NEW YORK (TheStreet) -- Makers Mark bourbon, Laphroaig Scotch whiskey and Courvoisier cognac are going to have to generate consistent earnings for over a decade if Suntory's $16 billion takeover of Beam Inc.
(BEAM) is going to work out for the Japanese spirits conglomerate.
Suntory's acquisition of Beam, done at a multiple in excess of 20 times Beam's trailing 12-month earnings before interest, taxes, depreciation and amortization (EBITDA), may sound a bit bubbly given that most private equity takeovers come in at a valuation of five-to-eight times EBITDA. The deal's price-to-EBITDA valuation would also make Beam among the most expensive stocks on the S&P 500 Index, up there with the likes of Starbucks
(AMZN), Alexion Pharmaceuticals
(ALXN), Forest Labs
(FRX) and Vertex Pharmaceuticals
The obvious thing to say is that Suntory's takeover of Beam is expensive on a price-to-EBITDA basis.
WATCH: Suntory Buys Beam for $16 Billion, Gets Maker's Mark and Jim Beam
But as with pharmaceutical and tobacco firms, the tail of earnings on a solid whiskey, tequila and cognac business is extremely long. A corporate acquirer could pay 20-times EBITDA for Beam and reasonably expect to recover that price-tag, over time. Bankers call this line of thinking a company's so-called terminal value or terminal growth rate.
Most businesses are valued at some multiple of their three-to-five year earnings streams, in addition to a reasonable growth rate that can be expected into perpetuity.
Two things stand out: The higher the growth rate one expects a business can generate into perpetuity, the more the business is worth. Also, corporate valuations can change dramatically given the terminal growth rate a banker or investor pulls from the sky. As the saying goes, garbage in... garbage out.
Some firms have little or no terminal value. For instance, the earnings streams of companies like Time Warner Cable
and Verizon Communications
are likely to be replaced by new technologies over time, so their cable, Web-portal, satellite radio and wireless services generally are given minimal-to-negative terminal growth rates.
In the wake of Beam's high-priced acquisition, likely based on some reasonably optimistic expectation of the company's terminal growth rate, I think it is important to compare the deal to Apple's
In contrast to the 20-times-EBITDA seen in the Beam deal, Apple -- one of the most innovative and profitable companies in American history -- trades at a multiple of about six times its forecast 2014 EBITDA, net of cash.
That valuation implies investors are only moderately impressed by the company's current ability to generate profits and cash flow. More alarmingly, their discounted cash flow analysis likely gives Apple's key businesses -- its iPhone, iPad, iMac and iTunes divisions -- zero to negative terminal growth rates.
In some respects, that makes sense.
Apple's mobile devices and computing products are extremely vulnerable to technological disruption that can make even the most dominant businesses obsolete in short order. IBM
basically commercialized the personal computer and within 10-years the company was on the doorstep of bankruptcy. Big Blue doesn't make PC's anymore.
Meanwhile, Apple currently holds just $17 billion in debt to go with a near-$150 billion cash stockpile. That net cash position isn't a sign of confidence, and has become a lightning rod of criticism for activist investors like Carl Icahn and David Einhorn.
I would argue that, outside of debates about Apple's capital structure, one of the company's biggest opportunities in 2014 is to convince investors that its earnings deserve a terminal value or terminal growth rate. Put another way, Tim Cook & Co. need to convince investors that their products and earnings streams aren't going to be replaced anytime soon.
That will be hard to do.
Apple generates a significant portion of its earnings from subsidies that telecom carriers like Verizon, AT&T
pay to Apple when subscribers join or upgrade their service contracts by way of an iPhone purchase. Those subsidies could change over time, impacting Apple's earnings. Meanwhile, a growing universe of mobile products from Google
pose direct competitive threats.
But 2014 could be the year where Apple proves its earnings streams are more resilient than many expect. Were iPhone and iPad sales to hold up and Microsoft or Google to begin showing cracks in their ability to chase mobile profits, it could underscore the stickiness of Apple products.
More importantly, after hiring former Burberry
CEO Angela Ahrendts to run the company's retail division, Apple may begin to press its standing in the marketplace as a premium-priced brand.
In a recent column
, I argued that consumer brands like spirits-seller Diageo
, LVMH Moet Hennessey Luis Vuitton
and Estee Lauder
might be better comparable's Apple's earnings than Google, Amazon and Microsoft, which all struggle to break-even on their mobile products.
For many of Apple's loyal customers, the ease of use, design and seamless integration of the company's products across its ecosystem warrants a premium. Why not pay $399 for an iPad if it offers a thriving app store and won't need to be replaced in a years' time? Many don't have the same confidence about discount-priced Amazon and Microsoft offerings.
Were Apple to better emphasize the merits of its brand and the resilience of its product price points, it could convert skeptical investors who see the company as a value trap.
Suntory's purchase of Beam provides a model Apple could use to reach that goal. In effect, Suntory is betting that Beam's best brands like Makers Mark and Knob Creek will continue to hold up, or even rise in the marketplace, generating lasting revenue. So much so, Suntory might not expect Beam's earnings streams to pay the deal back for over a decade. (We will see the valuation techniques used by Beam's bankers Credit Suisse
and Centerview Partners
in proxy filings.)
Also, let's face it, there is probably not that much difference in the cost to make Beam's premium bourbons like Markers Mark, vs. its discount Jim Beam line. Beam's margins are likely due, in large part, to a premium consumers are willing to pay for the company's top-shelf brands.
A small change in perception about Apple along these lines could go a long way. If stockholders and analysts begin to consider the company's earnings as attributable to a durable brand premium that Apple products carry, it could mitigate apparent fears about obsolescence.
If Apple can convince investors its earnings warrant a multiple of just half what Suntory was willing to pay for Beam, the company's shares would nearly double in price.
Apple shares were rising over 1.5% to $541.55. Shares in the company have underperformed the S&P 500 in the past 12-months.
-- Written by Antoine Gara in New York