Saturday, June 8, 2013

60% Yield! (CWGL: Crimson Wine Group)

So Barron's had an article about Crimson Wine Group (CWGL) last weekend.  It's a nice, small, ignored Leucadia (LUK) spinoff.  I talk about LUK so much that I feel like I have to say something about CWGL.   I looked at it like everyone else and just sort of shrugged; what am I supposed to do with a winery stock?  I don't have any particular view or opinion about the business other than my understanding that it's a tough business, prone to pests, weather, supply/demand problems etc.

But this article sort of got me thinking about it a little bit and there was an interesting article in the New York Times about wineries in general too, recently, so I thought I'd put them together to see what CWGL might be worth.

Oh, first of all, I have to explain my cheesy title.

60% Yield
OK, I think you can actually get something much higher than 60%, but here's the secret:  CWGL shareholders get a 20% discount on their wine purchases from them.  During the LUK years, this discount applied to both on-site tasting room purchases and wine purchased online and the Barron's article does say shareholders get a 20% discount on wine purchased on it's website.  I never tried, so I don't know if there are volume or frequency limits or anything like that.  Of course, they may stop you from buying bulk, but that's OK.  (During the Leucadia years, it was on an honor system; all you had to do was to say that you were a shareholder and you would've gotten the discount.  What's the return on that?)

If you bought 100 shares of CWGL, it would cost you $900 or so (of course you can buy less and really get a high yield).  Let's say you drink one bottle of wine per week and you like something in the $50 range (come on, I know you guys can afford it).  So that's $2,600 per year in wine purchases.  A 20% discount is worth around $520, so on your $900 cost stock that's a return of 58%!  If you have a taste for pricier wines or drink more, then your return would be even higher.  If you bought less than a round lot, your return would be higher too.

But anyway, I really don't know what the volume/frequency limits are so maybe this is baloney. And if this only applies to tasting room purchases, then only people out west can grab this yield.

Anyway, let's get to the other stuff.

One key point in the Barron's article is that CWGL trades at 1.1x price-to-book, but they recently sold some nonstrategic assets for 1.7x book.  These comparisons are a little tricky without knowing more; I wouldn't take one transaction and apply it to the whole, even though I would not be surprised if CWGL was worth more than book.  Comparisons to other listed vineyards may not be so meaningful either as one of the big purchases at CWGL happened as recently as 2011. Older vineyards may have lower cost basis.

But anyway, with Cumming and Steinberg, it would be hard to imagine that they would overpay for assets, even as a vanity play.  From that alone, book value may not be a bad place to start in valuing CWGL.  If they didn't overpay for assets and their accounting is conservative, then it's probably safe to say that CWGL is worth at least book.

$100 million in Sales by 2016
The other interesting thing in the Barron's article is that they quote (via Napa Valley Register) CEO Erle Martin as saying their goal is to double sales to $100 million by 2016.

By the way, I found a datapoint that showed that back in 2007 (yes, the peak), wineries M&A were done at an average of 4.4x EV/revenues.   That drifted down to 2.7x in 2010 and I don't have data after that.  With recent revenues in the $50 million range, that values CWGL currently at around $220 million versus the current EV of $195 million or so (@8.92/share stock price). 

If revenues get to $100 million by 2016, CWGL may be worth $440 million in three years.  But again, that's against the peak valuation (I think that's the peak) of 4.4x revenues.  It's not too prudent to use 'peak' values (or else, again, maybe investment banks would be worth 4x book!).  More on this later as it's not that simple.

Fetzer Vineyards was sold by Brown Forman in 2011 for what looks like 1.5x revenues, but Fetzer is a lot more down-market than CWGL so I don't know how meaningful that datapoint is (Brown-Forman kept the better vineyards in Sonoma etc.). 

New York Times Article
An article I read in the New York Times (April 26, 2013: Boutique Vintners Turn to Private Equity for Help) struck me as relevant to looking at CWGL.  I don't know how relevant it is as I don't have a high comfort level in evaluating vineyards.  But here are some of the details that I thought were interesting.   

The quoted expert on vineyards is Peter S. Kaufman of Bacchus Capital, which is a private equity fund founded by Sam Bronfman II (Seagram's founder's grandson;  Kaufman is a co-founder).  This private equity fund was set up specifically to buy wineries so I assume that's all they spend their time doing; looking at and thinking about vineyards.

