Wine and water

When Sam Bronfman contemplated his return to the wine business about four years ago, his plan was to acquire wineries on the West Coast. Bronfman, a member of the family that controlled the former Seagram Co. Ltd. and the older brother of music business luminary Edgar Bronfman Jr., has decades of experience in wines and spirits. He speaks passionately about the industry's long-term profile as the U.S. becomes more of a wine-drinking country.

"The higher the price, the faster the growth," Bronfman says of wine's bustling expansion.

But not just bottles of wine have been fetching ever-higher prices. As Bronfman and his bankers, Peter Kaufman and Henry Owsley at Gordian Group LLC, sought out acquisitions, they encountered buyout multiples that made them rethink their approach. They formed Bacchus Capital Management LLC, which aims to put $100 million to work over three to five years through wine mezzanine loans.

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"We noticed this financing hole, in terms of mezzanine debt, which is really not being used at all in the wine business," Bronfman says. Secured lenders agreed there was a need for this missing piece of the capital structure. "There really was a void in the financial markets."

The economics were more comfortable in mezzanine finance than in the buyout market. While wineries might sell for 12 to 19 times Ebitda, there are opportunities to lend at multiples of 4 to 8 times Ebitda. The firm aims to make loans in the $8 million to $12 million range.

It would also consider buyouts through what Bacchus calls a private equity "side pocket" if the right opportunity arose, although the focus is on lending.

"It came out of my interest in acquiring wineries and running them, but not finding anything really available at prices that I term to be appealing to us," Bronfman says.

Bacchus Capital's financing answers three general needs. The firm can provide financing for a winery that is going through a change in ownership, providing liquidity to cash out partners or family members who do not want to continue in the business. Second, when a winery wants to expand but secured lenders limit their lending to a percentage of total asset value or some other metric, Bacchus can provide second-lien financing. Finally, Bacchus can lend money to underpin an acquisition of another winemaker.

Despite trying to carve out a niche, Bacchus is hardly the only firm taking capital to the vineyards. Premier Pacific Vineyards Inc., backed by California Public Employees' Retirement System and Commonfund Realty Inc., has been developing high-end vineyards for a decade. Newcomer VinREIT LLC is investing in sale-leasebacks. San Francisco's GESD Capital Partners LLC is part of a group acquiring Geyser Peak and other brands, and Menlo Park, Calif., and London PE firm GI Partners LLP has taken a controlling stake in Duckhorn Wine Co. New PE firm Vinum Capital Management LLC is targeting wine investments.

Aside from Robert Parker scores, wine is an agricultural business steeped in romance that would seem antithetical to quantification. Nevertheless, there are increasing signs that the outlook for growth and the track record of successful wineries have made financial firms more at ease with the business. This nascent shift comes as many of the early winemakers who helped establish the industry are nearing retirement age, and pondering whether to leave the business.

"It's only logical that capital would come to this industry," says Dick Wollack, co-CEO of Premier Pacific Vineyards. Based in Napa Valley, Calif., Premier Pacific has been developing high-end West Coast vineyards for a decade. "To own a vineyard and to make wine and sell wine takes an enormous amount of capital."

It is said that great wine is made in the vineyard, meaning the quality of the fruit is vital to any vintage regardless of the winemaker's skills. Developing a great vineyard is a costly and time-consuming proposition, however, and it is only the first of many expenses involved in producing wine. A winemaker might buy an established vineyard but would have to pay a significant premium. Another possibility is to buy grapes someone else has grown.

Add the costs of pressing, fermenting, aging the wine in expensive French barrels, bottling it, aging it more. Then there is branding, marketing and moving the wine through the nation's complex distribution system, which is governed by laws dating to the appeal of Prohibition and increasingly dominated by a consolidated group of large wholesalers.

"What if you want to expand?" Wollack asks.

Premier Pacific, which is developing 39 vineyards on the West Coast, sells grapes to high-end producers. Wollack is a longtime real estate investor, while his partner, Bill Hill, handles vineyard development.

"What we do is find the land that has the right climate and the right soil," he says.

"You don't have to put up the capital," Wollack says. "You'll pay us a premium later [for the grapes]." With the strength in top-tier wines, the premium has climbed. Since the last grape glut in the U.S., planting has scaled back. Demand for high-end wines keeps rising, he says. From 2006 to 2007, prices per ton went up between 15% and 20%. On top of that, '08 prices have shown a 20% to 25% gain.

"Capital has gotten comfortable that this is an industry that is here to stay and is being driving by supply and demand," Wollack says. For one thing, he explains, the high end of the business has tripled in size in the last decade. There are upper-echelon wineries with strong profit margins, professional management and the potential for scale.

There are also promising demographic developments. Boomers have more money, time on their hands and interest in wine. Their children are also more interested in wine than earlier generations. "It was typically Europe where people drank wine," Wollack says.

Oenological interest has spread from big coastal metropolises to places like St. Louis, Kansas City, Mo., Birmingham Ala., and other cities throughout the U.S.

