state of the wine industry 0910

8/14/2019 State of the Wine Industry 0910

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APRIL 2009

2009 - 2010 State o the Wine Industr

Forward

Jerry Maguire: I am out here or you. You

don't know what it's like to be ME out

here or YOU. It is an up-at-dawn, pride-

swallowing siege that I will never ully tell

you about, ok?

Te 1996 movie Jerry Maguiretells thestory o a sports agent living the high lie o

sports celebrity, with all the accoutrements:

ancy cars, nice clothes, a beautiul ance,

Rolex watch, hot car, expensive wine and

membership in the local country club.

Jerry told clients what they wanted to hear

and made them ortunes by being loose

APRIL 2009

Written by Rob McMillan,Founder, Wine Division

2009-2010 State o the Wine Industry

with his word and ast with his pen. Ten

one day it was all gone (except or the

wine, in our Betamax version o the story).

Its a hauntingly amiliar story i you called

Wall Street your home last year. Seven-

gured high-yers living in the Financial

Center o the globe were taking risks thatproved catastrophic.

Te attitudes and preerences o the

U.S. taxpayer and wine consumer are in

markedly dierent places today than they

were a year ago. I the prevailing mood

in early September was disbelie, popular

opinion today places our Wall Street bank

cousins somewhere beneath ungi, mo

roundworms and viral parasites. Alo

with the Dow, ne wine consumpt

tumbled in Q4, taking our retireme

balances with it.

o be air to our Wall Street relatives, t

blame or our economic situation shou

be shared by some o our current a

ormer elected representatives who a

making some progress today, but doing

even better job o deecting constitue

scorn by viliying others. Paradoxical


2/25

2009 - 2010 State o the Wine Industry

APRIL 20

bump on the bottom, and positive

Q4 sales. We believe the year will

end essentially at in terms o overall

growth in the ne wine segment, andshow modest growth in higher volume

segments.

Wine supply is running in balance to

short.

More electronic tools are available to

support direct-to-trade and consumer

sales.

Per capita consumption continues to

rise in the U.S. Credit is available or smaller wineries,

though spreads have widened over

reasuries, the Prime Rate and LIBOR.

Cult wines sold out their allocations in

Q4.

Bad news

Q4 2008 was the worst Q4 in memory

or the ne wine business.

Restaurant sales are depressed.

We expect higher unemployment

(exceeding 10 percent by year end),

higher oreclosures and depressed

consumer spending through the year

as we seek a bottom. Te economy will

not return to the market experienced

during the past decade.

Price points below $35 are selling, but

wines between $50 and $125 are ina dead space, with only established

labels selling.

Some wineries will trade hands this year

at bargain prices.

Distribution has all but ended as a

viable sales channel or small wineries.

as o this writing, to bring about a

happy ending to our economic airytale

and drive improved prospects or the

wine industry, our elected ofcials ndthemselves in the awkward position o

asking the same people undressed or

public spectacle and pilloried in the

court o C-SPAN to participate in a

public/private partnership to rid the

banks o toxic assets and restart lending.

Someone should write a movie about it

someday. But in the meantime, you will

have to satisy your curiosity by reading

through our State o the Wine Industry

Forecast and Recommendations.

Jerry Maguire: But if anybody else

wants to come with me this moment

will be the ground floor of something

real and fun and inspiring and true

in this godforsaken business and we

will do it together! Who's coming

with me besides...Flipper" here?

Come with us in the ollowing pages,and you will nd our predictions or

2009 and 2010, as well as commonsense

explanations or the present state o

the economy and timing o a rebound,

a view o the rapidly changing wine

industry and practical advice rom

our experienced sta to guide you on

investment strategy and tactics in the

brave new world we ace.

Executive Summary

Good News and Bad

Good news

On a year-over-year basis, we predict

slightly improved sales in Q2, at sales

in Q3 as the economy continues to

2

Large credit extensions to single entit

are harder to nd, and syndicated cre

markets are nearly rozen.

Te secondary market or collectab

wines continues to soten.

Drought conditions persist

Caliornia.

Sin taxes are being widely applied

alcoholic beverages nationwide.

Distributors continue to drop sm

brands rom their books.

The Wine Industry at Large: Val

Comes in Vogue

Te next 12 months will be difcult or t

ne wine segment, with declining grow

rates and at year-to-year sales overall. T

is oset by higher volume segments th

are experiencing good business conditio

as consumers trade down to value-pric

wines, or which positive year-over-y

results are expected.

Down-trending economic conditions

the U.S. have exposed business models

the ne wine segment that were already

need o change, largely due to distribut

consolidation. Tis will lead to som

transitions in the near term at less-tha

hoped-or prices. Tat said, the negati

impact will be winery-specic and w

depend on several actors includi

price points, brand strength, appellatio

volume produced and most important

sales strategy.

Supply in both the volumeand premium segments is inbalance overall, which is asigniicant positive actor.


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APRIL 2009


Supply in both the volume and premium

segments is in balance overall, which is

a signicant positive actor allowing or

less discounting than would otherwise

be the case. Te opportunity to raise

prices, however, is limited at present

or producers and growers alike, though

growers in volume segments may have a

little more upside negotiating room this

year depending on the strength o the

dollar, corresponding prices o oreign

substitutes, inventory levels in large scale

producers and consumer spending.

With continuing increases in per capita

consumption, planting should take place

as non-bearing acreage is below vine

replacement levels. Tat said, a number o

actors will lead to continuing shortages

in vineyard planting: alling asset prices,

the high cost o land, lack o committed

contracts, conusion about pricing in a

deationary economy, uncertainty over the

strength o the dollar and the consequent

impact o imports, credit tightening and

general ear. Because we see a lack o

development today, growth in the U.S.

wine industry will be eclipsed by imports.

We acknowledge those plantings have to

be in the right places and at prices that the

market will support in bottle price.

Feedback rom the 2009 SVB Wine

Conditions Survey shows winery owners

believe 2009 will be a difcult year, with Central Valley suppliers the most

optimistic and Napa and Sonoma suppliers

the most pessimistic. Oregon producers

are more optimistic than their Caliornia

ne wine counterparts, but they may be

overly optimistic in our opinion.

Large-Scale Producers: Ever the

Optimists

Dorothy: I just want to be inspired.

Te SVB Annual Wine Conditions Survey

suggests this segment is appropriately the

most optimistic and inspired segment,

with many expecting solid growth

rates in the coming year and improved

contract prices at the grower level. Its an

assessment with which we agree. Only a

strengthening dollar opening the door or

higher volumes o cheaper imported bulk

wines, deepening economic problems,taris and protectionism, possible higher

carried inventories in large producers

that right-size later in the year and

water restrictions could moderate the

opportunity.

Fine Wine: Growth Declines and

Sales Stay Flat

Jerry Maguire: Jump in my

nightmare, the water's warm!

Despite declining growth rates and

nightmarish results in the ourth quarter o

2008, we predict wine sales will be sluggish

through the early part o 2009, but nish

the year with a better Q4 thus creating

at year-over-year sales in the segment.

While zero growth is comparatively good

in this economy, a growth rate that has

allen rom 23 percent to zero percent in

24 months causes many problems or a

business that has long-term contracts with

growers and has to commit to production

and inventory positions well ahead o the

kind o nancial collapse we experienced

last year. Tis will inevitably lead to

declining gross and net prot margins

over the next two years.

Te ourth quarter o 2008 saw wine

level sales slow precipitously into negat

growth territory compared to Q4

the prior year. Full-year growth rates 2008 were modest, but positive, howev

Distributors and restaurateurs aggressiv

worked down inventories in the

quarter o 2008, sending a demand sho

through the business when they held

reorders. But we believe depletion-le

sales still took place, albeit at a slow

pace, based upon inormation we ha

developed rom various industry sourc

Despite declining growthrates and nightmarish resultsin the ourth quarter o 2008, we predict wine sales will besluggish through the earlypart o 2009, but inish theyear with a better Q4thuscreating lat year-over-yearsales in the segment.

which include proprietary nan

inormation, surveys distributor-lev

depletion inormation, retail and wine

interviews. During the market collap

in Q4, even expensive wine was s

being consumed, but distributors w

not ordering and overall winery-level sa

in Q4 were dismal with more expens

wines suering disproportionately mo

Sales in Q1 are still negative compar

to the prior year, but we believe the U

economy will start to bottom out duri

2009, and consumption will pick

requiring inventory restocking.