So let's borrow their expertise here.

This is what Kaufman (and others) said:
  •  Before the financial crisis wineries were selling for the equivalent of 12 to 15x trailing EBIDA (earnings before interest, depreciation and amortization (not EBITDA!)).   It was a level more than they could stomach. Valuations have now come down.
  • Fundamentals for wineries are good for high quality producers with right distribution model.
  • Wine consumption has been increasing steadily over the past couple of decades and remained robust during the recession (Wine Market Council).
  • Baccus Capital thinks there is still plenty of growth, especially for premium wines.
  • Bronfman said wineries that can improve their direct-to-consumer distribution through wine clubs and tasting rooms also have tremendous potential.
  • Traditional channels (like restaurants and retailers) are still important, but can reduce margins by up to a third.
  • Kaufman says a well-run, high-end winery should have gross margins of 60% and EBIDA margins in the 20-25% range.

Leucadia's Last Comments on Crimson
Just as a refresher, this is what Cumming / Steinberg had to say about Crimson in the 2011 Leucadia annual report (sadly, the last report written by this dynamic duo):

So it seems like CWGL is all set to increase volumes and make some profits.  I post this to highlight the fact that the history of losses at CWGL may be just that; history.  Maybe going forward, they grow profitably.

As a cautionary note, here's a snip from the 2010 LUK AR:

Even in good times, it's difficult to make money in wine... jeez...  At least they are good inflation hedges (didn't Steinberg tell LUK shareholders at the 2012 annual meeting that people who don't see high inflation should just sell their LUK shares?).  But at least it looks like volume is going to get ramped up as they said in the 2011 annual report.

Putting This Together
OK, so let's put all of this together.  The above comments by Bacchus Capital seem to describe Crimson Wine pretty well, doesn't it?  Premium wines, focus on improving direct-to-consumer channel (via wine clubs and tasting rooms) to get higher margins etc. 

When I read the article, I immediately thought, gee, that sounds exactly like CWGL.  And it's no surprise that Cumming / Steinberg focuses on an area of growth (premium wines) and focuses on profitability (direct-to-consumer channel).

So let's look at the above numbers and plug them into CWGL.  Kaufman said that good wineries have gross margins of 60% and EBIDA margins of 20-25%.  You know where I'm going with this; in good times (pre-crisis), wineries used to sell at 12-15x EBIDA margins.

Plus we know from the above that CWGL is shooting for $100 million in sales by 2016.  So we have all the pieces we need to get a value for this thing.

Of course, I am going to look at CWGL using the pre-crisis valuation, which might be high.  Maybe it was a bubble.  Or maybe right now we all have PCSD (Post-Crisis Stress Disorder) and can't imagine anything trading at pre-crisis levels anymore.  But a quick look at the stock market, art and other assets should prove otherwise.

But yes, I understand that this valuation may not be 'conservative' or even reasonable.  I'm just doing this to get a feeling for what's going on here.

First of all as a reality check, let's make sure that CWGL has some potential to make the above margins.  In the first quarter of 2013, CWGL had a gross margin of 46.8%, and they had 49% gross margins for the full year 2012.  So 60% looks within reach if CWGL is ramping up production and is going to realize benefits of scale. 

EBIDA margins were 25% in 2012 and 22% in the first quarter of 2013 (excluding other income which was gain on sale of an asset), so that's already within the 20-25% range of a good winery.

Putting this stuff together:
  • CWGL goal is to get to $100 million in revenues by 2016.
  • A good vineyard will have 60% gross margin, so let's say CWGL earns $60 million in gross margin
  • A good vineyard has EBIDA margins of 20-25%, so EBIDA is in the range of $20 million - $25 million at CWGL in 2016.
  • Pre-crisis valuations were 12-15x EBIDA, so CWGL might be worth (using the low multiple on low end of margin range etc.) $240 million to $375 million.

First of all, let's see what happens with these metrics using historical figures.

In 2012, CWGL had sales of around $50 million (close enough!).  We already saw that they had EBIDA margins of 25%, so that's $12.5 million in EBIDA. 12-15x that is $150 million to $188 million.

