of boosting profitability, as the full amount of expenses from these subsidiaries was also eliminated. The only thing remaining for these subsidiaries was TAP’s proportionate interest in their profits, which flowed directly to TAP’s bottom line as pure profit.
Where does this leave us? We see that the company’s deconsolidation of major operating subsidiaries has made performance comparisons difficult. In these situations, the best thing to do is to value each operating subsidiary separately and then add up the value of the operating subsidiaries and subtract the cost of corporate overhead (this is the approach I took to valuing Mohawk Industries here).
Here’s how I valued TAP (feel free to skip the next few paragraphs and jump to the conclusion).
First, I looked at each operating segment historically and found the operating earnings and net capital expenditures (capex – depex). For the US segment, which became the MolsonCoors JV in 2008, I used TAP’s 48% economic interest in the revenues of MolsonCoors and its portion of earnings to find margins for this subsidiary post-2008. This gave me an idea of long-term normal operating margins. I was able to get an idea of net capex demands as a percent of revenues as well. My goal was to use normalized EBIT – normalized Net Capex as a proxy for free cash flow for the subsidiaries, valuing each subsidiary individually. I then looked at the company’s corporate overhead expense as a percent of total revenues historically to derive an expected future overhead charge.
My next step was to look at a few different revenue scenarios for each segment, and then calculate my proxy for free cash flow. Assigning a multiple of 12x for each operating segment and 14x for the company’s corporate overhead (calculated as the normalized overhead charge as a percent of total revenues multiplied by expected total revenues), I then calculated the enterprise value of the company. Subtracting debt and adding cash back yielded an approximate value of the company’s equity.
The result of all of this showed TAP to be at best fairly valued and likely 15 – 20% overvalued. I tend to be quite conservative in my growth estimates and I tend to use a higher discount rate than others (with debt as cheap as it is right now, WACCs for companies that utilize leverage are artificially low and are unlikely to represent long-term rates, so I bump up the discount rates that I use). For readers who are somewhat more liberal, a lower discount rate and higher growth rate could be used, which would have the effect of increasing the multiples for each segment and possibly push the company into “value” territory. For my purposes, I would rather buy something that is absolutely cheap on conservative assumptions rather than cheap only on more liberal estimates. Also note that the vast majority of TAP’s revenues are derived from mature markets, such as North America and Western Europe, and so growth is likely to be moderate even with the company’s expansion in Asia.
What do you think of TAP? Have I missed a significant source of value? Let me know in the comments below!