On a year-over-year basis we are orecasti

slightly improved sales in Q2, at sales

Q3 as the economy continues to bum

on the bottom, and positive Q4 sales. W


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APRIL 20

believe the year will end essentially at in

terms o overall growth in the ne wine

segment. Inventories in the cellar were

built or higher growth assumptions, sowe will expect some bulk eliminations and

reduced contracted demand or purchased

grapes during this harvest.

A zero percent growth rate would be

coveted in most businesses these days,

but this good news masks the truly

tumultuous change underway in many

amily-owned wineries, which is causing

predictable capitalistic Darwinism in the

weakest businesses on the one hand, andallowing market share growth among

the best run businesses on the other.

Furthermore, at growth when inventory

positions were built or higher growth will

produce compressed margins.

General risk conditions have increased

substantially or owners, investors and

bankers alike, and action is required to

navigate rough conditions both today, and

in a less vibrant landscape that will emergeater the ofcial end o the current recession.

Te next year will produce transitions in

some wineries at distressed prices.

The Economy

Rod Tidwell: Show me the money!

Investment bankers held this as a motto

early in 2008, but by the end o the year,

many were looking or work, and in theirplace it was the U.S. taxpayers who were

asking the very same questions o some o

the same people. We wish we could just

improve the situation with the snap o

our ngers, but we still have a way to go

to nd the real bottom o this recession.

It is coming, but we believe 2009 will not

produce an end; instead, we anticipate

higher unemployment (exceeding 10

percent by year end), higher oreclosure

and depressed consumer spending throughthe year.

While the stimulus is unlikely to have a

signicant impact this scal year (based

on administration estimates o timing and

spending), we believe the actions o the

Fed are improving credit conditions, and

eventually those massive interventions

will have a positive impact and the rate

o impairment in market conditions

will slowly all, leading to a bottom inthe economy in Q1 or Q2 2010 beore

starting a modest improvement in business

conditions. Te stock market as a leading

indicator is likely to remain highly volatile,

but it should see improvement in ront o

the upturn in business. Once the recession

ends, business conditions will not return to

what we had previously experienced over

the past 20 years, as tail-end scenarios o

a recovering economy all include negative

impacts related to the trillions being spentto stem the current problems.

2009-2010 State of

the Wine Industry and

Recommendations

The U.S. Wine Industry Primer

Te U.S. wine industry, a $30 billi

business according to the Wine Institu

has been growing in its allure

corporations and many wealthy investo

over the past 30 years. Te indust

predictably cyclical in 7- to 10-ye

increments bracketed by undersupply a

overplanting, has seen tremendous grow

particularly in the decade o the 199 when a record number o new winer

ormed and planting levels increased.

For a perspective on how the cycles work, le

look at the most recent bottom-to-botto

cycle, beginning with 2001 as a low poi

Early in 2001, the economy sotene

the tech bubble burst and over planti

rom the late 1990s created over supply

vineyards came into mature productio

Restaurant sales slipped with the sto the business-led recession, and th

4

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

YE 2006 YE 2008 26 Weeks

Total Table

$6-8.99

$9-$11.99

$12-14.99

>$15

Growth Rate Declines

Source: rade Pulse Scan Data (2009)


5/25

APRIL 2009


plummeted ater 9/11. Te growth rate in

the sales o ne wine dropped rom more

than 25 percent in the mid to late 90s, to

just 5 percent by 2002.

Unprepared or the supply shock that hit

the system ater 9/11, many premium

wineries were let holding high-inventory

positions that needed to be discounted

to move. For many Cabernet producers,

the negative impact o the 2000 vintage

year widely covered by the press urther

exacerbated the problem, and buyers

decided to wait or the 2001 vintage.

Te lower growth rates in ne wineand slowing restaurant sales that ensued

rom the tech recession soon reversed

as employment numbers held relatively

well and home prices ballooned, causing

many people to continue to eel wealthy.

Consequently, consumers continued

spending right through that recession,

and by the end o 2006 the premium

business was ying high again with

growth rates above 20 percent, while the

lowest price points were lagging. rading

up was the catch phrase o the day,

explaining the consumer preerence or

higher priced wines. But that recovery was

triggered by the Wealth Eect,1 which

was based on alse home values. It was

money consumers elt they had available

to spend. Tis phenomenon is clearly not

the case in the current recession.

Fast-orward to the present, and the term

trading up has been turned on its head;

trading down is the new catch phrase to

describe the business. Consumer spending

hit the skids in 2008 and value came into

vogue. Unlike the last recession, in which

ne wine held its own on market share

with higher volume producers, in the

present recession we see the volume in

wine consumption still growing slightly,

but the more modest price segments

experiencing better resiliency in their rateo growth. Also, unlike the past recession

in which consumers quickly resumed

purchasing wines at high price points, the

destruction o consumer wealth along with

what are predicted to be muted business

conditions and business spending ater

the recession is over, will likely keep price

pressure on wines over $35.2

Wine Conditions Survey3: What

winery owners sayResults rom the 2009 SVB Wine

Conditions Survey show winery owners

believe this will be a difcult year,

with Central Valley suppliers the mostoptimistic, and Napa and Sonoma themost pessimistic. Oregon producers aremore optimistic than their Caliorniane wine counterparts. While there maybe some basis or that given generallylower prices in Oregon, we believe

there may be more planted acreage thanpresently needed in the state. We suspect

distributors that helped the market growhen Pinot Noir was in severe shortain the market may drit back to high

volume suppliers in Caliornia i PinNoir becomes more readily availabthere.

Other opinions noted in the WiConditions Survey:

Size o winery: Tere is increasioptimism or smaller versus larg wineries. One can only surmise impact is related to the smaller wineridirect models, which cause their ownto eel they have greater control ovtheir direct sales, versus larger wineriSmall wineries also wield the leamount o inuence with distributor

Price points: Companies are mopessimistic as their price poin

increase with $40-65 and >$90 t

most concerned. Our own experien

is that under $35 works or red win

(less or white), $35-50 is a gray ar

and $50-125 is a dead zone with onthe best brands doing well. Ironical

-20%

-10%

0%

10%20%

30%

40%

50%

60%

CaliforniaCentralCoast

CentralValley

Napa

Oregon

Sonoma

Washington

Region

Bullis

h/Bearish

Regional Optimism

Source: Silicon Valley Bank


6/25


APRIL 20

wines that can sell or more than $125

to this point are selling out. Tere is a

question about a bulge in the secondary

market or collectable wines, however,with restaurants and consumers moving

bottles in their cellars to generate

liquidity and the secondary market

experiencing reductions in the gavel

prices.

Longevity in business: Te more time

our respondents have spent in the

business, the more pessimistic their

response. Wineries in business one to

our years were the only group with apositive outlook. Te result is slightly

counterintuitive, but we think it has to

do with smaller wineries dominating the

startup results. Tey are more ocused

on a more successul direct approach.

O course, the other possibility is that

the guys who have been doing this

the longest are just plain grumpy and

tired.

Adding to the good news, the U.S. brokethough the 3.0 gallons per capita mark o

consumer consumption in 2008. While

a new high or the country, per capita

consumption is still ve to six times less

than the major wine consuming countries

o France and Italy, demonstrating there

is still ample upside growth.4 According

to the International Organization o Vine

and Wine, the U.S. became the largest

consuming country o wine in 2008 in

total consumption ahead o both Italy and

France. Te home court advantage is nice,

but that newound status also makes the

U.S. the single biggest target or exporting

countries that are suering their own

economic tribulations and will look or

opportunities to sell where they can.

6

High-volume production

Dorothy: Maybe love shouldn't be

such hard work.

alk to armers and you will discover

optimistic people who love what they

do. But over the past several years,

growers in the high-volume segments

suered through lower demand due to

overplanting. Tat was subsequently

magniied when large-scale wine

companies extended their traditional

sourcing to include oreign bulk wine.

