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March 30, 2010

Grape Expectations

Dreaming of owning your own winery? Read this first

Welcome to the Golden Age of the American wine business. Consumption is burgeoning, encouraging news continues to pour in about the healthy effects of moderate wine drinking, new vineyards and wineries are springing up from Maine to Malibu, and—according to Motto, Kryla & Fisher (MKF), a Napa Valley wine business consulting firm—95 percent of the quality-minded players are toting up average annual profit gains of 33 percent. In New York's once moribund Finger Lakes district alone, 13 new wineries have opened since the beginning of the 1990s.

The upshot is that more and more Americans are becoming smitten with the idea of owning their own vineyard and winery. And why not? It's a business that admits you to an exclusive, international club. You can imagine morning light dappling autumn vineyard rows, candlelit feasts during which you pour your own wine for the admiring multitude while carrying on an urbane, Cary Grant-like repartee.

Before you fall too hard for the fantasy, however, you should know the reality of the wine business. It doesn't parallel any other industry in terms of cash flow, inventory control, competitive landscape, or regulatory demands. The rewards are apparent, but reaping them requires a formidable amount of specialized expertise, learned or hired, from agronomy and microbiology to marketing and machine repair. Ask anyone who's ever tried it: Making mediocre wine is complicated enough; consistently producing something special takes bear-down dedication and talent. It also takes money—lots of it.

Exactly how much money you need depends on your goal. "Are you going to have a little family-style winery by a brook, or a widely marketed, broadly distributed, corporate brand?" asks Vic Motto of MKF. "It's a big decision: One is essentially a family style of doing business, the other is corporate." According to Motto, the vast majority of American wineries remain small—3,000 to 10,000 cases per year—and most are 100 percent owned by a family or an individual.

It's certainly possible to make great wine without investing a fortune. At least two luxury-priced wines were initially produced in their owners' garages: Quilceda Creek, outside Seattle, and Kathryn Kennedy, in the Silicon Valley town of Saratoga. Both families grew the grapes, no kidding, in their backyards.

But if you have the Bordeaux or Tuscany archetype in mind—a "statement" building surrounded by estate vineyards—count on a substantial capital outlay and detailed preparation. Construction company owner John Petrocelli purchased 70 acres on the North Fork of Long Island and currently plans a winery that, according to his winemaker, Richard Olsen-Harbich, "will be of a quality that hasn't been seen around here." Petrocelli's estimates for the project are from three to three and a half million dollars.

Then there's the Jarvis Winery, which opened in Napa Valley in 1995. "I closed my eyes and stopped counting at twenty million dollars," says William Jarvis, a former telecommunications entrepreneur. Of course, what Jarvis had in mind was a mega-statement: a 45,000-square-foot winery built inside a cavern cut into a mountainside. For now, the winery produces a boutique-size 5,000 cases of wine a year.

"You've got to go at it with a big wallet, open eyes, and a smart financial advisor," says Tor Kenward, a vice president at Napa Valley's Beringer Wine Estates and industry insider. "The roads out here have grave sites up and down them from people who thought they had enough money to reach their dreams." He's speaking metaphorically, of course. But you get the idea.


The First Decision

"Figure out what wine you like to drink, then find the piece of ground that will grow that grape," says Carl Doumani, who owned Napa Valley's Stag's Leap Winery and who is now involved in new winery projects in Napa Valley (Quixote) and Oregon (Benton Lane).

This is not idle advice. Great spots for Chardonnay aren't right for Merlot; perfect locations for Pinot Noir won't ripen a Cabernet Sauvignon, no matter how hard you try. Small variations in soil composition, sun exposure, and rainfall, among other factors, can make the difference between tomorrow's hot-selling super-wine and one that lacks a distinct advantage over the hundreds of other competing labels.

