Source: Zepponi & Company
Santa Rosa, Calif., April 6, 2020 – Now, several weeks into COVID-19’s appearance and rapid spread in the U.S., the virus’s impact on the beverage alcohol industry and related merger and acquisition activity is starting to come into focus. Some commentators have covered in detail the epidemic’s impact on particular beer, wine and spirits brands and sales channels, notably the dramatic shift towards off-premise sales at the expense of everything else. Unaddressed is what this means for the current M&A environment and aspiring buyers and sellers during what looks to be a year of continued market volatility.
Beware the Ides of March
Since “shelter-in-place” orders were issued for California, New York and several other states in mid-March, M&A activity across all beverage alcohol categories has seen a sudden and dramatic slowdown. This comes at the end of what was otherwise shaping up to be an incredibly active 1Q2020, during which Zepponi & Company closed transactions for Diamond Creek Vineyards, Ransom Spirits, Valley of the Moon, and Niven Family Wine Estates, with another high-profile beverage alcohol transaction weeks away from announcement. Since mid-March, however, projects that were being brought to the market have largely been put on hold, many (if not most) sale processes have been paused, and the limited amount of ongoing deal activity is restricted to transactions that were already under contract and in due diligence.
Although M&A activity may have ground to a halt, sales of beer, wine and spirits have accelerated in off-premise stores and online sales channels. Not all producers have benefitted from these gains, nor have such gains compensated for the loss of revenue from on-premise restaurant and hospitality sales, as well as onsite tasting visits and tours. The prevailing mindset of buyers and sellers over the past two weeks has centered around tackling acute internal operational challenges posed by the new market realities. How buyers and sellers react depends on how long it takes for the virus to be contained and for normal economic activity to resume.
During the SARS epidemic that impacted Asia in 2002 and 2003, full containment took approximately 9 months to achieve after more than 8,000 infections across 29 countries. The infection count from COVID-19 has already surpassed SARS by a wide margin, with the global tally now over one million cases across 180 countries. During the SARS crisis, which effectively ended in July 2003, the disruption resulted in a 50% drop in China’s M&A deal volume for the full calendar year of 2003. The impact on the months and quarters prior to full containment was even more severe. Given that experience, in the current market it appears likely that the monthly volume of beverage alcohol transactions will significantly decline until containment of the virus is achieved.
How long the current crisis lasts is very much an open question. The aggressive, and in many cases unprecedented, steps taken towards containment in the U.S. and elsewhere provide grounds for optimism that a mid- to late-summer end date is achievable. The limited amount of M&A activity that occurs in the meantime will be spurred by relevant circumstances and the motivations of particular buyers and sellers.
So You’re a Seller in this Market Environment … What’s Your Super Power?
Most sellers of beer, wine and spirits brands have stepped back due to uncertainty around valuations and the shallower pool of available buyers. Those that remain in the market are largely those with the highest quality brands or assets that should be expected to extract a premium price regardless of near-term market conditions. In those instances, buyers may be more willing to look past near-term uncertainty or erratic financial performance in the interest of securing an asset that has clear long-term growth potential or synergy opportunities. Such was the case in the recent sale of Napa Valley’s iconic, luxury Cabernet Sauvignon producer, Diamond Creek Vineyards.
It is understandable that sellers would be reticent to engage in this market environment, as the prevailing current of valuation expectations of buyers for brands and assets outside the very top tier is now lower due to their increased exposure to market risks and volatility. This general observation is highlighted by the significantly lower valuations of publicly-traded companies, such as Diageo, Pernod Ricard and Treasury Wine Estates. It is difficult to say whether buyers are looking at large public company declines as relevant reference points for private sales. Most smaller and mid-sized businesses face similar, and in many cases more extreme, financial challenges and uncertainty surrounding their future sales projections. These economic circumstances have historically created formidable headwinds in market valuations. However, there are a number of factors at play in public companies that lack relevance when considering the market for private transactions. Some examples include the presence of short-selling, forced liquidations due to margin calls, and Exchange-Traded Fund (ETF)-related selling from unsophisticated retail investors. Accordingly, public valuations should be viewed as an interesting, but not especially relevant, data point for private market valuations.
The historic $2.2 trillion stimulus bill passed by Congress in late March is expected to provide broad-based relief to consumers and businesses alike. The stimulus bill, coupled with the surprising ongoing resilience of off-premise consumer demand for alcoholic beverages, suggest that most prospective sellers will exercise patience and wait for more normal market conditions before pursuing a transaction. If anything, the current environment will cause prospective sellers to show interest in more creative strategic options, such as short-term capital infusions in exchange for partial ownership interests in their business entities.
So You’re a Buyer in this Market Environment … Are You Ready to Jump Back in the Water?
On the buyer side, there is an enormous spread of capability and willingness to pursue beer, wine and spirits deals in the current environment. Buyers can be generally segmented into four categories: domestic strategics; foreign strategics; financial investors (including private equity firms); and high-net worth individuals.
