Spruce Point Issues “Strong Sell” Investment Opinion On MGP Ingredients (Nasdaq: MGPI) – Sees 60% – 70% Downside Potential

MGP Ingredients, Inc.

MGP Ingredients (“MGPI” or “the Company”) Is A Commodity Ingredient and Alcohol Producer Now Being Spun As A Sexy Transformation Story Into A Premium Producer of Branded Whiskey and Bourbon. MGPI is a simple story to understand. It operates two businesses: an ingredients business run from Kansas and an alcohol distillery in Indiana. Both of these facilities are old assets and prone to substantial operational hazards. Most recently, MGPI has experienced fires, work outages, and chemical disasters requiring the hospitalization of innocent people.

MGPI’s shares have appreciated 1,000% since 2014  as investors have cheered the Company’s decision to hire new management, reprioritize its businesses away from commodity ingredients, and focus on “higher margin” premium alcohol beverages. MGPI has also recently benefited from a temporary, yet unsustainable, increase in earnings from its 30% joint venture with Seacor (NYSE: CKH) called Illinois Corn Processing (ICP).

On the surface, the Company’s transformation strategy appears wildly successful. Its EPS has risen from a loss of ($0.29) in 2013 to positive earnings of $1.50 per share in the LTM 9/30/16 period. Over the same period, sales have essentially been flat, but gross margins have expanded from 6.4% to 18.1%

Spruce Point Believes Investors Should Be Cautioned Not To Extrapolate Recent Earnings Performance. We Believe There Are Numerous Business Risks And Cracks In The Growth Story That Are Not Being Adequately Discounted…

Executive Summary

  1. Rapid Whiskeyl Bourbon Sales Growth, A Key Driver of MGPI’s Recent Earnings + Share Price Expansion Won’t Continue As A Result of Substantial New Capacity Growth
  2. Diageo Is A Material Whiskey Customer Accounting For At Least 8% of Revenues, Its New Distilleg Comes On-Line In 2017; Best Case It Reduces I Eliminate Its Supply Contract With MGPI; Worst Case It Competes Directly Against It
  3. MGPI Also Appears To Be Quietly Covering Up A Large Market Share Loss In the Gin Category Associated With Seagram’s. Investors Should Study Both The Gin and Vodka Market As Case Studies For What Can Happen To Whiskey
  4. A Multitude of Other Contracts And A Key Ingredient Patent Expires in 2017 Which Significantly Increase MGPI’s Business Risk; Investors Are More Focused On The Alcohol Business, And Not Paying Close Attention
  5. MGP Ingredients Has A Histogy of Operational Disasters (Fires and Chemical Explosions) Which Could Harm Earnings
  6. MGPI’s Foray Into Branded Liguor Sales Have Shown De Minimis Results, And Are Likely To Disappoint
  7. MGPI Is Out of Cash, And Borrowing Heavily On Its Credit Facility, Funding Long-Term Construction With Short-Term Debt. It Must Turnover Its Barreled Whiskey or Face Severe Financial Strain
  8. MGPI Quietly Restated 2015 Results of Related-Party Transactions Affecting Its ICP JV With Seacor (Another Public Company) Both Companies Financial Reporting Do Not Reconcile, Which Potentially Puts MGPI In Violation of Its Credit Agreement. MGPI ls Also Quietly Restating Sales Figures Tied To Customer Freight
  9. Regulators Are Expanding An Audit Investigation of MGPI, Which May Result In Increased Taxes and Penalty Costs
  10. Follow The Money Carefully: MGPl’s Largest Shareholder And Founding Family Entered A Stock Sale Program on Dec 21, 2016 – Around The Holiday Period When Things Were “Quiet”
  11. Spruce Point Sees Approximately 60°/o – 70% Downside + Big Hangover Waiting For Investors Intoxicated By The False Hope of Future Gains. MGPl’s Valuation Will Revert To 8x-1ox EBITDA From 14.5x Currently Once Reality Selts In

Poy Close Attention To MGP Ingredients’ Recent Accounting Warnings

Taking a step back before reading our regortI we believe investors should carefully evaluate the unusual changes to MGPl’s 2016 10-0 filings it made. We believe the Comgany is signaling accounting strain and issuing a subtle warning. Look carefully at Note 1. Accounting Po/ices and Basis of Presentation. MGPI added a stronger cautionary statement suggesting its estimates may require material adjustment, and removed a statement that suggested its financials were fairly presented

MGP Ingredients

Spruce Point Believes MGP/ ls A Strong Sell” For The Following Reasons:

MGP Ingredients (“MGPI” or “the Company”) Is A Commodity Ingredient and Alcohol Producer Now Being Spun As A Sexy Transformation Story Into A Premium Producer of Branded Whiskey and Bourbon

  • MGP Ingredients is a simple story to understand. It operates two businesses: an ingredients business run from Kansas and an alcohol distillery in Indiana. Both of these facilities are old assets and prone to substantial operational hazards. Most recently, MGPI has experienced fires, work outages, and chemical disasters requiring the hospitalization of innocent people
  • MGPI‘s shares have appreciated 1.000% since 2014 as investors have cheered the Company’s decision to hire new management, reprioritize its businesses away from commodity ingredients, and focus on “higher margin” premium alcohol beverages. MGPI has also recently benefited from a temporary, yet unsustainable, increase in earnings from its 30% joint venture with Seacor (NYSE: CKH) called Illinois Corn Processing (ICP)
  • On the surface, the Company’s transformation strategy appears wildly successful. Its EPS has risen from a loss of ($0.29) in 2013 to positive earnings of $1.50 per share in the LTM 9/30/16 period. Over the same period, sales have essentially been flat, but gross margins have expanded from 6.4% to 18.1%

Spruce Point Believes Investors Should Be Cautioned Not To Extrapolate Recent Earnings Performance. We Believe There Are Numerous Business Risks And Cracks In The Growth Story That Are Not Being Adequately Discounted

  • The biggest aspect of the “bull case” surrounding MGPI is that it is a play on the explosive growth in consumer taste for whiskey and bourbon, and can transition to a branded producer. Investors fail to realize that MGPI is primarily a white-label producer that sells to other brands. One of its largest customers (which MGPI doesn’t adequately disclose) is Diageo, which owns the Bulleit brand. Diageo is close to completing its own Kentucky whiskey distillery that is expected to be completed in 2017. At best. Diageo reduces or completely eliminates up to 80/0 of MGPI’s sales, and at worst they start to directly compete in the bulk wholesale market
  • There are now over 1,000 craft distillers for whiskey / bourbon in the United States. Just like Diageo, many of these distillers are constructing their own distilleries, which would reduce / eliminate their need to buy from MGPI. The rapid proliferation of new distilleries and brands in the market makes MGPI’s ability to brand itself all-the-more challenging. Based on our research, its recent tiny acquisition of George Remus whiskey and introduction of Metze’s Select (Metze being MGPl’s master distiller who recently departed) have had limited traction, and are nothing more than way out-of-the money call options. Many high profile Iiguor brands endorsed by celebrities and billionaires have failed in the past. There’s no reason to assume MGPI will have any success
  • Because investors are so enamored with MGPI’s alcohol business, they are not paying attention to other material risks that loom large in 2017 such as: 1) key ingredient patent expiration, 2) collective bargaining agreement, 3) supplier agreements, and 4) added fines / penalties from a) recently expanded audit investigation by the TTB, and b) from the chemical explosion in 2016

MGPI’s Barreled Whiskey Inventory Is Rapidly Rising, While Sales Are Declining, And Inventory Turnover Plunges