Issue link: http://winesandvines.uberflip.com/i/918844
142 WINES&VINES January 2018 BUSINESS W ine industry transaction volume was notably down in 2017 compared to the previous two years, particularly among marquee brands. However, many of the fundamental dynam- ics that fueled the heightened levels of investment in 2015 and 2016 were still present in 2017, including a diverse pool of active buyers, which drove competitive valuations across a range of winery assets. Overall, wine companies that have been active over the past few years maintained their appetites for new opportunities in 2017. Con- stellation Brands, E. & J. Gallo Winery and Vintage Wine Estates all completed acquisi- tions for the third year in a row. Additionally, mid-sized wineries looking to build scale generated healthy demand for pro- duction assets, with some pursuing standalone winery facilities and vineyard opportunities in order to bolster capacity and sourcing strategies. Overseas investors continued to show high in- terest in U.S. assets, with Maisons & Domaines Henriot and LVMH Group becoming the latest in a growing trend of French wine companies to invest in the U.S. wine industry. Outside of a select few private equity firms, financially motivated buyers continued to focus primarily on the agricultural aspects of the industry, with multiple institutional invest- ment firms acquiring large-scale vineyards. Looking toward 2018, the ongoing success of the premium wine segment is likely to play a central role in mergers and acquisitions (M&A) activity, with suppliers using an acquisi- tion strategy to quickly shift the center of gravity toward portfolios that produce wine priced $15 to $20 per bottle. Additionally, continued consolidation among wholesalers and retailers is putting pressure on suppliers— especially mid-sized wine companies—to ex- pand portfolios in order to stay relevant in the marketplace. Interrelatedly, many of those suppliers will fulfill that need by venturing into "emerging" geographic wine regions, whose relatively lower input costs offer greater po- tential to scale brands with higher gross mar- gins. Lastly, ongoing consolidation of major production and vineyard assets by large wine companies (particularly in areas of limited supply, such as Napa and Sonoma) will have a trickledown effect as smaller and mid-sized wineries scramble to replace and/or secure increasingly scarce grape resources. In the absence of any major market disrup- tions, 2018 will likely see similar to slightly in- creased deal activity, as the "hangover" effect from 2016's M&A binge begins to wear off. However, a number of industry-specific and macro uncertainties could negatively impact this momentum in the near term. First, there are preliminary signs that the double-digit growth in the premium segments across all beverage alcohol categories is beginning to wane. Addi- tionally, the current expansion cycle of the U.S. economy is getting "long in the tooth" from a historical perspective. The current expansion in the economy marks the third-longest cycle since World War II (see "U.S. Business Cycle Expan- sions" on page 144). Based on past experience, buyers seem to associate greater risk the farther the economy moves into an expansion cycle. Lastly, there are growing political and economic uncertainties in the United States and abroad. While it is too early to say what effect the presi- dential administration will have on the U.S. economy, the implications of proposed federal tax reform (particularly a corporate tax rate cut), as well as changes in trade policy, have the po- tential to significantly influence the M&A land- scape in 2018 and beyond. As of press time, it is still unclear exactly what effect the October 2017 wildfires will have on Northern California's wine industry. In terms of ordinary business, the disruption to supply appears to be minimal, however, the impact on human resources and tourism crucial to many wineries is a new challenge that will likely re- verberate through the region throughout the coming months and years. From an investment perspective, there will likely be a short-term recess in M&A activity as businesses and their employees focus on recovery, which may extend into the first quarter of 2018. Consumer preference for higher priced wines By far the most influential factor driving M&A activity in today's environment is the growth disparity between wines priced above and below the $10-per-bottle mark. Consumption trends continue to bode well for higher priced wines, possibly at the expense of lower priced wines. This trend is part of a greater consumer migration toward "premium" goods that has reshaped the beverage alcohol landscape. Based on 52-week Nielsen scan data, sales volume grew 7.3% for bottles priced $10 and up, while the segment priced less than $10 per bottle dropped 2.2% (see "U.S. Wine Year- Over-Year Growth by Price Segment"). For many wine companies heavily invested in the latter segment, the past several years have been a race to "premiumize" their port- folios. In the intensely competitive sub-$10 per bottle price segment, it is difficult to increase the price of existing brands. Furthermore, developing a new, higher priced brand from the ground up requires significant marketing capital and can take years. As a result, many wine companies opt to pursue an acquisition strategy as a means to tap into the growth of the premium wine sector. Predictions for Wine Industry M&A in 2018 Success of the premium wine segment should drive much of the activity By Cody Jennings KEY POINTS An executive with Zepponi & Co., a wine industry mergers and acquisitions firm, discusses likely activity for 2018. Producers are shifting their portfolios to- ward wines in the $15-$20 category and need to secure quality grape supplies for the fast-growing demand. In response to the quickening pace of con- solidation in the wholesale and retail tiers, mid-sized wine companies are feeling compelled to add wineries and brands to stay relevant.