America's "wine country" is getting more diverse every year. There are now bonded wineries operating in 48 states—everywhere but North Dakota and Alaska—something like 1,440 of them all told, plus countless more commercial vineyards without winery facilities. There are 48 wineries in Virginia alone and 20 on New York's Long Island, up from 16 three years ago. New vineyards and wineries are sprouting up like shiitakes along California's Central Coast and across eastern Washington State. You might think you can set up shop anywhere—and in fact going off the beaten track may make perfect economic sense: Don't spend $40,000 an acre for land, and you can cut up to five million dollars off the startup cost of a 100-acre vineyard.

However, you face an uphill battle if your vineyard isn't located in California, Oregon, or Washington State. Reconnoiter a good local wine shop and see how many "other states' " wines are on the shelves. Ask your wine-loving friends how many non-West Coast wines they know of, not to mention purchase. Gruet in New Mexico? Horton in Virginia? Palmer and Hargrave on Long Island? The answer is: not many.

You've also got the opinion-makers against you. Though The Wine Spectator, the most widely read wine publication, has run numerous articles about "other state" wines over the years, here's a sobering tabulation culled from a decade of the magazine's "Top One Hundred Wines of the Year": 411 wines were from California; 44 from Washington; 15 from Oregon; one, back in 1990, from New York; and zero from any other American state.

But there's an even more immediate reason to set up shop where wineries abound: The existing support network. "If there are no other vineyards around, it probably means you don't have ready access to equipment, trained labor, or technical input," warns Phillip Freese, a Sonoma County-based wine-growing consultant and president of WineGrow. "If your vines start to die, there won't be anyone close-by to tell you what's going on. It's really tough to be a pioneer."


Setting Parameters

The quickest—and perhaps most expensive—way to enter the business is to buy an existing winery. "If you don't know anything about the wine business, you're probably going to have more trouble starting a winery than you would buying an existing one," notes MKF's Mike Fisher. "But there's a lot of demand now for premium wineries. They're selling at probably as high a price now as they've ever sold, because the industry's doing well."

But buying an existing winery brings with it a series of potential obstacles. For instance, the winery may be behind the times. Experts now recommend having closely spaced vine rows for some sites, so you may have to dig out the existing vines and replant them. If the wine is strongly associated with a particular winemaker, it's important that he stay on. If the grapes are purchased, it certainly helps if the contract isn't about to expire. You also have to find out if the winery enjoys a good relationship with its key distributors, and whether the wine maturing in inventory comes from strong vintages or not. Then there's the equipment, which might be outdated. Many older vineyards still use upright fermenters; if you want to own state-of-the-art rotary fermenters, you'll end up selling the uprights third-hand. Carl Doumani feels he and his partner are getting off lightly in providing their 13,000-case Oregon winery, Benton Lane, with $800,000 in equipment and a million-dollar building.

"You've got all this capital tied up in your building and fancy equipment," says Beringer's Kenward, "but except for the oak barrels and a place to store them, you're only going to use it once a year." That's a pretty expensive notion from a normal business point of view.

Even agreeing on a winery's sale price is difficult, since there's no industry standard for fixing the value of its goodwill or intangible assets. "Because of the extreme diversity in product mix, pricing, size, and assets, there are a lot of things to take into account," says Fisher. "I've had people tell me, 'Oh, figure it at so many dollars per case capacity or five times sales,' but they really don't know what they're talking about. Basically, intangibles are driven by the strength of the brand and potential profitability"—and by what the market will bear, which right now is considerable.

There are, however, cost-cutting alternatives to owning a vineyard and winery outright. Stevan and Christine Larner, for instance, bought 140 raw acres—80 plantable to vineyards—for $10,000 an acre in the Santa Ynez Valley, in California's Santa Barbara County. To save money, says Stevan, a director of photography whose credits include Badlands, The Buddy Holly Story, and the Emmy Award-winning Winds of War, "we'll be growing our own grapes but using existing nearby facilities for crushing." They also plan to age the wine at another local facility.

