Value creation at Anheuser-Busch: a real options example

            Anheuser-Busch (BUD) is a fine example of company that has been able to create $11.5 billion value addition in a matter of merely three years with only a $ 1.9 billion capital investment without having any major product growth opportunities in or outside the United States.
How BUD achieves this extraordinary value creation may cause perplexity when observed BUD’s joint venturing in small equity companies with very high risks and uncertain returns instead of  complete building investments in brewing and distribution systems. The plus point of the joint venturing strategy over the complete building strategy directly is that it allows BUD to have an opportunity to learn before making an actual huge investment and hence a better probability of risk avoidance. BUD would invest only in the Joint venture if the observed value of potential business is greater than the cost on its investment.

            For a better estimation of valuation, BUD requires various figures to be used in the Black-Scholes formula. This includes: discounted value of the operating cash flow of asset of the current year, time in years to exercise the option of complete investment, strike price of the asset which is the purchasing price, risk free rate of return and volatility percentage.
For a discounted value of cash flow, PV of operating cash flow of the asset in the year of fully building brewing and distribution system would be required. This can be found through various estimations of sales growth percentages, price per barrel changes over the years etc. Next, using a figure for the amount of years needed to avail this option, the required figure for the discounted value of cash flow will be available.
The figures for the time in years to avail the option, strike price will be determined before hand and the figure for the risk free rate of return is based on an estimate.
The trickiest and the most essential figure is the volatility percentage. The sensitivity analysis reveals major changes in option valuation if the volatility estimate is changed only slightly. A higher volatility represents higher uncertainty which means BUD actually has an area of probable learning through the joint venture investment, thus implying a higher option valuation at that volatility estimate.
Using the Black-Scholes formula, it comes into light that an option may still be valuable even with a negative NPV.
Using the same variables from the Black-Scholes formula and redefining the formula, BUD can find out the probability of whether the estimated strike price of an option will be exceeded or not. This is known as the option pricing methodology in which BUD can insert the data for the best and worst case scenarios and find out the probability of exercising the option at that valuation keeping the volatility estimate constant.
This formula can further be used from an analysis point of view before deciding on a particular volatility estimate. Any decision maker would have the opportunity to see the relationship between the strike price of the option at a future date and the probability that it will exceed that price. With higher volatility estimates, below median, there is lower probability for the value of the option to exceed that price and for above median, there is a greater probability for it to exceed. It is vice versa for lower volatility estimates.

Arnold, T., & Shockley, R. (2001). Value creation at Anheuser-Busch: A real options example.                  Journal of Applied Corporate Finance , 14 (2).

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