Te change in sourcing replaced grapesthat had been purchased historically

rom domestic growers. Even guys

who loved what they do couldnt do

it or ree.5 Starting in the early 2000s

more than 100,000 acres o production

were removed in Caliornia, mostly in

higher production appellations. Ten

just as supply and demand seemed

to be normalizing, the tech recession

evaporated, trading up reasserted itsel

and 2005 produced a record crop sizelowering price or the 2004 crop year.

Te series o events was discouraging

or long-suering producers and made

many wonder i they would ever see air

prots and just a little love rom buyers

again.

Now in a reversal, worldwide oversupply

which was present or years has now been

demoted rom lake status to pond

status, and the concentrate market that

essentially puts a oor on that business

is extending better pricing than has

been seen in years. Consecutive years

o moderated yield have reduced wine

in domestic tanks, and the recession

is driving consumers to value pricing.

As a consequence, the supply o grap

is presently better balanced than

has been since the late 1990s, a

contract pricing has improved to tpoint where many, i not most, grow

can make at least a modest prot.

a sign o optimism or the segme

or the second year in a row seve

knowledgeable industry participan

cautiously suggested that planting t

right varietals in the right locatio

under contract would be advisable giv

current supply.

In a continuing unavorable trenaccording to Gomberg-Fredrikson, u

year imports o oreign bulk wine gr

at an astonishing 27 percent (13

million 9-liter case equivalents)

2008, urther commoditizing the low

price segments. A strengthening dol

or a weak harvest could accelerate th

trend. Water supply in draught-strick

Caliornia may also have a destabilizi

eect regionally, reducing supply ro

some vineyards and enhancing val

rom another.

Other issues that may emerge (but

which the scale o impact is impossible

predict) include taris and protectionis

in addition to higher taxes on alcoh

rom both state and ederal lawmak

that can aect lower priced wines to

greater extent than higher priced win

We are also aware anecdotally o curre

higher carried inventories in som

large producers. We are unable to u

determine the depth o the situati

as o this writing, but i its sizable a

widespread, it also may aect harv

purchasing decisions later this year a

contract pricing next year.


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APRIL 2009


Fine wine production

Laurel: Don't cry at the beginning of

a date. Cry at the end, like I do.

Fourth quarter 2008 was the worst Q4 we

can remember or ne wine sales at the

winery level. But like Laurel in the movie,

we remind people this is the beginning o

the date and its the wrong time to start

crying. I you are going to presume that

2009 will be like Q4 2008 multiplied

by our quarters, you might convince

yoursel into jumping o a tall chair with

a short rope. Tat position would be alittle too negative, and there is still plenty

o time to cry later.

Good news

Lets start with the good news because it

exists even in todays market. Unlike the

last recession earlier in the decade, neither

the segment nor the industry is sitting

on large unsold inventories in the cellar,

which would otherwise orce even greater

discounting. For the most part, the newine segment has inventories that are in

balance with demand.

Since we are neither experiencing large

negative declines in average consumption

as ar as we are aware, nor are there large

stocks o non-bearing acreage to account

or, we expect supply to remain in a

balanced state or the next year at least.6

Adding to the good news, domesticconsumption o wine continues toincrease per capita, and there is every

reason to believe that trend will continue. Ater discouraging sales at the winerylevel in November, the months ollowinghave been good. In talking to distributors, we are told depletions did not stop,though they were soter than in the sameperiod the prior year. People are denitelystill drinking. (With all the bad news,its hard not to drink!) Te other goodnews is the price o potential substitutesrom France, Italy and Germany have all

dramatically increased since 2001 causingvolume reversals in bottled imports romall countries except Spain.7

Consumers still aspire to luxuryconsumptionalbeit only inconspicuousconsumption or the present, given socialsensitivities. Per capita consumption is still

climbing. While there is abundant b

news, its oset with wine businesses th

are still doing well, even in this depress

market. Tose models that are perormibetter include established brands, c

and near-cult brands with allocat

mailing lists, wineries with establish

direct-to-consumer models that alrea

have a good handle on custom

relationship management, regional wi

operations with concentrations o lo

sales in economically sound geograph

and larger-scale production wineries th

sell wines under $35 price points.

Financial perormance

Financial perormance in the ne wi

segment gave many participants

whiplash in 2008. Early reports us

proprietary and still unaudited nanc

inormation rom SVB showed that sa

12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 09/30/08 12/31/08

Sales Growth 5.2% 17.6% 25.5% 19.4% 21.2% 22.3% 11.6% 2.0%

Gross Margin 51.5% 50.2% 51.5% 52.8% 54.5% 57.1% 55.5% 55.3%

Pretax Proit 3.2% 6.3% 7.6% 12.6% 11.3% 16.3% 14.9% 9.5%

High-End Industry Proftability

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

12/31/20

02

12/31/20

03

12/31/20

04

12/31/20

05

12/31/20

06

12/31/20

07

9/30/20

08

12/31/20

08SalesGrowthandGrossProfitMargin

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

Pretax Profit

Gross Margin

Sales GrowthPretaxProfit

Source: SVB Peer Group Analysis

Source: SVB Peer Group Analysis


8/25


APRIL 20

growth through Q3 came in at 11.6

percent annualized, then ell to just 2

percent sales growth at the end o the year

as many wineries reported a poor Octoberollowed by a gut-wrenching November.

Sales growth or the segment in Q4 was

negative. Sales in December were slightly

better, and the rst quarter o 2009 also

appears to have produced improved results

compared to Q4, but decreased sales

overall when compared against Q1 2008.

Unaudited gross and net prot estimates o

55.3 percent and 9.5 percent, respectively,

should be adjusted downward as wineriescomplete work with their CPAs.

Bad news

Wait that was the good news?

Te ne wine industry, which has

demonstrated percentage growth rates in

the low twenties and high teens or some

time, has reached a tipping point where

the weight o the economy and both

distributor and retailer consolidation have

teemed up to tilt some business models

in the direction o ailure. But despite

a tough economy and severely aected

restaurant segments, we still predict at

year-to-year rates o growth. Tat said,

the modest sales orecast masks the truly

tumultuous change underway in many

amily-owned wineries.

Emerging trends resulting rom distributor

consolidation and evolving consumer

preerence patterns (both covered in prior

State o the Wine Industry reports), have

been magnied by alling restaurant sales and

the worst recession since the 1930s, causing a

reexamination o priorities and opportunities

with many amily-owned wineries.

Distribution

Avery Bishop: There is no real

loyalty, and the first person whotaught me that was you.

In the past year, distributors have dropped

hundreds o small brands rom their

portolios, citing them as unprotable.

And we see a continuing trend o

bigger producers aligning with national

distribution. It hasnt always been so.

When SVB began its dedicated wine

practice in 1994, it was common to seesuccessul models in nearly all volume

segments and price points. Micro-

brands seemed to thrive right alongside

estate operations, 50,000-case wineries

and smaller businesses; all through a

nationwide distribution model o regional

distributors. O course, there have always

been some who were more successul than

others, but the opportunity was there to

manage a small winery in a marginally

protable manner and let the distributor

sell the wine and handle complianand logistics. Te landscape has evolvdue to consolidation o distribution a

retailers, changing buying patterns younger consumers and the Internet.

Tere are varying statistics regardithe number o brands in the U.S. athe number o distributors selling thobrands. In part, this is because the numbo brands has been increasing almost daiprecise inormation is not available adistributors are still consolidating. Tmost recent available data suggest the

are about 6,000 U.S. wineries produciconservatively about 7,000 wine brand

Tose brands have to squeeze throuan estimated 550 distributors hthe number o 10 years ago or nalternative distribution channels to reathe roughly 76 million wine consumin the U.S. According to estimates roGomberg-Fredrikson last year, the t10 wine companies accounted or percent o total domestic shipment

Tat leaves the other 5,990 wi

8

Business Models

90%

80%

70%

60%

50%

40%

30%

20%

GrossMargin

Gross Sizes

EfficientFrontier

1,000 10,000 100,000 1,000,000 10,000,000

Small Integrated Direct

Model

Stuck inMiddle

Distributor/NegociantModel

Large ScaleHigh Volume

Low Cost

Source: Silicon Valley Bank


9/25

APRIL 2009


companies ghting over the remaining

18 percent o available space in wholesale

channels. Te predictable result is that

its been increasingly difcult or smallerproducers to nd good representation.

