More small wineries are looking for exit, but ‘expectation gulf’ separates buyers and sellers
Wine companies of varying sizes are finding themselves in vastly different positions as we evaluate the effects of the past year and how the COVID-19 pandemic has shaped the industry.
And while, as predicted by many, we are seeing an increase in mergers and acquisitions activity for large deals, there has been a notable lag in the number of deals for smaller wineries, even though there are plenty of interested buyers and sellers in the market.
In RaboResearch’s Wine Quarterly report, analyst Stephen Rannekleiv explores why this might be the case, as well as factors that smaller wineries should consider when determining timing for a potential sale.
Exercise caution when evaluating expectations
While there seems to be an increase in the number of small, family-owned wineries interested in selling due to reasons such as the pandemic and recent wildfires, an important issue that might explain the lack of deals being done in this space is the difference in valuation expectations between buyers and sellers. Some have gone so far as to coin this an “expectation gulf.”
Part of this divergence stems from the fact that the high-profile M&A deals that have closed recently have included fairly dramatic variation in valuations.
For example, Duckhorn’s IPO valued the company at 15 times trailing earnings before interest, taxes, depreciation and amortization (EBITDA), but the stock price rose immediately, and now reflects a valuation of about 20 times EBITDA.
On the other end of the spectrum, one might point to the sale of Constellation Brands’ numerous brands to E. & J. Gallo Winery. The terms of this deal were not made public, but most estimates suggest a valuation well below 10 times EBITDA.
Neither of these extreme valuations should be viewed as a “new normal” and are only representative of particular deals for specific assets. Still, potential sellers will now point to high-profile deals done at spectacular multiples, while buyers look to deals done at the low end to make their case for valuation.
It’s important to remember that valuations will ultimately be determined based on discounted cash flows (DCF), but that this still leaves a question mark in today’s context. The cash flows of many smaller wineries have been disrupted over the past year, and while sellers explain this as a short-term phenomenon, buyers might be reluctant to assume the risk.
On-premise recovery as an indicator
Just as the decline in on-premise sales over the past year have played a large role in decreased revenues for smaller wineries, the pace of recovery in this channel will be a guiding factor in aligning valuation expectations between buyers and sellers.
It’s great news for all, and potentially smaller wineries in particular, that the recovery of on-premise sales is in full swing.
Figure 1 shows the immense decline in seated diners at the start of the pandemic, a recovery last summer, the winter setback, and finally the strong recovery in recent months as vaccinations have been rolled out and the number of cases has waned.
The pent-up demand to go out and socialize again has also been confirmed by wholesalers who have reported seeing sales in some fully reopened bars and restaurants reaching levels at or above those from 2019.
However, along with the positive outlook for on-premise recovery, it’s important to remain cautious and consider some of the remaining challenges that might restrain growth.
First, the number of restaurants that will (or already have) permanently close due to the pandemic is still unclear. The loss of locations will somewhat counter the improving sales in those that are open.
Wholesalers also report that many restaurants are paring down wine lists as they reopen to better manage cash and improve operating efficiency, likely favoring larger, better-known brands.
Finally, chain restaurants are likely to recover more quickly than independents, also favoring the more established wine and alcohol brands.
Capital gains tax uncertainty
Smaller wineries contemplating a sale might be tempted to hold off in the near-term as improving trends in on-premise customer visitation forecast better sales.
For some, though, the Biden administration’s proposed increase to the capital gains tax may make it more profitable for some to sell today, even if at a lower price. To be clear, the passage of this increase is far from certain, but even just the possibility creates an important incentive for some wineries to get a deal done sooner and to be a bit more flexible in terms of valuation.
All things considered, it seems likely that the gap in valuation expectations will eventually resolve itself and that the ongoing recovery of the on-premise may put some wineries in a better position for sale.
There are, however, additional factors to consider for each individual circumstance and wine company owners should closely evaluate the full picture when determining if a sale now or in the future would be most advantageous.