Investment in the stars

04 March, 2011

As paths to world domination go, Constellation’s rise to become the globe’s largest wine producer has been a rocky road. Just eight years after it was formed, following the merger of Constellation Brands’ wine assets with BRL Hardy in a AU$1.9 billion deal, the empire has been carved up by its American owners, who offloaded the UK and Australian divisions in December after reporting losses of US$3 million.?The struggling businesses spent the last two years – a quarter of their lives under Constellation – in intensive care as the executive board in New York attempted to find suitable buyers.?After a long and protracted process, which included failed merger talks with rival Australian Vintage, Constellation finally sold up for a mere $290 million, a fraction of the original deal it did in 2003. A victim of jaw-dropping price depreciation, or overpricing in the first place? Either way, its new owner, Australian private equity company Champ, seems to have picked up a bargain, even though the business is still in the red.?Troy Christensen, head of Constellation’s UK and Australian arm, says it’s not as black and white as that.

“The price paid was sensible,” he says. “The challenges Constellation gave us were largely around possible high-risk strategies to recover margin because the business

fell so short of its original acquisition aspirations.?“Wine is very polarising. When Champ did the deal, 50% of the people called to say it was a good price and 50% said ‘you are crazy, why would you want to get into the wine market?’”?A ‘schizophrenic’ period?Christensen describes the past two years as a turbulent, “schizophrenic” period for a company distracted by a possible sell-off and a lack of clear direction.?He says: “It became almost death by a thousand cuts, trying to turn the various assets into cash. The bricks and mortar and structure were very different to the high-end stuff they have in the US.?“Most of the strategy was driven by the US and the decision was to be aggressive about driving price increases, but everyone had so much excess wine that prices came down and we were punished pretty heavily.

“We know there has barely been any price appreciation above duty and VAT in the UK and it’s the same in Australia. They are two difficult markets dominated by powerful retailers. So taking the corporate cookie-cutter strategy across the different markets didn’t work.?“Constellation wanted to focus on premium wine and we did that. Despite our size and scale our profit just wasn’t compelling to the corporate board. As a global business with a large platform in the US, if you were fighting for capital investment we would never win because there was always a better option to invest in there.?“Selling [when they did] was a bold step for Constellation, they could have hung in there for another few years and probably turned it around and played it out and maybe got a better value for it, but they let someone else come in and take a crack at it.”?Understanding the dynamics?Despite the challenges of margin pressure, volatile currencies and oversupply, which have dogged Constellation and its Australian rivals, Christensen is adamant Champ understands the market dynamics and is committed to the company.

He adds: “Champ has gone into it with its eyes wide open. Champ’s founder, Bill Farris, makes wine for a hobby in the Hunter Valley. And even though it is a global investor, it also has a passion for assets in Australia. Lots of the business patrons in Australia are proud that Hardys is back in Australian hands, so they hope to reinvest and make it a business to be proud of.?“The idea is that in hindsight Constellation spent a lot of money, but we have some great production facilities and the brands are still healthy and strong. Champ sees this as a value opportunity, and historically it has seen more value in growing a business than the slash and burn approach.

“It understands that we’ve been slicing and dicing assets in a way that’s been damaging, and sees that someone needs to come in with a sensible investment programme.”?But Christensen is acutely aware of the pressure to deliver. “It is a generalist investor but has a good track record – in 25 years it has averaged a 30% return.

“I would expect us to get narrowly focused on our strategy and then we would get some investment, more than we had before. Champ’s average investment horizon is three to five years, but it has kept investments for 10 years.?“It would be great to get it back in profit in five years – I would hope it would be less.”?A key element to transform the company’s fortunes rests on increasing output at its UK bottling facility, Constellation Park, which already bottles all of Sainsbury’s own-label as well as delivering better margins on its own brands.

Christensen is also eyeing international expansion, hinting that the roles of its UK team could be expanded. “I don’t think you’re going to see seismic changes here. But we’ve got to go across Europe and work out how we could leverage the people here.”?Though he acknowledges that in a price-sensitive, heavily commoditised market maintaining a large marketing team in the UK could be difficult to justify, he is adamant redundancies are not on the cards. “In this market, a lot of people are peddling wine on price like two guys in a phone booth.?“We have customer development, an innovation team, and customer marketing. It is difficult with all of those to say, ‘are we getting a return on that?’ It is difficult when you spend a lot of time talking strategies with the buyers to work out the tangible benefits, because you never get a retailer saying to you at the end of the year: ‘well, I was going to ask you for more margin, but you’ve done such a great job that I won’t’.?“But as market leader, I would rather focus on category development. How do we begin maximising our margin? I would rather find ways of engaging with consumers – trading up, better communication at the point of purchase. If we don’t do that, we just bring everything back to price and we get back to being like the two guys in the phone booth, just trading wine.?“That’s not where we want to be.”?

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