Getting Financing in a Credit Crisis

Most banks are bullish on the industry and putting their money out to prove it -- though applications are being closely scrutinized.

With a troubled economy and rapidly growing signs of weakness in wine sales, many wineries are finding it more difficult to borrow than a year ago. "Yes, it's harder to get loans today," says Rob McMillan, division relationship manager and founder, Silicon Valley Bank Wine Division.

He explains why: "With the sub-prime issues facing the industry, any institution that was underwriting consumer mortgages is dealing with credit and capital issues. Banks that were new in this business are more than likely retrenching and focusing on their core businesses again. Since many organizations still don't know how bad the problem will be with real estate, they are protecting their balance sheets and capital. It's simply not a profitable activity to raise capital to make loans."

Brian J. Kelly, president and CEO, Charter Oak Bank agrees, stating that the "economy is (as well as perceived to be) weaker--and therefore everything is scrutinized closer." Adam Beak, senior vice president/manager, North Coast Agribusiness Group of the Bank of the West, also agrees, noting that it is "slightly more difficult" to get loans.

Steve Herron, senior vice president of Exchange Bank, says the challenges to obtaining debt capital will increase into 2009. "For newer, younger, wineries in a growth mode or those planning significant capital expansion through debt, I would say yes. Lenders are asking a lot more questions and screening applicants more carefully than over the last three years."

If a winery is struggling, it may be "more difficult than a year ago" to borrow, according to Mike Sullivan, senior vice president, Wells Fargo Bank. Sullivan offered some good news, however. "If a winery is performing well, it should be no more difficult, but pricing is a bit higher." The industry is well banked. And if a winery is well banked and is turned down by one bank, "others will be lining up to take its place."

McMillan concurs. "There are enough committed banks in the business that there is still ample appetite today for wineries that need money for growth and/or acquisitions. Large acquisitions are slightly more impacted than a year ago though with spreads widening to get enough banks willing to participate." McMillon notes that many banks "will be more inclined to support existing clients instead of making loans to new clients."

New Players in the Market

One interesting development for potential borrowers and those seeking capital is new financial players pursuing the wine business, including real estate investment trusts, Wall Street-based private equity firms and buyout funds.

For years, wineries have been financed with farm credit, banks and insurance companies, notes Sullivan. "In the '90s, there was experimentation with public offerings and Wall Street. That clearly wasn't a model that worked. Now we see private equity coming in. There's a lot of interest and some deals already."

The most noted example of a deal was that of Ascentia, where Global  Wine Partners' affiliate VinREITacquired the hard assets to lease back and private equity firm GESDCapital Partners financed buying the brand and inventories. "VinREIT stepped into an ideal situation," says Sullivan. "It was part of the capitalization from day one."

These funds are not completely new, however. "They also came galloping in after the sun starting shining last time," Hinde says. They're not for everyone, he notes. "They're definitely here, but the new financing vehicles are looking at major players, not a 5,000-case winery."

While most lenders agree that the new financial players are looking at the industry, most are waiting to see how it plays out. "It's not a deluge," says Investment banker Perry DeLuca of Key Capital Markets; and Mike Silva, senior vice president, group manager San Francisco for Comerica Bank adds, "It's too early to tell about the new companies like Vinum and Bacchus."

DeLuca, noting the recent Chateau Montelena sale, expects more involvement from Europeans--like Château Cos d'Estournel--and maybe the big sovereign wealth funds forming around the world.

Beak agrees. "With the weak dollar, the Europeans are sniffing around."

One question is the buyer's interest. A buyer like Cos d'Estournel's Michel Reybier is probably in it for the long term, but DeLuca notes that most of the funds have specific lives and will likely eventually resell the property or force refinancing.

The industry may even see additional interest in IPOs. "Though they didn't perform well during their lives, they did well for the shareholders when they were sold," says DeLuca. Michael Mondavi recently said that he wished more employees of Robert Mondavi Winery had bought its stock, for in the end, the shareholders did well.

Lender's View
In spite of unsettling developments in the wine business (see sidebar), malaise in the economy and an uncertain harvest, lenders remain enthusiastic about wine companies--but they are also cautious.

DeLuca, who says he put together the Ascentia deal, says the wine business "looks good. It's still growing. Mid-year it's up about 4 to 5 percent and consistent."

Another fan is Charter Oak Bank's Kelly: "I feel good about the wine industry. It's healthy in spite of the stiff competition and issues with the economy." Kelly points out one big plus for the business: "In general, the wine industry has good management. Most winery owners have been successful elsewhere before starting their own winery." Of course, he also notes that Napa County where he operates is far less volatile than other areas, and that might heighten his enthusiasm.

Silva of Comerica Bank agrees about the state of the business. "We're bullish on the industry. There are a lot of positive fundamentals, including the weak dollar."

Steve Kattner, senior vice president, wine specialty group leader of Umpqua Bank in St. Helena, joined the firm last year to build a wine practice. He says, "This industry lags. We may see a slowdown as consumer spending slows in restaurants and retail." He thinks that the continued stream of information about the meltdown in the economy and problems of bigger banks cause concerns.

One ironic positive is that the industry appears to be dropping into a shortage of wine grapes, says McMillan, which could help firm prices. "2008 looks like a light year at the high end. High-end Cabernet is short; it's even becoming difficult to find high-end Merlot."

However, bank clients are getting concerned about fruit availability, particularly Chardonnay and Pinot Noir, warns Sullivan. This could impact sales and profits.