Now, the current recession has

exacerbated the problem and accelerated

the trend beyond the ability o some

wineries to adjust and move into a new

sales channel ast enough.

Ater interviewing more than two dozen

distributors in condence, we discovered,

not surprisingly, that the economy is

taking a toll on their businesses andmargins as well. In an eort to stabilize

their own returns, most have taken

rational actions to become more efcient.

Noteworthy to the ne wine producer,

they are eliminating less important brands,

smaller brands, slower moving brands and

those brands that deliver ewer nominal

dollars to their business. Furthermore, we

have not ound any mature distributor

willing to take on new brands or labels.

Tese actions hit square in the center o

the ne wine business.

While there are numerous startup

distributors who believe they can use this

trend to their advantage and expand their

own markets by taking the letovers rom

large distributors, those newer distributors

are oten undercapitalized, especially in

this environment. On the selling side,

they have to ght or accounts against

the larger distributors that have more

inuence with the end retailer.

Some o the newer distributors will nd

success by watching or larger distributors

to react to the recession and vacate lower

volume territories and ragmented retailers

in avor o more efcient ones. But that is

only an emerging opportunity that will need

to play itsel out. It wont be much help this

year or most producers looking to go tosmaller distributors in smaller markets.

Our business models chart on page

8 depicts the landscape. Te trend o

distributor constriction and current

distributor brand tactics have two

consequences. Tey orce a smaller ne

wine producer more rapidly to the direct

market or higher margins (moving to

the let and up in the chart), or imply

they need to get bigger to retain theirimportance to a distributor, (moving

down and to the right in the chart).

Getting bigger means building inventory

and borrowing more, and that is a roll o

the dice in a at-growth market or small

wineries. Te second option to scaling

bigger is acquisition or an outright sale,

but these options are still difcult in

todays tight credit markets.

For most small brands, the bestopportunities are in direct-to-consumer

marketing strategies. Finding the right

strategy may become absolutely criti

to a winerys success, i not its outrig

survival during the next several years. B

being stuck in the middle too smallget distributor attention and at the sam

time, too big to position wines at high

price points is proving increasing

unworkable as a viable business strategy

Even at this stage, somewhat early in t

economic tumult, we have noticed som

wineries quietly change hands at pri

that would have been considered bargaprices less than a year ago. We believe t

trend will likely continue to accelerate.

Te most likely candidates or transitio

like this are newer brands that nev

established a viable sales chann

brands and properties that were und

development beore the market cra

modest-to small-scale producers selli

through distribution, wineries larg

ocused in the restaurant trade, low pric

low volume wineries and wineries carryi

too much leverage. We are describi wineries on the edge o the risk cur

and many in the segment will see real sa

Total Bonded Wineries

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1975

1965

1955

1945

California

United States

Source: he Wine Institute


10/25


APRIL 20

setbacks and losses in 2009 without rapid

adaptation.

Like any business segment, this economywill expose the weaker players in the wine

business and capitalistic Darwinism will

play its role in right-sizing the playing

eld and strengthening and streamlining

the survivors. Since most o the U.S.

wine industry started subsequent to 1980,

and this kind o recession is historic, it

is worth noting that we are experiencing

entirely new operating conditions today,

and management teams cant go to a past

playbook or answers. New rules have tobe written, and that will challenge many

management teams that were used to a

airly slow rate o change.10

The delicate balance o supply and

demand

Land

Jerry Maguire: This is going to

change everything.

Dorothy: Promise?

Supply starts with land in production.

We have grown accustomed to long

agricultural swings in overplanting

leading to oversupply until demand

catches up. But what we are experiencing

might change everything we have

become used to in the land cycles. Up

to this point, high vineyard costs inthe established appellations have been

supported by consumers trading up to

high-priced wines, allowing or cheaper

oreign wine to take growing mark

share underneath. In the past decad

unplanted acreage would never get

3 percent non-bearing beore plantinwould take over, thus spurring the ne

cycle. But this time, planting has n

picked up despite non-bearing acrea

below both growth rates and replaceme

rates, and its been like that or seve

years now. Why the dierence?

We believe cheaper imports, a m

experimental consumer and the Intern

making quality comparisons easier a

imports more available are together changithe game. Add in a recession that mov

the consumer rom trading up to tradi

down and better supply-and-dema

10

26%

23%

12%13%

Projected*

5%

0%

Non-Bearing Acres (vineyards planted within last 3 years and not yet bearing fruit)

Bearing Acres (vineyards more than 3 years old, bearing fruit)

Non-Bearing Acres as a % of Total Planted Acres

20,000

40,000

60,000

70,000

100,00

120,00

02010P

2009P

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

10%

15%

20%

Non-BearingAcresasa%

of

TotalPlantedAcres

25%

30%

Bearing Acres

Includes: Napa Cabernet Sauvignon, Napa Merlot, Napa Cabernet Franc, Sonoma Cabernet Sauvignon, Sonoma Chardonnay, Sonoma Merlot Sonoma Pinot Noir,Mendocino Pinot Noir, Santa, Barbara & San Luis Obispo (District 8) Chardonnay and Santa Barbara & San Luis Obispo (District 8) Pinot Noir.Source: California Agricultural Staristics Service.* Projected bearing acres based on 2007 non-bearing acres maturing into bearing acres, less 2% annual replacement of o ldervines (assumes 50 year average life of vines).

2011P

3.6%

2.8%

Historic Low

Plantings Stopped in 01Grape

Prices

~2x

Next 5 Yrs

Grape

Prices

~2x

Next 5 Yrs

Historical Bearing and Non-Bearing Acres

Source: Premier Paciic Vineyards


11/25

APRIL 2009


inormation or the industry as a whole,

and we may be at a point where we will

not see the same kind o cycles that had

become normal in the ne wine industryin decades past. We are not ready to

call a long-term end to the pattern o

trading up because consumers still aspire

to better goods. Its more likely a little

lull in the trend. But consumers dont

have to buy domestic products when

trading up comes back, and growers will

correctly choose not to plant i there

arent buyers or their grapes going into

the right-priced wines. In either case,

its not likely investors will plant large

swaths o vineyards as long as good value

imports are available and the dollar stays

strong.

Regarding overall land values, this

recession will lower appraised values o

properties in the business on the whole,

but the best properties will retain value

and even see increases given their scarce

nature. With a setback in the purchaseo higher priced wines, discounting will

emerge in some bottle price/quality

ranges, which will eventually lead to

concessions rom those growers producing

that ruit, and nally lower land prices

in vineyards that are producing lower

returns on their investments.

Grape and Bulk Supplies

Jerry Maguire: How's your head?Rod Tidwell: Bubblicious.

Managing the volume o inventories at

the winery level is probably one o the

most critical jobs in running a winery.

Depending on year-to-year yields and

predictions o growth, this activity is

ull o SKU bubbles each year, leading

to potential discounting and problems

with shel pricing on the next vintage.

Its obvious that cost in the supply anddemand equation will take on a larger

role this year, even in a balanced and

bubblicious supply situation.

In the 2008 SVB Wine Conditions Survey,

we asked wineries on the West Coast what

they thought about the inventory supplies

in the cellar. At that time, 90 percent

elt they had either adequate or short

supplies in the cellar. Our conclusion

back then was that in general or ne wine, supply and demand were about

in balance on the whole. Tough sales

growth slowed during the 2008 year,

non-bearing acreage has not grown and

is now below the 3 percent level oten

cited as a minimum replacement level

or vines. Further, the 2008 harvest was

light in general. Finally, in reviewing our

clients inventory positions, wineries are

not sitting on large excesses o wine, and

that allows or a little more patience rom

producers to nd where monthly sales

levels will all in these uncertain times.

As o this writing, there is a question

raised about some o the larger producers

relating to the number o days worth o

inventory they are carrying. Our sources

suggest those positions may be high, but

we have no present conrmation o that

situation.

o get a better perspective on supply,

we need to look past the inventories

at the winery level, since its their job

never to have too much wine, even in

an oversupplied market. Examining the

relationship between vineyard production/

yield and the dollar sales o varietal win

gives us another indication o what is

the production queue.