With 24.4 million shares outstanding and no debt (they had debt in 2012 but that was converted to equity by LUK so there is no debt now), that comes to $6.15 - 7.70/share.  There is around $20 million in cash on the balance sheet, so add that and you get $7.00 - $8.50 in value. 

OK, so sales are growing so you have to take that into account.   Sales grew 18% in the first quarter of 2013 and 24% for the full year 2012.  They are increasing capacity (more on that later), so let's assume they grow revenues at the same rate of 18% for the rest of the year.  I have no reason to believe this is realistic, but we know it's growing and I don't know that there is any guidance on revenues from CWGL itself.

With all else equal, a 25% EBIDA margin and 18% higher sales, CWGL would be worth by the end of the year $8.26 - $10.00/share (this assumes cash stays at $20 million; at 25% EBIDA margin and $6 million in expected capex this year, there should be enough cash to leave cash unchanged if not rise). 

So from the above figures, CWGL doesn't look too exciting.  I think if CWGL is already earning 22-25% EBIDA margins, it may actually be headed higher as sales grow and they get benefits of scale.  In that case, obviously, the valuation would be much higher.

$100 Million Sales by 2016
So let's look at this $100 million sales by 2016 for a second.  That's double what they did in 2012.  Using the same model as the above, we get $20 - 25 million in EBIDA and a fair value range of $240 million - $375 million.  That's a range of $9.80 - $15.40/share for CWGL without taking into account any cash. 

The problem here, of course, is that it will take some investments to get capacity up to 500,000 cases.  At the end of 2012, just adding up the wineries listed in the 10-K, I get current capacity of around 260,000 cases.   The 10-K lists two types of capacity; permitted capacity and fermentation and processing capacity.

Here is the breakdown:
                                                     Permitted           Fermentation and
                                                     capacity             processing capacity  
Pine Ridge Vineyards                 126,000               80,000
Archery  Summit                           21,000              15,000
Chamisal  Vineyards*                   42,000    ->  100,000 by 2013
Seghesio                                      170,000              120,000   ->  170,000 by 2013

(Chamisal doesn't have a separate "fermentation and processing capacity" listed in the 10-K, so I assume permitted and processing capacity are the same for this vineyard).  Double Canyon doesn't have any production facilities, but does sell wine produced elsewhere; I don't know how that fits into our scenario)

So it looks like at the end of 2012, capacity was around 257,000 cases.  Sales in 2012 were 260,000 cases.

They are spending $300,000 this year to increase Chamisal capacity to 100,000 cases from 42,000 and $2,000,000 to up the capacity at Seghesio by 50,000 cases.  These figures are just what they will spend in 2013 to complete the capacity increase so isn't the total cost of expansion.

The 2016 $100 million sales target assumes 500,000 cases of sales.  At the end of 2013, capacity seems like it will be 365,000 cases.   So there will need to be 135,000 cases more of capacity.  An increase this size may have to happen via an acquisition. 

CWGL paid $86 million for Seghesio in 2011 for 120,000 cases of capacity (as of 2012-end; I don't know what the capacity was as of May 2011 when it was acquired).

If $86 million is required to add another 120,000 cases of capacity via an acquisition, the above math obviously doesn't work out.   CWGL does have a $60 million credit line so this may be for acquisitions.

Let's say they did another acquisition just like Seghesio for $86 million and adding 120,000 or so in case capacity.  When they did Seghesio, it was funded more or less 50%/50% debt and equity.  So let's say they do so again.  Assuming they borrow $43 million and issue $43 million in stock (say, for $9.00/share), then in the above scenario, they would have 29.2 million shares outstanding and $43 million in debt, or let's say $23 million in net debt (if they keep $20 million or so cash on hand).

So if the EV fair value range is $240 million - $375 million, the equity value would be:

$240 million minus $23 million net debt divided by 29.2 million shares outstanding = $7.43/share on the low end (12x EBIDA based on 20% EBIDA margin) and $375 million minus $23 million divided by 29.2 million shares $12.05/share on the high end (25% margin and 15x EBIDA).

If EBIDA margins are already 25%, we can just use that and the 12-15x EBIDA range and we get a valuation range of $9.50 - $12.05/share for CWGL in 2016.  Not that super-exciting.