With savings (and proceeds from the sale of a "cash cow" one-hour photo-processing business in Rome), the Larners took possession of their land free and clear. They are now in the process of planting the vineyard out. "Everybody and his brother is planting Merlot," Stevan says, "but we're reluctant because we think there's going to be a glut. Wine is always in a kind of a boom-and-bust cycle. We think Syrah will work well for us. From what we've seen in the California Crush Report, which lists the number of tons of grapes crushed in each county, and average prices, we think we can get twelve hundred to fifteen hundred dollars a ton for Syrah here." The Francophile Larners will also plant southern French grapes, like Mourvedre, Cinsault, and Grenache, to make the kind of dry, light-bodied rosés they love to drink in Provence.

Other decisions have followed in a flurry: surveyors, land-use permits, irrigation specialists, and vineyard consultants. Possibly the most important move was the $3,500 paid for a soil analysis, during which an expert came out and dug eight trenches with a backhoe, identifying areas where hardpan would create a drainage problem. The Larners are now taking bids from contractors to construct the trellis system they want: a closely spaced, bilateral cordon that sets the grapes high off the ground, where they will be easy to work with and get plenty of sunlight and breeze to wick away moisture. "It can cost so much to plant, at least twelve to fourteen thousand dollars an acre, that we will do as much as we can by ourselves," Larner says. With that in mind, they will plant only 50 acres at first—about what Stevan figures he and his wife, with some help from their son and daughter, can manage. Nevertheless, he expects to put at least $500,000 into the vineyard before he has picked a single grape.

Keeping things at a scale the family can manage themselves—the Larners expect to make about 3,000 cases of their still unnamed wine—means cutting down on labor and equipment costs. It also makes it theoretically possible to clear maximum profits by selling the wine from a tasting room on the property, directly to restaurants, or by mail order. That way, the Larners will receive full bottle price, instead of the 50 percent of retail value they could expect if they sold through a distributor.

This vineyard-only approach makes great sense, says David Freed, president of UCC Vineyards Group. "My best advice is to leave the bricks and mortar until last. If you can lease what you need and shorten the time cycle, you're going to be better off. You are also going to have a chance to prove your brand and concept without making multimillion-dollar capital investments first."

It's this kind of realization that has led to the growth of ancillary service providers in wine areas with high concentrations of wineries and vineyards. Many wineries or dedicated businesses "custom crush" grapes for other labels or rent out everything from bottling line time to barrel storage space. Associated Vintage Group (AVG), based in Graton, California, has taken the idea a step further. AVG is a vertically integrated facilitator that allows you to create your own Bordeaux-style Cabernet Sauvignon and Merlot blend, grapes and all, for around $60.36 per case (based on 3,000 cases) or a barrel-fermented Chardonnay for $55.98 per case—without sinking even a dime into fixed assets (see Hired Help). AVG includes 400 acres of grapes; five winemaking facilities in Sonoma and Mendocino counties; barrel storage; winemaking expertise; and financing services.

You also could forget winemaking altogether by doing what many vineyardists do: Grow your grapes and sell them off to the highest bidder. You won't have the satisfaction of seeing your name on a bottle (unless your vineyard becomes such a draw that a winery wants to list it on the label), but you also won't have to spend your working hours flogging the wine in the marketplace.

According to Phillip Freese, this option can be profitable. He says that if you owned 10 acres of raw land free and clear, you could plant out a medium-spaced vineyard for about $20,000 an acre over the first three years, until the first harvest. You could then farm it for about $2,800 an acre per year. If you got $2,000 a ton for the grapes—as is the case with desirable varieties of top fruit in many West Coast areas—while producing a reasonable five tons to the acre, you'd start to show a profit in the fourth year. By the sixth year, you'd also have paid back your planting costs.

On the flip side, says Bob Betz, vice president of enology research for the Washington-based Stimson-Lane (Chateau Ste. Michelle) winery group, "there's a lot of conflicting information today about whether it's wise to plant new vineyards. There's the threat of a grape glut in three to four years as a lot of replanted and new vineyards in California, Washington, and Oregon come into production. The current conventional wisdom says that you should hold off right now."