We use Winery Exchange Scan Data a

proxy or sales above $15, and Napa a

Sonoma (District 4 and 3) growth rates

harvested volume as a proxy or the supp

o $15 and above wines. Its not a prec

examination o the balance, but its anoth

indicator that gives us a better eel.

In a perect world, we would like to s

a chart that has a ratio o harvest yield

sales growth o zero percent, indicatithere were just enough grapes supplied

the current year or demand. We alwa

preer to have relative supply in balan

or even slightly short, (as indicated

yellow boxes on the right o the cha

because that oers the best opportun

or the best returns or growers a

producers alike.

aken together, we believe high-end supp

and demand is in balance or the 20

crop year and could run short in high-e

Cabernet depending on sales aected

recession.

Merlot and Cabernet had short harve

in 2008. Cabernet sales were good dollar terms, and while Merlot sales we

modest, we believe some o the volume

Merlot went to support higher Cabern

growth. Merlot is still slightly long

the high end o the market, but it is no

closer to a balanced state than might ha

been predicted prior to harvest. Witho

the recession, we would suggest Cabern

supply or the ne wine segment was sho

now, especially considering a weak yie

in the San Luis Obispo region, where t


12/25


APRIL 20

harvest was down the equivalent o more

than 1.4 million cases. Pinot Noir is still

short on average, but it is more balanced

than it has been in the past several years,and sales growth o the varietal has slowed

rom the high rates o growth triggered by

the movie Sideways over the past several

years to a still healthy 11.3 percent.

Marketing and selling ine wine:

Tone it down

Dicky Fox: If this [points to heart] is

empty, this [points to head] doesn't

matter.

Understanding what the consumer is

eeling in this recession is key to selling

wine. Consumer behavior in luxury

markets has drastically changed in the past

six months. Te most important changes

or the marketing o ne wine are:

Conspicuous consumption has changed

to inconspicuous consumption.

Consumers have lost aith with

institutions and seek non-institutional

and authentic products.

Price matters and aspirational brandsthat sold to the aspiring wealthy have

been hardest hit.

Bling has given way to understatement

today. Public criticism over the

unsympathetic actions o Wall Street

and Detroit auto executives has led

most socially conscious consumers

who might still have the desire and

means or luxury purchases to go

underground. Luxury apparel brands were quick to pick up on the trend,

marketing less ostentatious oerings,

trending back to sot neutrals, more

traditional looks and raised necklines.

One high-end watchmaker this year

came out with a new oering that

included a patina nish, making it

look like an antique. Te takeaway

or ne wine sales is that marketing

using a Liestyles o the Rich and Famous

approach may actually come o as

vulgar today. Consumers still aspire

luxury and always will, but today

the highest priced wines, you may ev

have to assuage a consumers eelings guilt or having the means to aord

very expensive wine. Add a compone

o social consciousness o your ow

perhaps donating a percentage o ea

sale to a cause, or example. A wi

estate owner today cant be identi

as a rich winery owner. Better bra

positioning would be as a amily armi

operation.

And that brings us to the next poi At a time when consumers have l

aith in the Establishment bo

the corporate and Washington stat

quo authenticity has become one

the most important aspects in a consum

sales strategy. Mass-produced goods are n

authentic. According to some research

o consumer trends, hand-made produ

are o ar more value in git-giving tod

than a year ago. Tis is a trend th

avors the amily wine producer sin

12

Sources: Winery Exchange, Caliornia Ag Statistics, Ciatti Brokerage, urrentine Wine Brokerage, SVB Analytics

Napa and

Sonoma Dist

3 & 4

2007

Yield

(tons)

2008

Yield

(tons)

2008

Growth

in Yield

2008

Growth

in Sales

(Dollars)

Ratio of

Harvest Yield

to Sales

Growth

Relative Supply

2006 2007 2008 2009

Chardonnay 82,665 76,272 -7.73% 5.20% -1.49

Sauvignon Blanc 20,742 22,094 6.52% 7.70% 0.85

Cab Sauvignon 99,956 75,398 -24.57% 9.10% -2.70

Merlot 44,110 28,183 -36.11% 2.80% -12.90

Pinot Noir 38,237 37,227 -2.64% 11.30% -0.23

Syrah 11,329 7,228 -36.20% -1.90% 19.05

Zinandel 18,703 15,220 -18.62% 5.20% -3.58

Overall Premium

Short

Short to balanced

Balanced

Long to BalancedLong


13/25

APRIL 2009


these products are about as authentic as

they come. Te takeaway rom this trend

is that wineries need to play up the hand-

crated production o their product andemphasize the detail and care they take

in producing wines or their consumers.

Tat may take the orm o a packaging

change, so someone in a grocery store

can tell your bottle was touched by

human hands. For a sel-made person

or winery owner who bet it all to make

wine their lie and succeeded, talking

about humble beginnings and hard work

may be a point o connection with yourconsumers today. But in all cases, nding

ways to touch the consumer o your

product through electronic and or direct

contact will be more important than ever

or ne wine sales.

Price: Focus on perceived quality

irst

Rod Tidwell: Anyone else would

have left you by now but I'm sticking

with you. And if I have to ride your

ass like Zorro you're gonna show

me the money.

In the late 1990s, i you had good wine,

you could almost take an aggressive

position with distributors and direct

clients at the same time. I remember

one client at the time who said, I only

sell wine to people I like. I I dont like

you, Im not selling you any wine.

Honestly, I appreciate that perspective

in relationships since nobody ever wants

to deal with an ass either in business

or in personal lie. But string together

some sot years in sales and or a single

transaction at the right price . I dont

know.

Te amount o wealth destruction we

have seen in this economy, and the ear

emerging rom such a bad Q4, can make

anyone start to panic and drive straightto the conclusion to drop the price. Tat

may be a solution, but we would suggest

reading a little urther or our perspective

on that. A ew o our clients have tried the

other approach raising prices in this

market and we can report their eorts

were met uniormly with anger. While a

consumer may not really care that much

about the retail price between a wine that

is $17.99 versus $18.99, distributors and

restaurants are oended when a winerysuggests raising prices today, in the same

way that a winery owner will be irritated

i a winemaking consultant raised his

or her consulting ees today. Increasing

bottle prices is viewed by restaurants and

restaurateurs as unsympathetic at best,

and at worst, its the Wall Street and

AIG bonus syndrome repeated. Tat said,

direct-to-consumer channels may bear

small price increases within pricing bands

in a minority o cases.

Luxury marketers break the wealthy into

categories because o behavioral and scale

dierence in purchase decisions. One

descriptor o a class is the aspirational

wealthy, composed o consumers who

have a modest net worth, but relevant

discretionary income. While we havent

yet seen statistics on this broad and loosely

dened class o consumers, it is reasonable

to presume this would be a class heavily

aected by alling home prices, and also

consisting o the kind o consumer who

would in better times be willing to scrimp

on a necessity to aord a luxury, such as a

moderately expensive ne wine purchase.

Paired with distributor consolidation that

avors higher volume lower price po

wineries, we suspect wineries produc

above $50 as a retail price point witho

cult status or a solid direct model mcome under extended price pressure, a

such producers will have more difcu

with price as a consumer objection.

We hear over and over that consum

are looking or good value. We encoura

you not to consider value as a synony

or price. Value is dened as perceiv

quality11 divided by price. Tere a

value purchases at all levels o goods. F

instance, you can get a good value whyou purchase a Mercedes, even i it

a $75,000 purchase. We advise you

think about all the things that you c

do to enhance perceived quality beo

dropping price. And when you do get

the price part o the equation, make su

that you are rst surrendering margin

a distributor or retailer to enhance sa

volume instead o dropping price on t

shel.

Here is an important example

emphasize the point: We are aware

a producer that, at the suggestion

its distributor, dropped price about

percent on the shel to get its brand mo

in line with another that was consider

a direct substitute. Ater two months, t

producers reported increase in volum

was: zero. Dropping price did not increa

volume. wo actions might have improv

its situation: It could have dierentiat

the product rom the winery that produc

a near substitute, or, i it decided to g

in on price, the decrease should ha

been divided between the retailers a

distributors pockets without aecti

shel price by much. Bottom line: Wh


14/25


APRIL 20

you work with the value equation, ocus

on the perceived quality aspect o the

equation rst. Hit your consumers with

what matters to them. I you ocus on theprice part o the equation, your choices

are limited to dropping price, and when

that is exhausted as a strategy, raising price

later becomes difcult.

