Summary:

Crimson Wine Group was spun off from Leucadia National 18 months ago.  Joe Steinberg and Ian Cumming, who should be well known to VIC readers from Leucadia but, for those unfamiliar, have a fantastic record of value creation, own almost 20% of Crimson and do not appear to have sold or gifted any of their stock since the spinoff. It is undoubtedly cheap on underlying asset value, though its cash flow and earnings potential remain to be seen.  In a market with few values, I am happy to accumulate Crimson patiently and wait, as it seems highly likely that the company either will start to realize its earnings potential over the next 3-5 years or be sold.

History:

Leucadia entered the wine business in 1991, buying Pine Ridge Winery in the Napa Valley from the FDIC.  Pine Ridge was founded by Gary Andrus in 1978.  Andrus, who passed away in 2009, made well regarded wines from the start. [1]  In 1993, under Leucadia ownership, Andrus started a second winery in Oregon:  Archery Summit, focusing on Pinot Noir.  A few years later after much critical acclaim, Archery Summit was the first Oregon winery to retain a Pinot for $100.  

By sheer coincidence, I have been a Leucadia shareholder since the entry into the wine business $18.and have most of its Annual Reports since.  Leucadia followers know that the letter in the Annual and the Shareholders‘ Meeting were the only two means by which Steinberg and Cumming communicated with investors.  The first mention I could find of its wine business was in the 1996 Annual, where it noted that Pine Ridge produced 75,000 cases and theoretically could go to 100,000 and Archery Summit at full production would do 15,000 cases.  A small operating profit should grow with increased production.  

Here are highlights of the wine business from subsequent annuals:

1998:  Sold 62,000 cases between the two wineries with a target of 115,000 estate bottled wine.

1999:  Total investment of $52MM.  Sales $12.5MM.  75,900 cases.  Expressed a belief that land purchases were at attractive levels.

2000:  A 7% pre-tax ROI.  The business was put up for sale (trade press reports indicate that the asking price was $150MM).  The letter states that the offers were inadequate but considerably in excess of Leucadia’s investment. Archery Summit investment stated at $17MM (or about 1/3 of the total).  Sales $14.4MM.  79.300 cases.

 2001:  Sales declined after 9/11 to $12,8MM and 68,900 cases.  (Note that Q4 is the critical period in the wine business.)  Andrus sold his 10% interest in the wineries to Leucadia.

2002:  Investment now $61MM.  “At this time we do not see necessity for further investment . . . generating sufficient cash internally.”  $15.7MM sales.  77,700 cases.

2003:  More discussion of the downturn; too much Merlot to sell.  (Note:  Pine Ridge made Merlot for several more years but no longer does.)

2004:  $13.2MM sales; 63,600 cases.  93% of revenues from wines retailing over $25/bottle. “The wine industry is becoming ever more competitive.”  At the same time, a good world-wide demand profile and success in building wine clubs and sales at wineries (both direct-to-consumer, with much higher margins).

2005:  $71MM investment.  $17.8MM sales; 81,200 cases.  The luxury segment described as “intensely competitive.”  More commentary paraphrased:  Several years ago we started a big effort to improve quality and get better scores.  “Planting grapes and farming using the best techniques not only produces good wine, but also produces an asset the value of which has outstripped inflation and provides a good real estate investment, especially in the Napa Valley.”  Decided to expand our presence in wine in Washington State.

2006:  $19.5MM sales; 81,000 cases.  Bought 611 acres in eastern Washington with ample water rights and planting a 90 acre test vineyard. “The value of our vineyards and wineries continue to go up.”  

2007:  $18.5MM revenues; 68,000 cases.  Washington State investment $5.9MM.  New CEO and CFO, who are still in charge.

2008:  Chamisal, founded in 1973 as the first winery in the Edna Valley (near San Luis Obispo), acquired with 82 acres in production.  Total investment now $91MM, suggesting that Leucadia paid about $20MM for Chamisal.  Washington State project put on hold.  $20.9MM sales; 90,000 cases.  Clear message that the consumer has already traded down.  Wine clubs/direct sales now 49% of revenues with much better margins.

2009:  $19.8MM sales.  92,000 cases.  Industry sales up but more than all of it at the low end.  Wines retailing over $25 “slowed dramatically”.  “Unprecedented marketing and discounting.”  “Even in good times, it is difficult to make estate wineries profitable.”  Volume key driver and need more.  “Having started one estate winery from scratch, we have seen that planting quality vineyards increases land value and may provide an inflation hedge.  Durable annual cash flows may be difficult to achieve, thus the ultimate judgment on our investment will have to wait until it is eventually sold.”