Restaurant Sales are a Big Concern

In spite of general enthusiasm, however, many lenders voice some concerns, particularly with restaurant sales. Some tasting rooms also may be feeling the pinch; and while some lenders say big wineries are faring well, others offer a less than optimistic outlook for high-end wineries.

Jason Hinde, vice president, senior relationship manager, Mechanics Bank, reports that the wine industry is "moderately healthy, with well-defined areas of weakness. Restaurants aren't ordering what they used to, and distributors are being a little smarter than during the last slowdown: They're watching their depletions and ordering less than a year or even six months ago."

Sullivan says most of their wine clients "seem to be doing well, though we're starting to hear tales about problems in restaurants, starting with casual restaurants."

One part of the slowdown in restaurants is the usual shift from going out to dinner to eating at home, with a consequent downgrading from restaurant wine sales to less expensive wines bought in grocery stores and wine shops. "There is some shift from restaurants to retail," says investment banker DeLuca.

McMillan of Silicon Valley Bank notes anecdotal information where no statistics are yet available: "Tasting rooms and restaurants here in Northern California tell us things are a little off. The same thing is true in most of the rest of the country, though there are pockets in the East benefiting from the weak dollar, which has made them an attractive option for European travelers."

Steve Herron of Exchange Bank says they are hearing of a "clear slowdown in ultra and luxury level wine sales targeted at the on-premises channel. This appears to be driven by problems with restaurants primarily in a faltering consumer economy. Scheduled fall allocations to distributors will be critical to wineries in these segments to determine how much of channel 'back-up' problem could extend into '09."

And while Wells Fargo's Sullivan points out that the big wineries are doing well, McMillan points to an ominous sign for high-end wineries. "We do see buyers trading down for the first time," he says.

Some Positive Signs

McMillan further confirms the mixed environment. "The situation is better in some ways, worse in others compared to the last downturn. The economy is not as bad--tech is holding up, for example--though services and autos are down. But it's much worse for the consumer and that's bad for restaurants and for wineries."

McMillan does note a positive aspect of this downturn: The wine industry doesn't have the inventory problems it did before. "Unless the economic situation deepens, the wine industry will do well," he says.

And he emphasizes, "It's not that wine sales are dropping--it's just that growth has dipped into the low teens and could be getting into the high single digits, and that's off from 20 percent growth."

How wineries are doing depends largely on how they are positioned and where in the market they compete. The low-end is crowded by big players, and there is no place for small wineries to play. "Our clients see the most opportunities in the middle- and high-end of the market," says Silva.

Fortunately for many growers and custom producers, it's been a rebound year for the high-volume producers. "We even see them getting into longer contracts for grapes," says McMillan.

DeLuca says, "The real uptick is in the $6 to $12 range. Some higher-end brands are doing okay. I wouldn't say that consumers are trading down. There's just less growth."

McMillan of Silicon Valley Bank says "things are choppy" for brands above $16 and that "luxury wines over $120 have smooth sailing."

Some wineries have carved niches with their flavors and wine clubs or they've created a good story building their brands. "Higher-end wineries with good brand loyalty are doing well," says Hinde of Mechanics Bank. "People who spend $60 to $70 on a bottle of wine are still buying." He adds that a 30,000-case winery without a clear niche may not be doing well, however.

Direct to consumer sales are another bright spot, according to Sullivan. "There's no concentration in sales that could drag everything down, so there's only a little slowing in direct to consumer."

Silva also likes direct sales. "For a long time, wineries have realized great economics of selling direct, and that's becoming even more true with the consolidation of distributors. There's a lot of talk about the Internet, but most sales are still driven by personal relationships including tasting rooms and wine clubs as well as sales visits and events."

Sullivan points out another potential bright spot. "I'm optimistic that we'll see a little lift out of Bottle Shock. It has a positive feel and creates excitement around wine."

Are New Wineries Starting?

In spite of uncertainty, many people still want to start wine businesses. Some are outsiders enchanted with the wine lifestyle, but others are those already working in the industry as winemakers or in other positions.

"People are definitely starting wineries," says Sullivan.

McMillan agrees, noting he currently has "two deals financing new people in the business."

 Beak, however, says it's slowed a bit. "We don't see quite as many start-ups as 24 or 36 months ago."

One change is that many newcomers are choosing to buy existing small wineries that are up and running rather than starting from scratch, says DeLuca. He laments, however, "They don't need an investment bank. They have money."

Many potential owners are professionals already in the business. "We see no slowdown in the number of winemakers or wine professionals that seek to create their own labels and eventually start their own wine business," says Herron. "The availability of capital, debt or equity, will ultimately determine the short-term growth rate of younger brands, but the motivating factors behind starting these new wineries are projected to continue for a very long time. Evidence of this is found in the strong demand for custom crush services catering to a proliferation of new brands across the North Coast region."

Sullivan notes that those in the industry buy grapes and custom crush. "That's the least risky approach. Build the brand first. That's more typical of local people," he says.

Nevertheless, some prospective entrepreneurs are discouraged by business conditions. "We see younger people from the industry who want to be négociants but many haven't followed up after initial inquiries. Maybe they don't want to buy bulk wine in this environment," says Kattner.

And what do they want to do?

"We see a lot of interest in Pinot," says Sullivan.

Hinde agrees, "We see a lot of new players interested in Sonoma Pinot Noir. It's the hot commodity. You don't need a ton of money to do it like with Napa Cabernet. But too many people may be getting in. It's like Napa Cab the last time."