Direct-to-Consumer: Wineries need

to get better at Internet dating

Laurel: Dorothy, this guy would go

home with a gardening tool if it

showed interest.

Buying a bottle o ne wine is a little

like trying to date. For a person who has

never tried your wine, its like a blind

date. Te consumer is in the position

to spend meaningul sums o money

on something he or she has never tried.

But the buyer isnt desperate or your

bottle. Tere are many sh in the sea.

While showing interest in the consumer

is a large part o the battle in the sale

o a ne wine, just like a nding gooddate, getting a recommendation rom a

riend you trust will rank high on the list

o selection criteria. raditional tasting

rooms can support a piece o the sales

puzzle, since that means its not a blind

date anymore, but or most wineries,

electronic and more regional methods

o selling wine outside the distributor

channel are becoming required skills or

success. Bottom line: Wineries are going

to have to get better at Internet dating.

Jerry Maguire: Help me... help you.

Help me, help you.

We would love to be proven wrong, but

with the sole exception o [insert your

winery name here], we cant point to a

single wine production company that

integrates anything close to a practical

suite o electronic applications andsocial media tools available to execute

a successul direct-to-consumer digital

sales strategy. With so many wineries

losing distribution, one would think

management teams would ock to these

solutions, but its been slow in coming.

Te explanation or slow adoption is

varied, but part o the reason is that

online sales are still a much smaller

percentage o most wineries total sales,which remain dominated by clubs, tasting

rooms, direct-to-trade and traditional

distribution. Since its a small part,

there is less emphasis placed on digital

distribution. In an environment like

the present, the problems with existing

strategies get the attention o owners,

instead o the opportunities in other

solutions. Te situation reminds me o a

Japanese story I heard as a child:

Amaya: Why dont you x the holes in your

roo?

Masumi: Its not raining.

Amaya: Are you going to wait and x the

holes when it rains then?

Masumi: O course not. Id have to go

outside and get wet.

How many Masumis are out there looking

at the holes in the ceiling when there

are clouds overhead? According to Inertia

Beverage, less than 1 percent o all U.S.

wineries have a dedicated online sales and

marketing team. For many in the throes

o decision making, younger available

consumers, distributor consolidation

and the ailing economy will now orce

marketing changes and new approachto selling wine that use electronic toas support. Te real question or a lar

percentage o these companies is, Whdo you even start? Increasingly, vendor atechnical solutions are emerging to hwineries do a better job o selling online

E-commerce platorms like CultivaInertia Beverage and Vin65 continto improve the ground oor o a digimarketing plan.

Consulting rms like Vintank aavailable to walk wine compan

through the development o customizepractical and cutting-edge digistrategies that maximize opportunitieswine marketing, business developmand sotware architecture.

Compliance solutions roShipCompliant, eCompli aRethinkcompliance oer solutioto help streamline the challenges compliance.

Fulllment houses like Wine astiNetwork, New Vine Logistics aCopper Peak Logistics are investing technologies to improve all aspects delivery.

WISE Academy (www.wineindustryeseducation.com/) has been ormed a pair o industry veterans to raise tcaliber o direct sales employees.

Well over 25 social media companies wine have launched, and more than

dozen wine-specic iPhone applicatioare now live.

We are happy to make introductionspeople who might assist you in thinkithrough your digital sales and marketi

plans i you give us a call.

14


15/25

APRIL 2009


Alternative sales channels

Sign in Locker Room: A positive

anything is better than a negativenothing.

Some clients in November 2008 told us

they pretty much hit a negative nothing

in sales that month. Tere are other ways

that can include little in the way o up

ront investment and can make a positive

something. For instance, 2009 could be

the year alternative sales channels enabled

by the Web make a meaningul impact.

Te two most noticeable will be the

e-Marketing agents like Te Wall Street

Journal, and the growth and development

in social networks and blogs.

Winery direct and e-Marketing agents

A new direction or moving wine online

is the e-Marketing agent. Many o the

largest online businesses, including

Amazon.com, Expedia and eBay, serve as

marketing agents or other products. Te

marketing agent is an entity that delivers

customers and/or purchase orders or a ee

but holds no ownership in the product.

Last year, attracted by the high customer

value potential o wine as a category, we

saw the launch o such initiatives rom Te

Wall Street Journal and 1-800-Flowers, as

well as some tests with other major online

entities. We also heard the announcement

that both Amazon.com and Sears were

entering the wine industry, as well as

a slightly dierent direct model in a

partnership between Costco and Inertia

Beverage. Tough new retailers are

challenged at learning how to manage

the intricacies o the wine industry, the

entities have tremendous amounts o cash

to invest and audiences that will drive

sales or customers to specic brands.

Social networks

Jerry Maguire: Have you ever gotten

the feeling that you aren't completelyembarrassed yet, but you glimpse

tomorrow's embarrassment?

I you cant explain what Facebook or

MySpace do, or i a blog sounds like

something Drano would help remove,

then social media may not mean much to

youbut it should. I may be glimpsing

tomorrows embarrassment by admitting

this, but beore writing this report, I

actually signed up on Facebook and

MySpace and within a day, had all these

people who wanted to be my riend. I

even knew most o them! Why would I

sign up? Because I started to understand

that I am a dinosaur and late adopter o

social media. I wanted to see what it was

all about and can report to you neophytes,

its pretty interesting conceptually. I youre

like me, Ill bet you didnt know the Web

site Facebook is growing by 500,000 new

subscribers daily according to a recent

Oprah interview with Facebooks ounder.

Which age group presently is responsible

or the largest growth? People over 30.

Tat might surprise those who believe

these social media sites are simply digital

entertainment or 13-year-olds.

Social media reers to Web-enabled

communities o people who share common

interests. One o the largest difculties o

online wine retailing is sampling. You cant

do it. But beyond rsthand experience,

the next most noted driver or wine

sales is peer-to-peer recommendations

a riend who gives you a tip about

a wine. Currently such diverse sites as

eRobertParker, Wine2.0, Crushpad,

Vinolio, WineBid, Wine Woot, Wine

Spectator, Vinography, Snooth and ma

other orums are lling with peop

sharing their discoveries o new win

and their love o the grape. Inuencithose channels can stimulate demand

a manner previously reserved only

the wine rating services. Social med

are becoming more relevant or creati

awareness each day, and delivering tact

that authentically inuence these group

Digital sales and marketi

recommendations:

Make sure in this economy that yarent just ocused on tactics a

responding to the problems o slow

distribution or tasting room sales. Do

miss the opportunity to make progr

in developing or urthering a digi

sales and marketing strategy.

Consider directing a portion

production to an e-Marketing agent.

When developing a digital plan, st

at the oundation: Figure out whisystems to use, how youll manage a

leverage your data and inormati

and how you intend to grow usi

the technology to support the action

(Electrons dont sell wine.)

Create a customer service plan th

crosses all our direct consum

channels (tasting room, club, pho

and e-commerce).

I you have been using an in-house Wplatorm, consider upgrading to use

e-commerce company that specializes

wine and can help direct your progr

in the channel.

Consider shipping costs as a marketi

opportunity. Avoid channel con


16/25


APRIL 20

with your retailers by posting higher

prices and give ree shipping.

In cost containment environment,

analyze shipping rates with your

shipping team or ulllment partner

to make sure you are getting what you

and your customers want in service and

cost.

Keep your customer relationship

management database clean by

scheduling twice a year phone

conversations with your customers. Its

also an opportunity to reinorce your

personal relationship with them andencourage higher purchases.

The Economy

Avery Bishop: There is a sensitivity

thing that some people have. I

don't have it. I don't cry at movies,

I don't gush over babies, I don't

buy Christmas presents five months

early, and I DON'T tell the guy who

just ruined both our lives, "Oh, poor

baby." But I do love you.