2010:  $22.7MM; 111,000 cases.   The Forefront label, a less expensive Pine Ridge offering with sourced grapes, was over 20,000 cases.  Luxury market improved somewhat but growth still concentrated in the under $20 segment.  “Heavy marketing costs (largely payments to distributors) and deep discounting delayed meaningful profits for another year.”  Oversupply and intense competition--sheer number of brands combined with owners having to sell out last year’s vintage near cost casts a constant anchor on price.  

2011:  Bought Seghesio, a Sonoma County Zinfandel specialist, for $86MM, about 4.3X revenues.  With annual sales over 100,000 cases increases volumes by nearly 70%.  Adds scale and market power to improve margins and bring cash to the bottom line.  Pine Ridge non-estate wines (Forefront and a Chenin Blanc/Viognier thriving).  A freeze in Washington State--need to start over; should have 75% of a full crop in 2012.  

The Spinoff:

Scrooge wrote up Leucadia on VIC in February, 2013.  In the message thread, there is a healthy discussion on why Crimson was spun off from new Leucadia.  I think it is pretty simple:  Jefferies’ management thought and said it wasn’t worth more than book value.  Steinberg and Cumming disagreed and probably believed that, with 5 wineries in various stages of development, Crimson had the requisite scale to succeed (and, if it didn’t, it could be sold for a minimum of book value, so they would not be worse off in a bad outcome.

Current Business:

Here is a snapshot of the business over the last 3 years.  The 2013 Annual, though, breaks out financials for Seghesio in 2012--its first full year as part of Crimson.  If Seghesio is a model for what the other parts of Crimson can become--and I think it is--the business will look much more interesting:

Backing Seghesio out of Crimson as a whole, one can see that the balance of Crimson ran at little better than break-even levels.  I think this shows that Crimson--true to the Leucadia playbook--is focused on long-term business building as opposed to short-term earnings.  In a rare interview when Crimson was still part of Leucadia, CEO Erle Martin stated, “They don’t try to manage on a quarter-to-quarter basis. It’s the best of both worlds: They have great resources and as long as you attain the returns agreed, they’re happy.” 

Not surprisingly given the company’s provenance, management is uncommunicative.  In late 2011, though, Martin was interviewed (not the same one) in a trade publication. [2]  It is worth reading for a sense of his philosophy.  At the end, he outlines goals for Crimson 2016:  about $100MM in revenues and selling 500,000 cases.  If Crimson could achieve Seghesio margins on the overall business, operating income would be over $22MM and EBITDA around $30MM.  One key is raising volume to better spread fixed and semi-fixed costs.  Another is raising DTC sales, now 38% of revenues and half of total gross profit, with gross margins of 63%.  

Balance Sheet:

Crimson has pristine financials with almost $25MM in cash and investments and no debt.  Additionally, it announced the sale of 307 acres of non-strategic land for $4.2MM at the end of March, which will be reflected in the Q2 balance sheet.  Book value, which is undoubtedly very understated, is $8.14/share.  D&A ($7MM run rate) exceeds planned CapX of $5.4MM, mostly for vineyard development and new barrels.  Crimson has over $11MM in Federal NOLs that do not begin expiring until 2022.

So What’s it Worth?

Assume Martin is aggressive and that Crimson hits $100MM in 2018 rather than 2016 but can achieve 20% operating margins.  Remember that Seghesio did a little better than that in its first full year under Crimson ownership.  Another check is Bacchus Capital, a private equity firm focused on high-end wineries.  One of its principals suggested last year that well-run high end wineries should have cash flow margins in the 20-25% range. [3]   At 12-15X forward EBITDA, which is not a crazy multiple in the wine business, that would translate into a stock price of $14-18 in three years. 

While it might sound crazy, it is just possible that Crimson could be auctioned for that today either in piecemeal or en masse. As one example, Pernod Ricard just bought Kenwood--about the same size as Crimson in sales but without the very valuable land holdings (the Napa land of Pine Ridge is probably worth $200-300K/acre, or $34-50MM) and its other wineries all have valuable acreage as well.  

Winery LInks:

http://www.pineridgevineyards.com

http://www.archerysummit.com

https://www.chamisalvineyards.com

http://www.seghesio.com

http://doublecanyon.com

Footnotes:

[1]  http://www.winemag.com/February-2009/Pioneering-Vintner-Gary-Andrus-Passes/

[2] http://www.shankennewsdaily.com/index.php/2011/12/07/2055/californias-crimson-wine-group-doubles-in-size-with-seghesio-acquisition/

[3] http://dealbook.nytimes.com/2013/04/25/boutique-vintners-turn-to-private-equity-for-help/?_php=true&_type=blogs&_php=true&_type=blogs&smid=pl-share/&_r=1