One way to take advantage of such a glut would be to do what up-and-coming DeLille Cellars, a new winery outside Seattle, has done: invest in winemaking facilities, not vineyards. "We basically have a small château," says partner Greg Lill. "We buy grapes from the best vineyards in the eastern part of the state and make all the wine on our own premises." By cutting out vineyard planting expenses, the partners were able to get their brand on the market much more quickly. DeLille's 7,000-square-foot, $700,000 facility includes the working winery, barrel room, banquet room, and a few VIP guestrooms. It is situated on 10 acres of land the Lill family owned in suburban Woodinville—essential since the DeLille partners didn't want to take on bank debt. Greg's father, Charles, is underwriting the project in return for interest payments, while Greg and two other "sweat equity" partners sign over shares to Charles to fully collateralize the loan. "We set out to make the best wine we can," says Greg Lill, "but obviously we have a budget, so that means we can only make so much."

DeLille's total investment since 1992, including building and operating expenses, has been only about $1.2 million. Investing in the winery, which currently produces 3,000 cases, included the purchase of two one-ton-per-hour Zambelli crushers ($1,200 apiece), 15 two-ton-capacity fiberglass vats ($1,300 each), a used Vaslin rotary press ($4,000), a two-inch must pump ($2,000), 130 new French oak barrels per vintage year ($650 apiece), and, of course, the grapes themselves—approximately 60 tons per year ($1,500 to $2,000 per ton). According to Lill, DeLille has done very well for itself so far: The 1995 vintage reds were sold out by their official release date, November 1997.


Long-Range Prospects

So with all the good times for American wine, what kind of prosperity can a winery owner expect? The answer seems to be: somewhere between what you could have gotten on T-Bills and what you'd have gotten on a middling stock—but probably closer to the stock in risk, and the T-Bill in return. MKF's survey of mostly California wineries showed that 95 percent of the premium wine producers (those selling wine at above generic, "jug" wine prices) turned a profit in 1996, with an average gain of 33 percent. But, cautions Mike Fisher, even though the wineries are profitable, the capital-intensive nature of the business means that they still may be getting a relatively low return on assets. "We're not an industry that's matured enough—and we're just too diverse—to come up with general numbers that provide a really meaningful gauge," he says.

Jean-Michel Valette, senior analyst at the San Francisco-based investment bank Hambrecht & Quist, agrees. He estimates that industry-wide return on assets may be something on the order of five to seven percent, with a wide spread from top to bottom. But, says Vallette, "return on asset numbers don't capture very well the notion of appreciation on land or assets. Many people base their wine investment decisions on the assumption that those assets will in fact appreciate. Sometimes those decisions have been wise, sometimes not."

Deloitte & Touche prepares an annual survey of 100 California wineries, called "Winning Strategies in the Wine Industry, Benchmarking for Success," that points up a significant truth. In a 1996 survey participants showed an average return on equity (ROE) of 16.3 percent, with the top quarter of the survey's performers posting 27 percent and the bottom quarter posting 10 percent. Back in 1990, in less heady times for the wine industry, the average return on equity was just eight percent, but, interestingly enough, the top quarter still managed a 32 percent ROE. What happened was that in a down market the bottom dropped out for the marginal players: In 1990 the wineries in the bottom quartile lost 17 percent of their money. The moral according to Mike Rudy, Deloitte & Touche's partner in charge of the wine industry: "The people who have figured out the profit formula for success can make it work even in down times."

Ask winery owners what they feel the business returns to them, and you'll probably get an answer like that of Dennis Groth, owner of Napa Valley's Groth Vineyards and Winery. "It took a long time to get here, but the business is profitable now and providing a very satisfactory return." Then ask him what he really thinks. "I get to live here in Napa Valley," Groth explains, "and I'm having more fun than I've ever had. And you know, I can go into many of the best restaurants in the country and buy my wine. There's a lot of satisfaction in that."