Over the past six months, like Avery in

the above quote, weve all had to adjust

to new surroundings. alking to clients

about the economy, weve been direct and

tried to be sensitive; not dwelling on bad

news because some people believe with

conviction that talking about bad news

will elongate the recovery. Still, no matter

what we do or how short a discussion

we make o this, people always wantto go back to the credit crisis and the

economy and dig deeper. So we will give

the topic a small treatment this year, and

avoid easy topics like how we got here.

It eels good to debate and assign proper

puritanical blame, but it wont aect

decisions you make about running your

wine businessthough we have to admit

it is excellent theatre.12

While the nal accounting on marketdestruction, asset devaluation and

government spending is still out and

the markets are still retracting and

de-leveraging, this March 11, 2009

comment rom CEO Stephen Schwarzman

o the highly regarded Blackstone Private

Equity Group stands out: Between 40

and 45 percent o the worlds wealth has

been destroyed in little less than a year

and a hal. Needless to say, that is not

a good thing, especially considering wearent done.

o eectively plan or the uture, you

still have to have an idea o how long

the recession will last and how bad it

will get. Will we be through the trough

and back to normal by year end, or will

this be a longer term issue? We can say

with some level o certainty that the

housing problem will be corrected in

the next 18 months, with or without

the help o the government program

so we will skip that discussion.13 Wh

is more important than deating hom

prices getting back into line with mediamily income is median amily incom

itsel. We cant get the economy goi

without the consumer spending, and t

consumer cant spend without consum

credit. Focusing on just the credit mark

we have a perspective to share in the ho

it will cut through the haze o battle a

give you an idea o the state o the cred

markets that aect your business and t

consumer, as well as an understandingwhere the real problem is and what has

be done to get the markets unctioning

Credit Markets

Lending conditions in the wine business

We noted this quote rom the CFO

major U.S. bank in early March 2009: W

are returning to our core business as

enabler o commerce and eschewing ris

ventures. Te days o exotic instrumen

and low-cost credit are gone.

16

CRE

100.0

75.0

80.7

74.0

57.6

50.0

25.0

TighteningStandards(%)

0.0

-25.0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Residential Mortgage C&I

Senior Loan Ofcer Survey - 50 Largest U.S. Banks

Source: he Board o Governors o the Federal Reserve System


17/25

APRIL 2009


I honestly dont know i that is news or

not, but it is a repeat o what the wine

industry has experienced in past down

markets relative to lender commitment,and it reminds us o this quote: Jerry

Maguire: I'm still sort o moved by your

"my word is stronger than oak" thing.

In a positive cycle, well intentioned people

who run lending institutions will go ater

markets and believe in their commitment

to the business. When lending markets

are in a negative cycle though, the same

people will always internalize what they

dont ully understand as risk and retreatto the core business they do understand.

As noted in the graph, according to a recent

survey o the 50 largest banks conducted

by the Federal Reserve, credit conditions

are tightening across all lines o banking.

Te same holds true o the insurance

industry and Farm Credit System, which

are experiencing their own issues and

unding problems. For most wine industry

borrowers, this means greater scrutiny o

business plans and orecast assumptions,

more questions asked regarding collateral

valuations, and perhaps slightly more

restrictive covenants and terms than you

experienced in the past.

Most lenders will tell you with their

corporate ace on, Its business as usual,

or something along those lines. But that

is counter to the Federal Reserve Chart o

the op 50 Banks showing conditions are

not as usual. In talking casually to most

o the lenders in the business, we believe

as o this writing the hardest place to nd

credit is a new transaction larger than $30

million to a company with a short track

record. oday, $50 million transactions

that a lender would have happily takenalone a year ago will probably require

a couple o banks to work together in

a club-type acility. Larger syndicationsover $100 million are the most aected,as its difcult to get a team o lenders on

the same page and to evaluate risk in a

consistent manner.

Te good news is that credit is available

or most amily wineries looking or credit

below $15 million. In act, while there

are ewer lenders in the wine space today

than there were in 2008, those that remain

are anxious to support well-run wineryoperations, and banks still compete

or that business, though at slightly

higher spreads. Credit tightening means

companies at the edge o the risk curve

will suer the most. Specically, wine

businesses with unproven or bruised

business models, those with high leverage,

the inability to absorb a setback and those

with inexperienced management teams

will have a more difcult time nding

nancing support rom banks today.

Loan pricing in the wine industry

Jerry Maguire: So this is the world,

and there are almost six billio

people on it. When I was a kid

there were three. It's hard to keep

up.

Loan pricing has changed radically in t

past year, and it is hard to keep up w

the market changes. Te chart o yie

on selected securities demonstrates wh

has happened to the relationship betwe

NY Prime and AAA Corporate Securit

since December 2007. It shows or t

best rated corporate borrowers in Ameriwhile NY Prime has dropped, the actu

borrowing rate or the top-rated compan

in America hasnt changed that muc

Higher rate spreads are reecting uncerta

and more risky business conditions,

well as a lack o overall bank indu

protability, which has been declini

since the mid-1990s, as noted in the ch

o Credit Availability in U.S. MarkeTat said, we are still talking about ve

low nominal rates when considered in t

context o the last 40 years.

Corporate AaaPrime Rate

Percent

8

7

6

5

4

3

2

1

0Dec2007

Jan Feb Jan2009

FebMar Apr May Jun Jul Aug Sep Oct Nov Dec2008

Yields on Selected Securities

Source: he Board o Governors o the Federal Reserve System


18/25


APRIL 2018

Credit availability in U.S. markets

Jerry Maguire: I'm not trying to

make history here.

History has denitely been made this time.

Our nancial system broke down last year

and credit markets did and still are seized

up in spots as o this writing in early April

2009. Fixing this historic credit crisis is one

o the keys to getting the U.S. economy

working again.

oday, while we are starting to experience a

little more optimism in general, despite the

massive and unprecedented coordinated

eorts between the government, Federal

Reserve and the U.S. reasury, there is still

inadequate debt capital being delivered to

borrowers. Tis single topic is generating

the largest amount o misinormation,

starting with calling the problem a credit

reeze, as i all it takes is a little patience

and a warm aternoon or a credit thaw.

You have probably heard the ollowing

sound bite: Te problem is the banks arent

lending. Is that true? Look at the chart

rom the Federal Reserve, showing that in

act commercial banks in the U.S. have

more debt lent than beore the recession

started.14 How can that be possible given

the number o times credible people have

said otherwise?

Most people are surprised to learn that

banks as they know themthose on Main

Street USA cornershave declined in

market share over the years, to the point

where traditional banks have less than a

25 percent market share. Te larger part

o the market is commercial paper15 and

the asset-backed securities16 (ABS) market.

While the commercial paper market has

been somewhat resuscitated, the ABS

Shaded areas indicate US recessions as determined by the NBER2008 Federal Reserve Bank of St. Louis: research.stlouisfed.org

5.0

4.5

4.0

3.5

3.01980 1985 1990 1995 2000 2005 2010

(Ratio

)

Shaded areas indicate US recessions as determined by the NBER.2008 Federal Reserve Bank of St. Louis: research.stlouisfed.org

8,000

6,000

4,000

2,000

01990 1995 2000 2005 2010

(B

illionsofDollars)

market is virtually without a pulse. How

broken is the ABS market? New issuance in

Q4 2008 dropped to $2.7 billion, down

87 percent rom the third quarter. Inact, the ourth quarter marked the rst

time in history that our o the major

ABS sectors (home equity, credit card,

student loan and equipment leases) had

no issuance whatsoever.17

Te reasons the market collapsed has

do with a loss o aith in the system

investors; specically a lack o aith

rating agencies, given their perormanin the sub-prime pools, and lack o a

in collateralized deault swaps18 whi

is an important ingredient to issue n

asset-backed securities. With investo

unwilling to jump into the market

these securities, consumer credit dries u

Net Interest Margin or all U.S. Banks (USNIM)

Total Loans and Leases at Commercial Banks (LOANS)

Source: Federal Financial Institutions Examination Council

Source: Board o Governors o the Federal Reserve System


19/25

APRIL 2009


Without either a unctioning

securitization market or a commercial

banking system that can sufciently

expand to make up or the loss o the ABSmarket, business will continue to de-lever

and GDP will continue to all until it

meets up with the debt that is already

available. Te government developed

the erm Asset-Backed Securities Loan

Facility (ALF) program to ll the gap

rom the ABS meltdown and committed

a trillion dollars to get the securitization

market back on its eet. As o this date,

the central bank unsuccessully oered

the rst $200 billion o AAA-rated paperor issuance to the public under the

program. It received only $4.7 billion

o subscriptions or the issuance: $1.9

billion in auto securities and $2.8 billion

in credit card securities and no interest

in the pools o Student Loans and Small

Business Loans.19 Te second issuance

in early April received even less interest.