For domestic strategic buyers, there will likely be a clear demarcation for acquisitions of off-premise, wholesale-focused brands that have the potential to be scaled. The largest players generally over-index to the off-premise channel, which is in a position to benefit from stronger sales in the near-term due to the shelter-in-place reality that has devastated the on-premise and on-site direct sales channels. Stronger sales activity suggests that they will continue to have stable cash flow to reinvest in growth, including M&A where appropriate. These larger-scale enterprises are also likely to experience uninterrupted access to bank financing due to their broader diversification and asset bases. With interest rates falling sharply, access to cheap financing could provide a real advantage to this type of buyer whenever they look to re-engage with the market.
Foreign strategic buyers are in many cases dealing with even more acute circumstances than those in the U.S., as evidenced by the state of chaos in Italy, Spain and France. The pending state of global travel restrictions and the fact that the U.S. is in the beginning phases of the pandemic present serious obstacles for foreign strategics to explore transactions and perform due diligence, particularly where the buyer lacks an established presence in the U.S. On the flip side, these buyers may emerge from the crisis sooner than others and find themselves in “pole position” to pursue deals as circumstances return to normal.
Financial investors will be particularly interesting to observe in this market environment. Dry powder (i.e., capital that has been committed, but not yet invested) remains near record highs for this type of buyer, thus, their capability to invest in beverage alcohol M&A remains quite strong.
Yet, it may be too hasty to expect a surge in activity from financial investors for several key reasons. First, financial investors are focused on returns on their invested capital above all else. As such, they will likely want to see meaningful valuation discounts before re-engaging in the market. Second, high diligence standards dictated by private equity entities’ fiduciary responsibility to their investors may pose challenges to new investments where financial projections remain highly uncertain and subject to second guessing. Third, financial investors are typically industry-agnostic and will look beyond the beverage alcohol category into other industries for the purpose of finding the best relative values and financial returns. These factors are likely to result in greater deal discretion and a reduced number of transactions. However, deal skeptics could be surprised by financial investors given the large amount of undeployed capital that they have available for investment. Less competition from other buyer types would play to their advantage in sourcing investments in the beverage alcohol space. This category of buyer also tends to have a higher degree of comfort with more complex, structured transactions, and as a result has greater options for bridging divergent valuation expectations.
High-net worth individuals have arguably been more severely impacted by the current market turbulence than any other category of buyers. The wealth of these individuals is often tied in significant part to their shareholdings of public companies and securitized financial instruments. There will of course be exceptions, but the negative wealth effect from stock market declines and ongoing financial volatility is expected to take many of these buyers out of the market for the foreseeable future.
Where Does This Leave Us?
The ongoing pandemic has materially impacted all categories of aspiring sellers and buyers of beer, wine and spirits brands. At the moment, most buyers find themselves in a challenging position to pursue deals as they address financial disruptions to their own sales channels, while also trying to understand the scope and timing for economic recovery. Similarly, most sellers are consumed with stabilizing their business operations and, thus, electing to step back from pursuing transactions until there is evidence of a return to normalcy in the market.
As long as active containment measures remain in place, M&A activity will likely be limited to deals already committed or those with an absolutely compelling strategic rationale. As the global economy moves toward a period of recovery, we would expect to see a return of buyers and sellers willing to transact despite anticipation of lingering market risk. In the meantime, there are rays of hope and opportunity despite the present market turmoil. The beverage alcohol industry has been faring better than most other consumer-facing industries, such as the restaurant, hospitality and travel industries. Many producers are positioned to emerge from this crisis stronger given the surge in off-premise and online beverage sales. Along these lines, several wineries are investing in digital platforms and engagement strategies to promote, sell and keep a share of voice with consumers.
Overall, present circumstances have forced producers to evaluate their branding strategy and sales capabilities, and to accelerate needed operational changes. The M&A market will ultimately reward those producers who embrace these challenges as a time for self-assessment and improvement.
About Zepponi & Company
Zepponi & Company is a leading global merger and acquisition advisory firm that is dedicated to the beverage alcohol industry and has been the most active advisor in the North American wine sector. The firm has served as the financial advisor on numerous transactions involving ultra-premium and luxury beverage alcohol brands and assets, such as the Bib & Tucker, Mastersons, and Ransom spirits brands, as well as the Pahlmeyer, Orin Swift, Meiomi, Patz & Hall, Kenwood Vineyards, Penner-Ash, Siduri, and WillaKenzie Estate wine brands and assets. Additionally, Zepponi & Company has advised some of the industry’s largest beverage alcohol companies, including Constellation Brands, Ste. Michelle Wine Estates, Diageo, Jackson Family Wines and F. Korbel & Bros. Zepponi & Company has offices in Santa Rosa, California and Portland, Oregon. For more information, please visit www.zepponi.com.