The wine business has come a long way in the past few decades. Back in the 1980s, I was an investor in Edna Valley Vineyards and I learned that equity investors don’t do very well in the wine business. The investment was still a good one only because of their annual “shareholder event” which featured top chefs and premier wines. It was all more of a family business back then.

Wine is a big market though. The domestic table wine market in the US alone is $30B and it’s been growing at about 2x GDP. It’s also very fragmented with over 10,000 producers. However, distribution has been consolidating over the years and stands at just under 1000. This reality favors larger producers and larger retailers.

At the same time the wholesale buyers have consolidated and become more powerful the direct-to-consumer market has opened up. Now even wine producers can implement “omni-channel” distribution as their business and go-to-market strategy.

The wine business is very profitable these days. For the six months ended January 2021, Duckhorn (NAPA) had gross margins of 49%, 33% operating margins, and net margins of 22%. That’s on $175M in revenue for the period.

The wine business is more like any other consumer business today. It’s about brand, scale and distribution. Any insider in the liquor business will tell you that the different between brands is 90% marketing, 9% how much you spend on the bottle and 1% what’s inside. It’s an exaggeration of course but only a minor one.

Positioning

Duckhorn is aiming for the premium (>$15 bottle) category with a range of wines that goes all the way up to “aspirational” or $100/bottle.

If there is one picture that really tells the story here it’s this one showing their growth relative to the industry and their targeted segment. It’s a testament to both their execution and the reality that large producers have a substantial structural advantage in this market.

Scale is important because national retailers and restaurants want to offer their customers a consistent selection of products across multiple price points to capture sales. Small brands that they can’t reliably keep in stock are not viable.

The brands stretch from $100 Duckhorn to $15 Decoy.

The strategy consists of getting more share with their existing brands and launching some new products like wine-based seltzers. They also plan to do some acquisitions when they can find strong brands that are additive to the portfolio.

Valuation and Stock Conclusion

I like the business and the management team but there are one or two things to be aware of. First of all the PE firm that owns them will still own 75% of the company post-IPO. Proceeds are being used to pay off some of the debt but there will still be some pro-forma.

There’s also evidence that the PE firm too quite a bit of money out of this along the way and have fluffed up the numbers quite a bit to make recent results look very strong. It’s not cooking the books or illegal but more of a setting of the stage.

I put together one PFV model based on management guidance which I’ll say represents the base case. As you can see it doesn’t suggest lots of upside from the IPO price. However I do think investors appreciate the quality of the management team so there may be some post-IPO momentum that drives shares higher.

Below the base case I’ve added a “stretch” but still reasonable model that shows better top line growth and a small margin expansion. That could get the shares up to $25.

Investors should be aware that the large PE position may represent an “overhang” of shares available post-lockup.

A Base Case Model
A Better Case Model

Right now there is talk of a small increase from the proposed range of $14-16. It feels like a buy below $18 for sure. Despite guidance the return of consumers to restaurants will probably drive above-trend growth for at least a couple of quarters here so the shares may do well if or until YoY growth “normalizes.”

Roadshow Notes

  • Notes and thoughts from the roadshow presentation.
    • Focus is on being a luxury brand
    • CEO there for his entire personal career – 40 years.
    • Compare to the SPAC IPO name – Vintage Wine Estates
    • The Duckhorn brand started in 1976. They brought Merlot to Napa in 1978.
    • Expanded portfolio over the decades to include all key varietals.
    • Launched Decoy brand to reach lower into the market.
    • Believe they have some things that make a moat:
      • Curated portfolio across the right price points.
      • Strong brands (10)
      • Scale is important (big market)
      • Omnichannel distribution
      • Ability to optimize production capability
      • The leadership team is best in class from top to bottom
    • US $53B market (271M sales), WW $340B in annual sales (big opportunity)
    • High growth high-value luxury segment (>$15/bottle) thinks this is about a $5-8B of annual sales.
    • They are taking share, at about 2x. 34% in 2020.
    • Wine-based seltzers launching this spring. Not sure about this one. Chardonnay with Lemon and Ginger? Doesn’t sound good to me.
    • Aspirational brands at over $100 per bottle.
    • Current sales are growing around 17%.
    • Gross margin ~50% with 40% EBITDA margins (!)
    • Playing the ESG card. Six UN sustainable development goals.
      • Diversified grape sourcing.
      • Bilingual employee communications.
      • Sustainable practices and water conservation.
      • Cover crop enhancement.
      • Expanded tuition reimbursement.
      • Average FTE is at 5 years vs 3.3 industry average.
    • The luxury wine market is super fragmented – 1800 in 1995 to 10,400 last year. Most are niche, money-losing businesses.
    • 3000 distributors to 950 over the same period. Plays into their scale strength.
    • Sales channel up from 1 to 81 at NAPA during this time.
    • The goal is to be the “one-stop luxury shop” for wine. Only pure-play.
    • Interesting idea of being there for all “consumer drinking occasions” like other retailers.
    • Sales split 60% wholesale ex-CA, 21% direct to retail in CA, and 19% direct to consumer via wine club.
    • Personally, I’ve had some trouble with their prices relative to quality.
    • Plans to acquire strong brands into the portfolio over time. States they will only do deals that fit their strategy. Kosta Browne and Calera were both acquired. Claims it’s “additive but not necessary.”
    • Duckhorn and DECOY represent most of the sales (~73% FY2020).
    • The wine industry was mostly flat in 2020 due to restaurant closures – there was growth in direct to consumer and retail. Should see a rebalance post-COVID.
    • LT growth targets are high single-digit top line, 50% GM and 35%+ EBITDA. Seems a little mediocre.
    • Stock outstanding after offering 115M. 20M share deal with 13.3 primary, 6.7 secondary, and a 3M shoe.
    • TSG (a PE firm) will continue to control ~75% of the stock.

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