How bad will it get, and how long until we

reach the bottom?

Tis is a difcult thing to predict because

many decisions that are required to nda bottom havent yet been made. In

addition to the surprises that we seem to

keep encountering, we also have to trust

our government to make good calls on

additional programs, bailouts, regulation,

taxation, scal and monetary policy.

Tus ar, the track record has been best

described as a political dance between no

mea culpa and hurling the proverbial

kitchen sink (a gold-plated one, we might

add) at the problem.

Te unknown includes debate about the

question o too big to ail and the

value o just selling some o the large

institutions in pieces. Further, there is

still a possibility we will see secondary

banking bubbles in commercial real estate

and consumer loans that will compound

the credit crisis urther. O even greaconcern is a ailure in the ALF and toxasset purchase proposals that are intend

to be a public-private partnership. investors do not go along with the oerio assets, there could be a tremendosetback in progress made thus ar towarebuilding condence in the econom which could push the timeline back months or even a year.

For the economy to unction at all,sufcient level o debt has to be availabor consumers and businesses. T

reasury and Washington have reactin historic ways to break the credit reeprop up the commercial and investmebanking industries and kick-start the Aand commercial paper markets. Tey ahave ooded the nancial market wliquidity to take money supply out the equation. Federal Reserve ChairmBen Bernanke has made it clear he willing to drop money rom helicoptei needed.20 Te supply o money not the problem. Getting the moninto the markets as well as restoriinvestor and consumer condence the problem.

Despite the cheerleading o governme

ofcials and optimistic, but cave

laden, orecasts rom Chairman Bernan

suggesting the beginning o a recovery t

year, our prediction is 2009 will not inclu

a real recovery, but we will see a bottomi

process that will evolve throughout the ye

Our guess is based on:

Our estimate that the housing ballo will nally all back to earth near end o this year or early next.

Te ALF program will take time deliver the intended results. We exp

Total Banks Loans And Advances(Including Consumer Loans)

Total Securitization(Agency & GSE-BackedMortgage Pools and ABS)

40%

35%

30%

25%

20%

15%

10%

5%

0%

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

PercentofPrivateCreditMarketDebt

PercentofPrivateCreditMarketDebt

Total Private Credit Market Debt

Source: Bianco Research, LLC


20/25


20 APRIL 20

the end o the year as a reasonable, i

not early, time to see the start o realrecovery in the ABS markets.

Price Waterhouse Coopers, LLP in a

March 24 report suggests retail sales

will be little changed this year beorebeginning a rebound in 2010, which is

an important component in a consumer-

driven economy.

According to the administrationestimates, only 15 percent o the

economic stimulus unds will be spent

in scal 2009; so once again, we are

looking at next year or the stimulus tohave meaningul impact.

A Bloomberg survey o economists

conducted in early March 2009

predicted U.S. unemployment will reachnearly 10 percent this year. We suspect

that may be slightly optimistic given

subsequent unemployment gures rom

the Bureau o Labor Statistics, whichshow a still unabated rate in job losses

ater the survey was taken.

Tis year we anticipate a slowing o the

rate in broad asset destruction that has

been present since early 2007 and a real

bottom in Q1 or Q2 o 2010. Markets

in general will still remain volatile in

the ace o continuing bad unemployment

data, higher levels o oreclosures, and poor

corporate earnings news both domestically

and internationally.21

But i the world can be slightly more

predictable in the second hal o 2009,

that will reduce ear, encourage consumers

to spend some o the money that is sitting

on the sidelines in savings and hopeully

support modest growth in ne wine sales

by the time we reach Q4 2009.

So when will things get back to normal?

Jerry Maguire: [mutters] I don't

believe this. How'd I get myself into

this?

I dont think the magnitude o this degree

o change has sunk in or most people

yet. Its like a bad dream, surreal at times.

Once we nd the bottom, it is only the

beginning o crawling out rom under

the economic storm cellar. Te question

we are most oten asked is, When will

things get back to normal? Oten, this is

posed by those who have come to expect

10 percent annual returns in both thestock and residential real estate markets.

In that sense, things will not get back

to any resemblance o normal any time

soon. When the economic winter turns

to spring sometime in 2010, the reeze o

taxpayer mistrust thaws, and the balm o

more and new regulatory scrutiny is built

back into the nancial services industry,

the business environment will emerge

indelibly changed, and the echoes o the

high cost now being paid by the U.S.

government or stimulus, new social

reorms and bailouts will come due.

When we see a non-recession business

landscape again, we will not be in a robust

economy producing the ination-adjusted

returns that we have come to think o as

normal over the past 15-20 years. ail-end

scenarios or this economic cycle include

a return to stagation as a middle case,

muted economic growth or 7- to 10-years

as a best case, or a repeat o Japans Lost

Decade as a worst case. Gone or the

oreseeable uture will be a return to the

1990s genre o conspicuous consumption

that spawned the emergence o new wine

labels every day and Wall Street closing

dinners celebrated with the intoxicatirerain o Waiter? Just bring me your bwine and keep it coming.

Happy days will come again

Rod Tidwell: Jerry? You are hanging

on by a very thin thread... AND I

DIG THAT ABOUT YOU!

Outside o the higher-volume producetimes are tenuous in the wine industas producers deal with the unknown an economy that is working thorouhistoric shocks. Flying a little blind t

year, the industry is orced to make moinstinctive reads than usual. But we wouremind you o the mood taken by tpopulace in the 1930s, when aced wa decade that started with a market craexacerbated with the Dust Bowl aended with World War II.

ake a look at the popular music o thodays. Sure there were songs like, Budcan you spare a Dime that reect

discouragement, but even more commwere songs that talked about what peopaspired to be; songs like Accentuate tPositive, Ive got the World on a Strinand Happy Days Are Here Again.22

People aspire to a better lie. Tey din desperate times during the GreDepression, and they do in less desperatimes today. What evolves is the denitio better. Given consistent growth

per capita consumption, there shoube little doubt that wine is growing popularity with the American consumIn a capitalistic economy that mighave a black eye today, we should remiourselves that at a point, the consumwill look avorably on ne wine as part

a better lie.


21/25

APRIL 2009


oday some o the industry is holding on

by a thin thread while we nd ourselves in

a new world o needs versus wants. Many

consumers have voted with their walletsthat they dont need to spend so much

on wine, but maybe they want to drink

wine all the same. Our hope is that by the

end o this year, the U.S. consumer will

be able to say with condence, Happy

Days Are Here Again, and with that

condence will come the aspiration to a

live a better lie that will include just a

little more spending on wine.

GOVERNMENT WARNING: (1) ACCORDING TO THE SURGEON GENERAL

STRESSING ABOUT THINGS YOU CANT CONTROL WILL LEAD TO DEFECTS IN

LIFESTYLE.(2) COMPLETELY IGNORING THESE DEPRESSING EVENTS THOUGH WILL

LEAD TO THE EARLY TERMINATION OF YOUR CHOSEN PROFESSION.(3) LISTENING

TO THE FAR LEFT OR RIGHT REGARDING ROOT CAUSES OF THE ECONOMIC

MELTDOWN WILL CAUSE INCREASED CONSUMPTION OF ALCOHOLIC BEVERAGES

WHICH IS A GOOD THING IN MODERATION BUT IMPAIRS YOUR ABILITY TO DRIVE A

CAR OR OPERATE MACHINERY, AND MAY CAUSE HEALTH PROBLEMS IF SAID

MACHINERY IS BIGGER THAN YOU. (4) THE GOVERNMENT IS HERE TO HELP AND

HAS THE SITUATION UNDER CONTROL.


22/25


22 APRIL 20

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