Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on MGP Ingredients, Inc. (Nasdaq: MGPI)
Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled "Over A Barrel" that outlines why we believe shares of MGP Ingredients, Inc. (Nasdaq: MGPI) ("MGPI" or the "Company") face up to 35% to 55% downside risk, or $45.70 ? $66.00 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and important updates.
Spruce Point Report Overview
Based in Atchison, Kansas, MGP Ingredients ("MGPI") is a producer and supplier of distilled and branded spirits, and food ingredients such as starches and proteins. MGPI has long promised investors it would diversify away from commodity ingredient solutions into a leading distiller of whiskies, bourbons, and premium spirits. Stage one of its multi-year transformation involved improving the operations of its aged Lawrenceburg facility, while optimizing its product and customer mix. Stage two involved producing, storing, and leveraging the value of its aged whiskey. Finally, in stage three, MGPI purported it would become a branded platform of spirits.
In Spruce Point's original report from 2017, we argued that MGPI's grand ambitions would fail as whiskey supply caught up with demand, and the category would be become saturated much like the craft and premium vodka market had become years earlier.1 In 2019, MGPI cut its long-term expectations for the distillery business, its CEO and CFO both departed, it exited a Joint Venture where we found problematic financial reporting, and has retracted freight cost disclosures tied to revenue recognition where we identified inconsistent reporting.2
Now under new management, we present new industry data showing that in 2021 Bulleit, a key brand contract-distilled by MGPI for its material customer Diageo, has been slowing and losing market share. We believe this may have hastened MGPI's decision to complete a $445 million merger with Luxco Inc. ("Luxco"), a branded spirits distributor on April 1, 2021. Spruce Point's forensic research findings suggest there are many valid reasons why MGPI's final Stage Three transformation is failing:
- Multiple signs that the Luxco / MGPI merger is failing to deliver planned benefits. Based on subsequent SEC filings and revisions, it appears that Luxco's revenues were declining between October 2020 and year end. Spruce Point finds evidence that MGPI may have spring-loaded results by making changes to Luxco's go-to-market strategy immediately after deal announcement. We observe it launched a "Shop Now" feature and partnerships with online retailers, with Luxco's sales spiking from $44.4 to $59.3 million from Q1 to Q2 2021. The CFO proudly stated results, "exceeded our expectations," but made no mention of a change to Luxco's sales distribution model. MGPI claimed that Luxco would help expand its gross margins, long-term profitability and be immediately accretive to free cash flow generation. Now with the benefit of five subsequent reporting quarters post-closing, we observe that margins and free cash flow have declined. Luxco was promoted as having 46% of its sales tied to premium brands, but now MGPI is reporting approximately 30% of branded sales as premium. Our price checks indicate many of Luxco's branded spirits are being sold 5% to 50% below suggested retail price. By unravelling the contribution from Luxco in 2021, we also show that MGPI's core business has been under increasing margin pressures. In addition, we now learn that MGPI's legacy branded sales were a bust. By our assessment, MGPI can't possibly succeed in branded spirits given it spends just 3% of sales on marketing versus 9% to 17% by peers and reports no R&D expense that would enable it to innovate with new products to meet changing customer preferences. Best disclosure practices are to include inorganic contributions from merger targets for 12 months post transaction close. However, MGPI ceased further disclosure of Luxco's revenue and earnings before tax (EBT) contribution after three quarters.
- Multiple signs of financial misstatements are emerging. MGPI recently restated Q2 2021 branded spirit segment results that affected all line items except the "other" account. In addition, it noted an immaterial error and correction to gross PP&E, amortization and accumulated depreciation. Even more concerning, MGPI recently made two retroactive SEC disclosure changes to its prior year operating cash flow discussion. Of note, it now says that Q2 2021 results excluded changes in Luxco's operating assets and liabilities. This is a highly unusual revision that goes against management's claim that Luxco was cash flow accretive, and the deal having closed on April 1, 2022. As such, Q2 2021 should have included all contributions from Luxco. Secondly, MGPI changed language to say that inventories increased in Q1 2021 when in fact the reported results show a decrease. This leads us to believe that MGPI is signaling a financial misstatement tied to inventory. Our suspicions of financial misstatement are corroborated by MGPI's rapidly declining earnings quality. We compare operating cash flow to its GAAP Net Income and find that it was >200% in late 2020 but has been in steady decline and hit a low of 59% in Q1 2022. The Q2 2022 operating cash flow discussion recently added caveats about timing of collections of customer payments and an increase in finished goods inventory. If sales were as robust as described, why would collections be an issue and finished inventory increase? MGPI claims it is not seeing customers trade down from high end premium to value brands, despite a clear shift in its results in Q2 2022 and commentary from a global spirits company noting a tempering at the very high end.
- Concerns about management and recent leadership changes. We believe MGPI investors should not put undue reliance on CEO David Colo's generally optimistic statements. In his prior role at SunOpta (Nasdaq: STKL) he was hired in February 2017 as part of its Value Creation Plan in its food and beverage businesses. Despite ringing an optimistic tone, Mr. Colo was unexpectedly terminated on February 26, 2019 when gross margins eventually tanked. SunOpta's share price declined 67% under Mr. Colo's leadership. In addition, Spruce Point warns that MGPI's CFO Brandon Gall has held various roles at MGPI such as Corporate Controller and Director of Financial Planning & Analysis during a period we identified unusual financial reporting tied to freight costs and revenue recognition and its ICP Joint Venture. MGPI has subsequently ceased freight cost disclosure and divested its ICP equity stake. Lastly, Spruce Point highlights that MGPI's VP, General Counsel and Secretary mysteriously left some time after October 2021. The only hint that he had departed was the fact that MGPI announced the hiring of a new Chief Legal Officer in September 2022. Despite the CEO's claims of successful integration, MGPI hired a Director of Business Development and Integration just last month, who "will collaborate with the company's finance and IT departments to facilitate finance system integration, implementation and improvement following mergers and acquisitions." Our interpretation is that there are problems to be fixed. In August 2022, David Dykstra, MGPI's top VP of Alcohol Sales, and a named executive, also announced his retirement.
- We Estimate Between 35%?55% Downside Risk to MGPI's Share Price. MGPI's valuation multiple has expanded materially in the face of increasing evidence that its branded spirits ambitions are not living up to management's claims, and consumers are trading down to value spirits, away from MGPI's premium offering. In our view, a telling sign of MGPI's share over-valuation is its own decision not to renew a $25 million share repurchase program on February 27, 2022. This corresponds with the approximate closing of Q1 2022 where MGPI started making financial restatements of revenue and revisions to last year's cash flow discussion. It's also worth noting that MGPI's Chairman and family members continue to sell stock and meaningfully diluted their exposure to the Company through the merger with Luxco. In 2022, their reported ownership hit an all-time low of 18%, down from 31% in 2015. We believe MGPI currently trades at a premium to its sum-of-the-parts of its alcohol and specialty ingredients businesses at 3.3x and 15.1x, 2022E sales and EBITDA. We estimate fair value at $45.70 ? $66.00 per share or 35% - 55% downside risk.
Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point has a short position in MGP Ingredients, Inc. and owns derivative securities that stand to net benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
1 Spruce Point Report, "Intoxicated By The Moonshine", January 12, 2017.
2 CEO Gus Griffin Retirement Notice (May 2020) and CFO Tom Piggot Resignation Notice (March 2019).
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