Monday, September 28, 2020

Why beer companies should never buy wine companies

On the face of it, there seem to be two arguments here. On the on hand, accountants at brewing companies seem to think to themselves something like this: “Beer has alcohol in it and so does wine, and therefore buying another (currently profitable) alcohol company would create administrative synergies, which would lead to economic efficiencies, which would in turn lead to even bigger profits.”

On the other hand, even Blind Freddie can see that the economics of beer making and the economics of wine making have almost nothing in common, even though one of the ingredients of the end-product is the same. This seems to lead to the conclusion that the accountants at any given brewing company should not be allowed within 10 miles of any wine company, because they will destroy it.


There are, sadly, quite a few examples of the latter (destruction of wine assets), and almost no examples of the former (an efficiently run combined company). One extremely unfortunate example lead to the creation of what is now called Treasury Wine Estates, which has been in the news recently, for having financial problems even as a single wine company. It is a simple story, in principle: a large beer company bought a large wine company, for a lot of money, then systematically destroyed the wine company's assets over only a very few years, subsequently spinning it off as a separate wine company again, and then selling if for only a fraction of what it originally paid.

Economics

The issue here is very simple. Beer companies do not usually produce any of their ingredients themselves, but instead buy them from primary producers. All the company needs, in principle, is some brewing equipment, to process the ingredients, and a bottling / canning line to package the output. Yes, this does make them dependent on the grain and hops growers, but there are plenty of them, should any given relationship turn sour (no pun intended). Brewers are thus not primary producers, they are intermediaries between the growers and the drinkers. Moreover, beer does not take long to make, even if one does mature the brew for a while before sale; and it can be made all year long. So, the return on investment is quite fast — they get their money from the buyers not long after they have to pay the growers. Finally, it is not hard to adjust volumes to market conditions, due to high turnover.

Nothing could be more different from being a wine company, could it? These companies are almost always primary producers, as part of their activity. They often own very large tracts of rather expensive land, made even more expensive by having to grow grape-vines on it; and the bigger the company, the more widespread these tracts of land are likely to be. Grape-vines are not fast to establish, not cheap to maintain, and not easy to modify should you decide to change the mix of ingredients (in this case, grape varieties). All of this requires a massive up-front investment, which will not produce much of a return for at lest 5 years, if you start from scratch.

Then, having got the ingredients, the company needs a winery, or two, to process the grapes and bottle / can the output — this can happen only once per year. Furthermore, in between the annual input and the final output there may also be a requirement for a large number of oak barrels, in which the nascent wine will be stored, for one or more years. This requires a large area of controlled storage conditions, which is also somewhat expensive. This all leads to a situation where the company is not likely to get its production money back for at least a year after it spends it, and, for many wine types, several years. And let's not contemplate for too long the nightmare of trying to adjust volumes to prevailing market conditions, or trying to deal with environmental effects, like smoke taint.

So, it should be obvious that you cannot run a wine company the same way you run a beer company. Maybe you could run a spirits company in somewhat the same manner as a beer company, although it often needs some barrels, too. But the economics of wine is another thing altogether.


A specific example

So, why do beer companies sometimes buy wine companies? It cannot possibly turn out well. Let me briefly describe the example mentioned above, although it is perhaps an extreme one. It comes from Australia, so open a beer and settle yourself into a comfy chair.

The beer company involved is (or was) called Foster's Group Limited. While probably known internationally as a particularly Australian brand, Foster's beer is actually quite rare in Australia itself. Its biggest market is the UK, where it is apparently the second highest selling beer. Like all big companies, Foster's has a long history. It started in Australia in 1888, but in 1907 the company merged with five other brewers to form Carlton & United Breweries (CUB). Courage Brewery (from Britain) was acquired by CUB in 1990, which by that time had been re-named Foster's Brewing Group. In 2011, CUB and its products were bought by the conglomerate SABMiller, which in turn was incorporated into the multinational Anheuser-Busch InBev in 2016. CUB is currently being sold to Asahi Breweries.

There are actually two wine conglomerates involved. The first one in our story was called Mildara Blass, a highly profitable business, seen in the industry as a model for return on investment, driven by the big volume Yellowglen, Jamiesons Run and Wolf Blass brands. It was formed in 1991, when Wolf Blass Wines and Mildara merged, each being a large well-run company in its own right. Wolf Blass Wines International had been formed in 1973, and was publicly floated in 1984. Although founded earlier, the Mildara trademark dates from 1937. It remained largely a “sherry” producer until well into the 1960s, but during the 1970s and 1980s it expanded rapidly, acquiring a series of high-profile wineries.

Fosters moved into the wine business in 1996 by acquiring Mildara Blass, which itself acquired other wineries (eg. Rothbury Estates and Saltram). By 1999, the wine company claimed c. 40% of the Australian sparkling wine market and 25% of its premium table wine market. Then, in 2000, California’s Beringer Wine Estates joined Foster’s wine business, and the name changed to Beringer Blass Wine Estates (shortened in 2004 to Beringer Blass). However, by then the difficulty of running an international wine business had become apparent. For example, in the year to June 2004 the wine division returned just 4% on its AU$4.4 billion of assets, compared to the beer division’s 25% on AU$2.2 billion of assets.

The second wine conglomerate in our story was called Southcorp Wines, a name that dated from 1994. It was then the owner of many of Australia’s greatest and oldest wine brands, including Wynns Coonawarra Estate, Penfolds, Seppelt, Lindemans, Leo Buring, Coldstream Hills and Devil’s Lair. In 2001, it merged with what had been the highly successful Rosemount Estate. However, the two entities did not work well together, from the management point of view. Even worse, both their local and their export combined market shares were decimated — retailers were not going to be dictated to by this now enormous supplier — according to Chris Shanahan, they “learned the hard way that they were the tail, not the dog; and the big retailers would wag them, not the other way around.”

So, just 4 years later, in 2005, Foster’s moved in, paying top dollar for Southcorp. Sadly, the downhill movement continued (eg. a 10% slide in wine sales during the first half of 2006–2007). As described by Shanahan:
Foster’s first major blunder after the acquisition was to funnel all sales across it vast beverage portfolio through a single sales force. Friends in the trade at the time said it was farcical. And the loss of market share experienced by the merged Southcorp-Rosemount was repeated by the merged Southcorp-Foster’s.
There were therefore repeated write-downs of assets. David Farmer cites an estimate of around AU$8 billion being used to build Foster’s wine assets, but by 2010 these same assets had an estimated value of just AU$2.5 billion. That is one helluva write down!

In 2010, Foster’s Group finally saw sense, and decided to split its global beer and wine divisions into two separate companies, to be listed on the Australian Stock Exchange. In the process, it changed the name of its wine business from Foster's Wine Estates to Treasury Wine Estates (TWE). This gave TWE control of its own destiny, based on whatever it could salvage of its wine assets. This strategy seemed to work for a decade, based on the strength of its premium holdings, notably the Penfolds and Wynns wines. It also moved strongly into the emerging Chinese wine market, leading the concerted Australian attempt to take over from the French in that market.


As a sad postscript, is Treasury Wine Estates doing particularly well, 10 years later? Obviously not. Its current income is far below previous expectations, for various reasons; and the current pandemic plus the current trade war between China and Australia have made things even worse. As a result, TWE currently has at least two class action suits against it (one; two), for deliberately misleading investors with forecasts of forthcoming riches. Ironically, it has been considering de-merging its portfolio of wines, taking us right back to the 1970s.

Why would anyone want to own a high-profile and expensive wine company? Freddie may not be as blind as his name suggests, but accounts sometimes seem to be.