Defining Mergers and Acquisitions
Mergers and Acquisitions in the wine sector are the same as in any other sector. They occur when two companies are combined. Subsequently, all of the operations of both companies are subsumed under a single holding company.
What is the difference between a merger and acquisition
One difference between a merger and an acquisition in lay terms relates to the relative size of the companies involved. If two companies of similar revenues combine, that’s a merger. If one company has much more revenue than the second company, that’s an acquisition.
Formally, a true merger is where the companies cease to exist. Shareholders get new shares in that case. An acquisition is where both companies continue to exist as entities but the target becomes the subsidiary of the other. It’s not really about the relative strength / revenue of the companies. Maybe in practice you will rarely find true mergers between companies who have vastly different revenues. However, that’s a statement about a practical matter not a “definition” of a merger vs an acquisition.
Why do companies do Mergers and Acquisitions?
Obtain synergies. There may be opportunities to reduce overall costs. This could involve eliminating duplicated capacities at the two headquarters. It might get bulk discounts on supplies. The company could eliminate headcount in operations. It could save money by combining IT systems.
Increase negotiating power. The merged entity will be a larger player in all its operations and may be able to drive a harder bargain with suppliers, landlords, distributors, finance providers or retailers. The general aim of M&A activity is to produce a strengthened combined operation. I list ways to do this below.
Expand capacity. The merged entity will have a broader portfolio of capabilities or opportunities. For example, the acquiring entity may gain e.g. vineyards/ grapes/locations. Perhaps the target has a state-of-the-art IT system or difficult-to-find liquor licences. The acquiror could also gain a broad and well-designed distribution network. It could benefit from political connections in an emerging market.
Conduct financial engineering. Often, acquisition targets will be under- geared. This means that they fund their operations more with equity than with debt. That’s inefficient because dividends payable to shareholders are not tax deductible whereas interest payments on debt are by contrast tax-deductible. This angle is often of interest to private equity players.
Enable investment. Frequently, target companies lack sufficient cashflow to develop and enhance their operations and the acquiring company can supply this to allow the combined company to fully exploit its opportunities. Again, this angle is often interesting to private equity.
Add expertise. An acquisition creates the opportunity to attract a best-in-class management talent. In fact, employees at all levels will be easier to find. There will be improvements in training and staff development.
Specifics of Wine Sector Mergers and Acquisitions
Duckhorn Wine Company: https://www.duckhorn.com
The history of Duckhorn is a good example of how private equity activity has shaped the wine sector.
Duckhorn is based in Napa with 243Ha of vineyard estates in California and in Washington State. Duckhorn had been family-owned and run since inception in 1976.
In 2007, GI Partners acquired Duckhown. GI is a middle-market private equity fund. It originally aimed at providing investment diversification to major Californian pension funds. The purchase price was $300m.
GI worked on developing the management team during its ownership, both via external hires and internal promotions. The product lineup was expanded. Additional focus on the Decoy brand caused it to become “one of the industry’s top luxury wineries.” GI also invested more than $60 million in Duckhorn during their ownership.
This investment achieved the following outcomes.
- Add 140Ha of vines, allowing a significant expansion of production under both existing brands and new ones.
- Create state-of-the-art winemaking facilities via construction and acquisition.
- Introduce Canvasback, a boutique Cabernet Sauvignon from Washington State’s acclaimed Red Mountain.
- Expand distribution to a wider base of customers locally and internationally.
- Achieve significant industry recognition. Duckhorn now has the premier US luxury wine portfolio.
GI exited the investment in 2016 by selling Duckhorn for $750m to TSG Consumer. TSG is another private equity firm. It focusses on opportunities in the branded consumer sector.
The initial purchase price of $300m and the stated investment was $60m. So the this Wine Sector: Mergers and Acquisition resulted in an attractive IRR of 9.1% for GI. (I assume that the $60m of investment was distributed equally over the eight non-initial and non-final years of ownership.)
How this Wine Sector Mergers and Acquisitions Changed the Broader Wine Industry
The profitable nature of this investment for GI underlined the appeal of this sector to private equity investors more generally. That is underlined by the subsequent exit to a different private equity house.
It also showed that the opportunities to create value in the sector by adding investment and expertise were achievable relatively easily.
Consequently, the deal increased the value of a restricted number of ultra-luxury US wine operations and brands. It also emphasised the importance of some scarce qualities such as quality vineyards in key locations and a brand portfolio which is ripe for expansion. The brand portfolio was further exploitable. However, it was helpful for the purposes of the acquisition that Duckhorn had significant high-end brand identity. It also had wide awareness among high-involvement consumers and specialist industry players.
The deal showed management teams that private equity could be an appropriate steward of assets. The deal added value while not impeding the expression of core values. It also created rather than destroyed employment. Finance of appropriate size and patience was available. Wine Sector Mergers and acquisitions could benefit everyone.
Duckhorn ended its period under GI ownership with greatly expanded distribution in all US states and in 50 countries on five continents. Distribution is improved with private equity ownership and investment.
Further Transactions Stimulated by the Duckhorn Acquisition
The transaction stimulated further transactions in the US luxury wine sector.
In 2018, Duckhorn (still under the ownership of TSG) acquired Kosta Browne Winery. The seller was Boston-based private equity firm JW Childs Associates. Thus Duckhorn has now become almost a private equity player in its own right in the wine industry.
The President of Duckhorn Alex Ryan said “you can’t market your way out of a lower category into a higher one.” Wine sector wisdom generally agrees with this idea, with the caveat that it can be done but it is very difficult.
Ryan’s statement indicates that one motivating factor for the transaction was to expand product availability without dilution of brand identity. It is possible but very difficult to improve brand identity. Symington’s has been attempting to move its Cockburn’s Port brand upmarket through significant and extended investment.
The stated aim of the transaction was to operate Kosta Browne as a separate unit but expand it via both organic growth and acquisitions, thus further underlining the likely future importance of M&A in the sector.
Ryan noted the importance of private equity in the wine sector, stating that it was “good to have scalable, professional investment coming in to the space” which illustrated “maturation.”
We can expect private equity involvement in the wine sector to continue to be of major and growing importance.
Wine Sector Mergers and Acquisitions: Future Developments
A banker involved in the sector commented as follows on the likely effects of further private equity involvement on the sector.
Further consolidation between companies already involved in the sector is likely. There is more focus on capital appreciation under private equity than “lifestyle” under family ownership. This means more focus on expansion of businesses.
There will likely be higher production of existing brands. That may require broader distribution. This in turn may increase compliance issues within the US three-tier market and internationally.
Portfolios of brands will expanded. That means more expenditure on marketing, market research, segmentation analysis and advertising.
One question raised is whether the successful strategy shown in the GI transaction is scalable. Can the Duckhorn approach also work at Kosta Browne? There could be saturation effects at the luxury end of the market.
Are there opportunities at the value end of the market? There may not be if major conglomerates have already exploited them. We may assume they have been running their businesses at maximum efficiency and with no lack of investment capital and management expertise.
Established luxury wine assets will attract high multiples. These assets are sought after by private equity as well as already established family owners and individual wealth family offices.
The wine business is attractive since it is tangible, easy-to-understand and recession-proof. Potentially it also has some lack of correlation to financial markets more generally.