Paying the Premium

According to wine consultants Motto, Kryla & Fisher, California premium wines—popular ($3 to $7 a bottle), super ($7 to $14), ultra ($14 to $24), and luxury ($25 and up)—are undergoing a boom that's not about to end. They estimate that premium wines will average a 16 percent growth rate through 2000, compared to a two percent growth rate for generic wines, which use lower-cost fruit.


The Wine World According to Groth

Here's some financial realism, courtesy of Dennis Groth, a CPA and former chief financial officer of Atari who now owns the well-regarded Groth Vineyards and Winery in Napa Valley. Groth imagined the startup of a winery similar to his own 16-year-old operation, but in a 1998 scenario: a 30,000-case facility, with its own estate vineyards in Napa Valley. Granted the figures are based on the priciest vineyard land in America, and on a far larger winery than most startups, which usually produce 5,000 to 10,000 cases. Still, his calculations are revealing.

"You get about sixty-four cases to the ton," Groth notes, "so a thirty-thousand-case winery needs four hundred and sixty-eight tons of grapes. Let's say that's one hundred acres, and you probably need to buy one hundred and twenty gross acres to get one hundred that are plantable, plus a site for your winery. Let's assume you can buy an existing vineyard, like I did to cut down the startup time. In Napa Valley, that costs between forty and fifty thousand dollars an acre for anything decent, so you're already in about five to six million dollars for your parcel. You'll need to invest another three million dollars on a fifteen-thousand-square-foot facility with a little tasting room and entertainment space. Add another three-quarters of a million dollars for your equipment, plus a bunch of barrels for your first vintage. You're in about ten million bucks—and you haven't even made any wine yet.

"Now you've got to start paying farming costs—that's about three hundred thousand dollars a year on one hundred acres—plus production costs to get the wine made. You don't have anything to sell the first year—or really the second year, either. If you have a white wine, say a Chardonnay, you might be able to get it into the market in the fourth quarter of year two. If you have red wine, you have to barrel-age it, so three years will pass before you can sell it. Assuming some of your wine is red, it's only in the fourth year that you're producing and selling your thirty thousand cases, and that's if you do a great marketing job and get your projected cash flow. Of course, not everything works as you think it's going to."

By Groth's calculations, this hypothetical winery would begin to break even in about four years with strong sales and no loans outstanding, seven years if there's substantial borrowing. In about 15 years, this winery could expect to have its debts paid off and be operating in the black.


Message in a Bottle

Before buying an existing vineyard or winery, consider the following:
• Does the winery have mass-market reach or boutique appeal?
• How strong is the brand's image? Is major image rebuilding going to be needed?
• Does the image depend on a particular vineyard or on a group of vineyards? If so, are those vineyards healthy? If the grapes are purchased, what is the status of the supply contracts?
• Is the brand strongly identified with a particular winemaker? Will he or she be staying on after the change of ownership?
• How is the wine priced? Generic or premium?
• Are sales concentrated in certain local markets or in the hands of a few key distributors? If so, how strong are these relationships?
• What kind of sales and marketing is required—hands-on and personal or semi-corporate?
• Does the winery have up-to-date equipment?
• Is there a tasting room? If so, does it generate substantial traffic and income?
• Does the existing facility allow for growth?


Weighing the Options

Why buy an existing vineyard and winery instead of starting your own? Here's what it comes down to.

BUY AN EXISTING ONE
• Startup time may be cut by five years: three years for vines to bear fruit, plus two more years to mature reds.
• Sales and distribution networks presumably in place.
• Brand already has a following.
• Shorter learning curve.
• Possible savings on raw startup money for equipment and facilities.

START YOUR OWN
• Your name on the label and your concept put into effect from day one.
• Lower base land-purchase price.
• No risk of purchasing obsolete equipment or unwanted vines, then paying to replace them.
• No lingering negative associations from an existing label.