If it's true that CWGL is just getting up to scale and they can start to make more money, it's certainly possible that this 25% EBIDA margin is way on the low side.  It would actually have to be for this investment to be exciting.  At least from what we see in the above analysis.  

But in 2013, when they finish capacity expansion at their current vineyards, capacity will increase by 40%.  If sales grow to use that up with minimal incremental capex going forward, operating leverage can be significant.  I don't know the wine business so I can't tell you how much, but it does feel like it can be substantial.

Sales at Capacity
OK, so looking out to 2016 may require assumptions on how CWGL gets capacity up to 500,000 cases.  So why not just look at this from the point of view of where capacity would be during 2013?

We see from the above that after the 2013 capex, they will have total capacity of 365,000 cases;  40% higher than the 2012 year-end capacity.   These figures are just based on what I see in the 10-K.  Others may have different capacity figures and I may be missing something. 

So let's assume, instead of getting to 500,000 cases by 2016, that at some point within the next couple of years, sales gets up to 2013 capacity of 365,000 cases.   This way, there would be no new capex or acquisition assumptions required (other than maintanence and other non-expansion capex).

So from the $50 million sales from 2012, we will just add 40% because that is how much sales they can grow without an acquisition or expansion capex (other than what's planned for 2013). 

The new sales would be $70 million.  From here, let's just assume 25% EBIDA margin because as I said, they are already there and further sales gains should show some operating leverage and may even go higher.

With sales at $70 million and 25% EBIDA margin, that's $17.5 million, and 12 - 15x that is $210 million - $263 million.  Again, let's leave cash there at $20 million, so add that to the EV figures for a range of $230 million - $283 million. 

With 24.4 million shares outstanding, that's a range of $9.43 - $11.60

This may actually be on the low side since the new capacity expansion is at existing facilities, which means there should be some scale leverage at the facility level (and not just SGA leverage from increasing overall volume at the corporate level).  If gross margins move up to 60%, EBIDA margins may well get into the 30s, and if that's the case the above figures could move up by 20% or more.

But I actually don't know as I am not too familiar with this industry.

Other Valuation Guidepost
As usual, I just did a quick search of recent wineries deals and couldn't find much in the U.S.  One very visible one was the Constellation Brands purchase of Mondavi in 2004.

Citigroup used the following comparables for valuation:

Wine Companies:
  Chalone Wine Group
  Vincor International

  Lion Nathan Ltd.
  Southcorp Ltd.
  Evans & Tate Ltd
  McGuigan Simeon Wines

  Baron de Ley SA.

They didn't provide mean, average, high and low as usual, but Citi said the valuation range using the above group for Mondavi would be 10-12x 2004 EV/EBITDA (as of May 2004).

For transaction analysis, they looked at 15 U.S. and 16 non-U.S. deals between 2000-2004, and the valuation range came to 12-14x EV/EBITDA.  Taking out the T would make a 12-14x EV/EBITDA higher than 12-14x EV/EBIDA.

Of course, this is 2004 so pre-crisis (but also pre-super-bubble of 2006-2007).  But unlike banks, which may very well have a reason to have valuations much lower than pre-crisis, it wouldn't be surprising to see winery valuations get back to more 'normal' levels.   Of course, whether this is 'normal' or not is arguable and I don't necessarily have a strong argument either way.

Other Comps
The other listed comparables are Vina Concha y Toro (VCO) and Treasury Wine (TSRYF).  Vina Concha seems to trade at an EV/EBITDA multiple of 16x and 23x p/e.    Subtracting 2012 taxes from ttm EBITDA (so not apples to apples, but close enough for a 'rough' estimate), it seems like VCO is trading at 20x EV/EBIDA (Yahoo Finance data). 

In a later post, I may take a closer look at VCO, TSRYF and whatever other comps from the above Citigroup list still exists.

But just from the fact that VCO is already trading at 20x EV/EBIDA (and they have much lower gross margins) seems to indicate that it might not be too far-fetched to assume that U.S. winery prices get back to 12-15 EV/EBIDA or even higher for profitable, high quality wineries (which would seem to suggest some upside for CWGL after all).

