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94 W i n e s & V i n e s n o V e m b e r 2 0 1 4 R E A L E S T A T E T here is a widely held percep- tion in the wine industry that merger and acquisitions (M&A) activity is currently quite robust, and that selling their wineries is how owners will exit the business. In a report published by Silicon Valley Bank earlier this year ("Ownership Transi- tions in the Wine Industry"), more than 10% of the winery owners surveyed were "strongly considering" a sale in the next five years. Will 500 West Coast wineries actually be sold in the next five years? The short answer is no. For a variety of reasons, the 10% who are thinking about selling today will result in 2% who actually do. It is true that there is currently a strong level of transaction activity in the wine industry. However, most sales have been of vineyards and the occasional winery facil- ity. These are real estate sales transactions, which sometimes get erroneously conflated with M&A. The winery merger and acqui- sition market (meaning the sale of a wine company and/or associated brand[s] as going concerns) is quite different, with activity levels currently slow to normal. It is difficult to see perfectly what hap- pens in the wine industry M&A market, since there are so many small operations, and many transactions are not publicized. However, a review of the data about West Coast wineries collected by Wines Vines Analytics from 2005 through September 2014 provides a clear and remarkably con- sistent picture. (Included in the many inter- esting facts in this data, used for the Wines & Vines Directory/Buyer's Guide and other services, is the ownership of the winery, for most entries.) On average, there are approximately 20 M&A transactions a year. There are some basic microeconomic principles that can explain why, although there are 500 winery owners who currently want to sell their wine company and/or brands, there are only 100 who will. Fantasy Island Some of these 500 "sellers" are sellers only if someone knocks on their door and offers them a ridiculous sum of money. The prob- lem with this plan: It almost never hap- pens. In the real world, the sale of a wine company occurs after the owner decides to pursue a sale, hires a professional advisor who establishes a realistic asking price and then conducts a complicated, lengthy and expensive preparation, marketing and negotiation process. Wineries owned by this kind of daydreamer will not, therefore, be sold in the next five years. Human nature A growing area of economics applies cog- nitive psychology to the study of human behavior in the marketplace. "Behavioral economics" is establishing that the theo- retical economic agent maximizing his or her return does not exist, and that humans are more complicated and "buggy" and often make decisions that don't pencil out. Empirical studies in this field have shown that people have a ten- dency to dramatically discount the value of gains in the future and overvalue immediate gains. People are more moti- vated by the fear of losing than by the hope of winning. People prefer the status quo over a better alternative. In sum, given the choice between a possible large future payday at the end of an expensive and difficult sale process that results in a winery owner having to change their whole life or continuing to run their busi- ness and live in their house on the vine- yard, most winery owners will choose the latter. So a large number of the folks who checked "yes" to a future sale in the Own- ership Transition Survey will never begin the process. What will happen with those that do? Two for the price of one The winery merger and acquisitions mar- ket is in a state of permanent disequilib- rium. That is to say, there are no simple mechanisms by which the large number of wineries for sale (the supply) will be cleared by price adjustments or adjust- ments in demand as there are in markets for less complicated items such as com- modities or consumer goods. For exam- ple, there are many reasons why a winery owner will not accept a lower price in order to get a deal done. Some are similar to what we find in the residential real estate market, such as the amount of debt on the winery or the desire to preserve equity or obtain a reasonable return on an investment that has been held for many years (if not generations). In the absence of urgency created by outside forces (e.g. a bank or partners demanding repayment), many of the sellers who actu- Will 500 West Coast Wineries Sell? What the wine mergers and acquisitions market really looks like By Carol Collison