Hired Help

If you're not interested in owning a vineyard or winery of your own, you can still create your own wine label. The trick is to purchase grapes, then to contract for custom grape crushing, bottling, and barrel storage. The Associated Vintage Group (AVG) in Graton, California (707-744-1700), is one such outfit that's put the whole operation under one roof (well, actually under several). Here's a sample AVG winter 1998 price analysis for creating one case of barrel-fermented Chardonnay (minimum 3,000 cases).

Grapes ($1,700 per ton): $26.16
Crushing, pressing, lab work: $4.03
Filtration, stabilization: $0.43
Chemical additions: $0.14
Barrels (mixture of new and used): $5.00
Barrel fermentation: $1.20
Barrel storage: $1.90
Bottling charge: $2.60
Bottles, corks, boxes, labels: $10.00
Miscellaneous (e.g., freight): $1.50
Excise taxes: $3.02

TOTAL COST PER CASE: $55.98


Wine Shop

ASSOCIATIONS
AMERICAN SOCIETY FOR ENOLOGY AND VITICULTURE (ASEV) 530-753-3142
CALIFORNIA ASSOCIATION OF WINE GRAPE GROWERS (CAWGG) 916-924-5370
THE CAWGG COSPONSORS WITH ASEV THE UNIFIED WINE & GRAPE SYMPOSIUM, A TWO-DAY EVENT HELD THE THIRD WEEK OF JANUARY, WHERE WINEMAKERS, WINE GROWERS, RESEARCHERS, AND EQUIPMENT COMPANIES GATHER. TO REGISTER, CONTACT ASEV.

EDUCATION AND REFERENCE INFORMATION
PRACTICAL WINERY AND VINEYARD MAGAZINE (BIMONTHLY PUBLICATION) 415-479-5819
WINE BUSINESS MONTHLY 800-895-9463
WINETECH/GRAPETECH (SEMINARS) 707-462-7196
UNIVERSITY OF CALIFORNIA, DAVIS OUTREACH PROGRAM (JIM LAPSLEY) 530-757-8692

EQUIPMENT SELLERS
ASSOCIATED WINERY SYSTEMS (ALL WINE PROCESSING EQUIPMENT, FROM FILTERS AND CRUSHERS TO PUMPS) 707-838-2812
THE COMPLETE WINEMAKER (ALL WINE PROCESSING EQUIPMENT, FROM FILTERS AND CRUSHERS TO PUMPS) 707-963-9681
KLR MACHINES (EQUIPMENT FOR DESTEMMING AND PRESSING GRAPES AND PUMPING MUST) 707-823-2883
SCOTT LABS (ALL PROCESSING EQUIPMENT AND SUPPLIES) 707-765-6666; WWW.SCOTTLAB.COM
TONNELLERIE FRANÇAIS (FRENCH AND AMERICAN BARRELS) 707-942-9301
WINE COUNTRY CLASSIFIEDS (ADS FOR USED EQUIPMENT, BULK WINE, CELLAR SERVICES, ETC.) 800-995-9463

FINANCIAL ADVISORS
DELOITTE & TOUCHE (ACCOUNTANTS, MIKE RUDY) 510-273-2364
GOMBERG & FREDRIKSON (INVESTMENT ADVISORS) 415-957-5071
HAMBRECHT & QUIST (INVESTMENT ADVISORS) 415-439-3000
MOTTO, KRYLA & FISHER (WINE BUSINESS ADVISORS) 707-963-9222
PACIFIC FARM CREDIT (SPECIALIZED AGRICULTURE LENDER) 707-963-9437
UCC VINEYARDS GROUP (VENTURE CAPITAL, SEMINARS, PUBLICATIONS) 800-927-6272

VINEYARD CONSULTANTS
ORGANIC AG ADVISORS (BOB CANTISANO) 530-268-6563
WINEGROW (PHIL FREESE) 707-433-8945

Richard Nalley is a contributing editor at Departures.