I didn't intend this post to be a really close, comprehensive look at CWGL (nor did I think it would be this long!).  I just wanted to do two things:
  • point out the investment return (admittedly not scalable) one can get by being an owner of CWGL (20% discount; you can't eat outperformance, but you can drink this yield!) and also
  • to put the expert thoughts on wineries by the folks at Bacchus Capital to use and put it together with what we know about CWGL to see what pops out.

In a later post, I may take a closer look at some of the comps and get a better feel for winery valuations from around the world.  I know wineries also tend to be valued per acre and other 'asset' measures, but I have nothing to contribute on that front.  You can google and get all sorts of per-acre valuations, but I have no idea what applies to CWGL so I would have no conviction on those kinds of valuations.

I tend to look at comps as important information, of course, but as an investor myself it's more important that I understand the economics of the business and see what the profits to shareholders are going to be.  Sure, it's fine if an industry trades at 20x EV/EBIDA or EV/EBITDA, and if something trades way below it, there can be profits to be had if valuations move up.

But I'm usually more comfortable with something simple, like, if I buy this what is my pretax return on investment?  When the two together fit well, that's great.  When it doesn't, then I am a bit more reserved.  

Also, CWGL is tiny at $50 million in sales.  So comparing them to other larger entities might not be that meaningful.  Again, I really don't know this industry.

Anyway, this post is way longer than I intended so I want to get this out. 

I may (not guaranteed!) post a followup to this after looking closer at the comps and some simple earnings model to get at a regular p/e ratio.

Although I have no real interest in this industry, I think it's worth the time to look at it because:
  • It's a spinoff, and one from a company I really like (Leucadia)
  • It's tiny so not worth the time for most institutions (which means we should look at it!)
  • Run by two incredible managers with big ownership
  • Industry is not viewed favorably (at least I don't think it is)

In any case, the key driver for this year and next is going to be the ramp up in volume due to the expansion of Chamisal and Seghesio and the leverage that will kick it at the facility level and the corporate level (leverage SGA).  It's possible that 25% EBIDA margin is way, way, too laughably low for CWGL (in which case it would be worth far more than the above analysis!).


  1. One piece that is missing from your analysis is their use of third party grapes and production facilities. For example, last year they produced 65,000 cases of Chenin-Blanc this way. Foremost is also produced from third party grapes using third party production.

    1. Hi,
      Thanks for that. I don't see that data anywhere but yes, I figured there were some (Double Canyon) that are not included.

      Without data, I don't know how to incorporate that into my analysis.

      Hopefully there will be more data forthcoming over time. But then again, this is a small cap OTC stock so maybe there won't be...

      Thanks for the input.

  2. I agree that they should provide more data. But at a minimum this suggests that no acquisitions are necessary for them to reach their 500,000 case target.

  3. fantastic analysis, I owned this stock post spin off and sold it not too long after I did more work. I think their business is unlikely to hit some of these higher margin estimates that have occured in the past for a few big reasons. one is that the distrbutors in this business have become increasingly strong over the past 5-10 years to the point now that distributors of wine get much better economics. Also CWGL has publicly stated they intend to ramp up the sale force and marketing spending. indeed, the CEO is an ex sales guy. So I would argue that op margins need to account for a signifigant increase in S&M expense. Furthermore, the global wine industry has become increasingly competitive. Those valuations you quote from past years are from before australis, south america, etc got more serious about the wine game. I truly doubt margins and valuations will return to those levels. CWGL is getting squeeze from competition, distribution and then they are also not the right size. The really big guys have scale and the small wine guys are niche and CWGL is just kind of caught in the middle where they have little leverage with their distributors and not much scale yet. If you google the CEO's name there are some youtube videos of him presenting at winery conferences post seghesio acquisition that are interesting and I recommend. I think the merger execution here is also an underestimated risk as this management team seems smart but I do not see anything in their past indicating they have experience integrating extremely large acquisitions of companies that seem to me at least to have quite different cultures

    1. Hi,

      Thanks for the information and comment. That's very interesting. I was thinking that they would keep S&M constant with sales, but I wouldn't know how to model that. I would use a constant 22-24% of sales, or something like that but if they ramp up hiring for that, it may go higher but I imagine sales should pick up after that.

      You are right that wine is competitive; just reading the Crimson comments in the LUK letters show us how tough it is, and they have a history of inventory write-downs too, so that's a risk.