"There are complexities and mysterious things about being in the wine business," he says. After years of weathering business cycles, he suggests, it is becoming increasingly clear to investors that the premium and superpremium wine business is not a fad. "It is really a business that, in a little bit of time, you can wrap your arms around and understand," he says.

Malcolm Ross of Dickstein Shapiro LLP suggests "there are an awful lot of properties that are likely to change hands." Ross was counsel to W.J. Deutsch & Sons. Ltd. in a recent deal. The wine marketing company in June joined with GESD Capital Partners and former Beam Wine Estates Inc. executive Jim DeBonis to buy Geyser Peak and other West Coast wine labels from Constellation Brands Inc. for as much as $234 million. The pact operates under the name Ascentia Wine Estates, also known as Eight Estates Fine Wines LLC.

"In part, the reason for that is there are an awful lot of wineries around," he says. Many are family businesses, operating in a capital-intensive business with limited access to capital.

Ross refers to oft-cited report by SVB Financial Group's Silicon Valley Bank and Scion Advisors DBA that foresees a coming shift in the U.S. wine business. The report is based on a survey of nearly 250 family-owned wineries in California, Oregon and Washington.

Many pioneering vintners who got into the business in the mid- to late 1970s face retirement and must transfer their properties to children or sell. SVB and Scion estimate that more than half the wineries in California, Oregon and Washington plan to go through a change of control in the coming decade. That could mean more than a thousand wineries changing hands, or about a hundred a year for the next 10 years.

Of the respondents, 82% were first-generation owners who started out in a different era.

"The business was young and cottage-based at the time, and the pace was slower, with sales often made out of the back of a truck, and grape contracts mostly done on a handshake," the report says. "The Internet was not yet a part of sales, and regulatory compliance was less onerous." And making good wine was enough. Today branding, sales, marketing and getting the attention of distributors, many of whom have grown large through mergers, are vitally important. "Not all winery owners have those skills," the report states, and not all are large enough to bring on outside pros.

Successful wineries have either sold or taken outside capital in recent years. Early Zinfandel proponents Kent and Kathy Rosenblum agreed to sell Rosenblum Cellars Inc., founded in 1978, to Diageo plc for $105 million in January. Stamford, Conn.-based UST Inc. and Tuscan wine producer Marchesi Antinori Srl bought Napa's Stag's Leap Wine Cellars for $185 million last year.

In 2006, UST's Ste. Michelle Wine Estates bought pioneering Oregon vineyard Erath Winery in. 2006. GI Partners took a controlling stake in Saint Helena, Calif., winemaker Duckhorn Wine in 2007.

WR Hambrecht + Co. founder Bill Hambrecht is backing Russian River Valley producer C. Donatiello Winery. TPG Capital co-founder Bill Price has taken a minority stake in esteemed Sonoma winery Kistler Vineyards Inc. TPG was involved in a well-known 1990s wine deal when the firm and Silverado Partners purchased Nestlé USA Inc.'s Wine World Estates, which owned the Beringer Vineyards label. They took Beringer public and sold it to Foster's Group Ltd. for $1.2 billion in 2000.

There are other signs of PE activity. For one, there is the Ascentia Estates pact with GESD and W.J. Deutsch to buy wineries from Constellation brands.

Vinum Capital Management is creating a $250 million fund devoted solely to acquiring and operating wine properties in California, Oregon and Washington making between 20,000 and 150,000 cases per year.

Global Wine Partners LLC and Entertainment Properties Trust launched the real estate investment trust VinREIT in 2007. The JV invests in wineries and vineyards through sale-leaseback transactions. The firm says it has closed $200 million in transactions and expects to have $400 million in deals by year's end.

With all the real and potential dealmaking wafting through the industry, the partners at Bacchus tout the value added to their capital. Gordian Group contributes expertise in the analysis of credit, balance sheet and valuations. It is also a leading turnaround firm, which helps if one of its investments encounters problems. "The real sizzle is in the distribution skills we have and the distribution capabilities of some of our investors," Kaufman says.

Bronfman brings experience in marketing, distribution and other operational areas. Early in his career, he worked in the marketing department of Paul Masson Vineyards. He later became a senior executive in sales and in 1996 was named president of Seagram Chateau and Estate Wines Co., which owned such brands as Sterling Vineyards, Mumm Champagne, and Perrier-Jouët, and also had importing and distribution units.

When Seagram merged with Vivendi Universal SA, the company divested its wine and spirits operations through sales to Diageo and Pernod Ricard SA.

Bronfman was chairman of Diageo's global wines from 2001 to 2003.

Much has changed in the wine business since Bronfman entered it. Jug wines marketed as chablis or burgundy have given way to superpremium labels targeting a more informed consumer, mindful of terroir and grape varietals. Screw tops and synthetic corks have become more accepted, though some argue they diminish the overall romance of enjoying a bottle. Wholesalers have consolidated through mergers, making marketing and distribution much more complicated.

Wine has become more glamorous, but is also more a part of everyday life for many Americans. That a new group of firms is springing up to finance wineries reflects all this.

Yet despite all of the changes, Bronfman's partner, Kaufman, says there are still timeless links to the past.

"We're back to biblical times," he says. "Wine and water are the two biggest consumer growth categories."

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