Drink Brick, but be careful with the stock

On the heels of the Molson/Coors and Sleeman/Sapporo transactions, Waterloo-based Brick Brewing (BRB:TSX) correctly decided a few months ago that it needed to be reviewing its “strategic options”. After engaging CIBC World Markets to do a thorough review of the choices before the company, Brick has concluded that the best choice is to soldier on, just as before.

With the simultaneous departure of Brick President & CEO Doug Berchtold, it won’t all be as before, however.

Three short years ago, Doug Berchtold joined Brick as top dog as part of an equity infusion transaction and Board change-up. Doug had been President of Sleeman through its hyper growth years, and had successfully integrated the Upper Canada acquisition in 1997 as well as the Strohs Canada (think cans of Old Milwaukee) licence deal. And he built an $8 million canning line for the key Sleeman products to broaden the appeal of craft beer as the fad wore off in the late 90s.

John’s marketing genius and Doug’s steady financial hand made Sleeman into a roaring success.

After succeeding at Sleeman for a decade, Doug decided that he had enough money and said his goodbyes in Guelph. His plan was to “tour North American golf courses and read books”. I think he cut 10 strokes from his handicap but I never heard much about the book component of his retirement.

18 months later, the Brick recap opportunity appeared. Bay Street had confidence in Doug, and Brick shares rallied from about $0.75 to $1.25 merely on the news of his arrival. Doug was also able to use his debt relationships to redo the balance sheet with an appealing deal from RoyNat. Some i-bankers also paid attention, and new equity was provided as well.

During his three years at Brick, volume grew to the point where the tax benefits that accrue to tiny brewers would no longer be available to Brick – that’s how well Mr. Berchtold’s new strategy impacted some tired Brick products.

The big guys haven’t been playing fair, as Mr. Berchtold outlined on Sept. 11/07 after Brick’s weak second quarter:

Gross revenues in the second quarter decreased by 6.8% to $22.0 million compared with $23.6 million in the previous year. Ona net basis – after deduction of distribution fees and production taxes – revenues were $9.6 million, compared with $11.3 million last year. This decrease in net revenue, despite a 3.6% increase in the Company’s per unit selling price, was largely attributable to an 11% decline in total beer volume. Volume sold at The Beer Store (TBS), the industry’s dominant distribution organization, declined 12% while volumes sold to LCBO outlets increased 16%.

“The contradictory sales patterns for our brands at the LCBO stores compared to TBS stores are highly instructive,” said Doug Berchtold, President and CEO of Brick Brewing. “Our brands are outpacing the market at the provincially-owned LCBO stores. However, at TBS stores, which are owned by the national brewers, our sales are lagging. Clearly, we believe, the recent changes in the retail and marketing policies implemented at the TBS stores are having an adverse effect. To date, the Company has been unable to persuade TBS or the Ontario government that these new policies unfairly disadvantage Ontario small brewers.”

For historical reasons, The Beer Store is owned by Labatt, Molson and Sleeman.

The chance for a strategic sale, just as Labat, Molson and Sleeman have done, is over now that the strategic review is complete; none of the “alternatives” seemed to appeal to the Board. They likely reviewed a merger with Alberta’s Big Rock, a sale to a foreign brewer looking for a Canadian platform, and a going private transaction sponsored by all those flush merchant banking folks we read about in the DTM. For whatever reason, the torturous strategic review process was for not.

The market seemed to have known this was coming, as the protracted process (and maybe a bad quarter) caused the stock to fall from $2.20 to its current $1.36. Mr. Berchtold’s departure is telling, if one can deduce that his departure (hurriedly scheduled for this Friday) is tied to the Board’s decision to do nothing, even as most other players in the industry concluded that was an untenable path to take. Perhaps Mr. Berchtold didn’t agree with Executive Chairman Jim Brickman’s rosy view of the future.

“These strategic accomplishments position Brick well for the future,” said Jim Brickman, Executive Chairman and Founder. “Despite the near term realities of increased Ontario production taxes, the longer term prospects lead us to believe that we can successfully realize our future growth opportunities and achieve improved profitability. With the strategic review process behind us, we can now more fully concentrate, with renewed vigor, on the efficiencies offered by our expanded facilities and focus on a new streamlined operation which recognizes the current realities of the marketplace.”

Sounds rosy. Maybe Mr. Berchtold just missed the links.

Either way, a key human asset at Brick won’t be there 48 hours from now, and shareholders have reason to be worried. Having grown net revenue from $15MM (’04) before he joined to $30MM in 2006 and $35MM in 2007 (FYE January), and kept it profitable as well, Mr. Berchtold did what he went to do back in May 2004. In 2003, by comparison, Brick lost $2.3 million on $18.9 million of what appears to be gross revenue.

Lots has changed in the Canadian beer business since Brick was started in 1984. Mr. Brickman and the Brick board are about to find out what the journey is like when you don’t have the benefit of the services of the best brewing operator in the land.

MRM