      I see VCO, though, trading pretty high so maybe valuations do have room to improve, but I certainly don't have a lot of comfort level with this business. (VCO is bigger so they may have other benefits that merit a higher valuation. This is the problem with comparables analysis, of course. As you say, CWGL doesn't really have the scale that might help the big players).

      Anyway, thanks for the tip on youtube... I will certainly look for it.

      I guess the very simplest case for CWGL is, as Cumming/Steinberg said in one of the LUK letters, is that this is an inflation hedge and getting that at close to book (which reflects prices that the LUK folks paid) can't be too bad a bet.

      I own the spun off shares, but I haven't bought any additional CWGL yet.

  4. Great post!

    I used to have a small stake in Foster's Group, the beer brewer in Australia before it was acquired by SABMiller. In 2011, it spun off Treasury Wine Estate. At the time I looked at beer vs wine (the business). I liked everything about beer and disliked wine: capital intensive, high fix cost, long lead time. And I had zero knowledge on winery valuation. So I sold it. Since then, it's up 70%... Sigh.

    Anyway, your post now gives me a starting point to understand wineries. I just need to wait for the next TWE.

  5. I own CWGL through spinoff and also bought some shares when it started trading. I'm not expert on winery business, but I'm placing my faith in Cumming/Steinberg. They kept saying this is a tough business year after year, yet they keep investing in it. I be it's not because they want to get wine for 20% discount! LUK tend to be conservative about book value (plus some were acquired long ago...they have since appreciated in value).

    I tend to believe the Cumming/Steinberg wanting to keep all of this business away from the merger so it doesn't get diluted by JEF shareholders. Perhaps they think it's one that has greatest value. Being a hard-to-understand business JEF is OK to let this one go.

  6. In my own look at CWGL, I also focused on a combination of land values and the likelihood of a looming tight wine grape market (at US and global levels) in addition to what you discussed above.

    Napa and Sonoma vineyard land values have increased at respective CAGRs of 7% and 5% between 1960 and 2010 and seem to dramatically jump in value when the market enters a boom market (like 1.5-3x land value in a period of 1-3 years). Further, in slumps these vineyards tend to exhibit price stickiness and simply flatline until the next cycle of revaluation begins and appears to be on the horizon.

    A booklet on CA agricultural land values is put out annually and if interested, I can send a's helpful but not exhaustively informative:

    Granted, I think I'd estimated their vineyard land values to be at $80M to $120M (before expected increased land values) for their ownership in these two counties which isn't all that exciting relative to their overall assets but I suspect that it will be a hidden asset for these guys in a takeout down the road provided that we enter a tight market and a major like TWE (which has expressed interest in similar businesses in an older PPT presentation by their IR team) wants to secure a steady supply of grapes in a rising price market.

    The flipside is that the contracts they've entered for buying wine grapes are for their lower-margin wines that boost volume and offer strategic value (larger volumes makes them more relevant to the distributors) and there's really no guidance on whether their current arrangements reflect an asset or liability in the current market but my assumption is that it is neutral at worst as Cumming and Steinberg seem quite reasonable at discussing downside risks.

    As for the wine industry cycle, a group called Turrentine Brokerage has a concept that shows past wine market cycles and likely future direction that I found helpful:

    What is unique about the potential for an upcoming shortage is that a prolonged slack market ran from 2001 and only recently moved into balance which is the longest period on record and is expected to result in a prolonged boom market compared to past cycles due to the lack of growth in acreage in CA vineyards in the past ten years while domestic demand has increased quite steadily over time.

    The Wine Institute shares some interesting data ( US recently became the largest retail market in the world (surpassing France) while per capita consumption provides a fairly strong runway for growth on the demand side. The key risk seems to be the increased globalization of the wine market and how that could impact supply in the US. Another argument is that currently there is excess supply at the distributor level but I'm not so sure on how to test or quantify that observation. Lastly, the time to plant vines until the wine comes to market can take 4-6 years so that is one benefit of the capital intensive nature of the business in current market conditions for a co like CWGL.

    The signal that intrigues me most will be when management is issued RSUs, options, etc because these must be issued at market price and do not vest until the price has doubled.

    Hope these notes are of some help and enjoyed your post. Greg

    1. Hi,

      Thanks for the detailed post and information! I will have to check this stuff out.