Business in China and Risk Pricing

Unfortunately, I have to miss class this week. So, I wanted to do a bit of research on the China topic, since I found it interesting. I reached out to one of the Napa wineries mentioned in the case (not Frederick) and spoke with the person who runs their export business. This winery had chosen the logistics partner option and worked with Gliding Eagle for a couple of years when they first entered China. After some disappointing performance, they moved to Napa Reserve as their logistics partner for a spell. Turns out that the China performance was only partially due to the partners and that a lot of the problem was China itself and trade with the country. The winery end up pulling out of the country entirely about four years ago when China imposed a 14% tariff on U.S. wines. This has since risen to 29%. Even before the latest tariff, U.S. share of China's wine declined in actual (volume) and relative (share) terms significantly -- the winery I spoke to was not alone in its pain. (source)

Bringing it back to the case, I'd point out that the difference between discounted cash flows of the (high or ~100% probability) bulk grape sale cash flows and the potential China cash flows becomes negligible when you use appropriate discount rates. Specifically, there's no difference in NPV when you price China ~15% higher (in discount rate terms) than the bulk option (depending a bit on your probability-weighting for the China scenarios). Such a gap in discount rate is fair, in my opinion, given the different risk profiles, which you see play out in the above winery’s experience.

To round things out, I would be curious to hear how grape prices in Napa have trended. There’s not more land being added to the Napa AVA, as far as I’m aware, and I was surprised to see flat prices in the bulk forecast at ~$5,900 per ton. A friend at a (different) upper/mid-tier Napa operation using very similar grapes to Frederick’s pays closer to $6,500 per by this point, for example. Therefore, I think the default option of bulk sales is understated in its attractiveness. 

The Great French Wine Blight

Grape Phylloxera. What the heck is that? We keep talking about it as if it is a commonly known event/disease/thing that I don't even know enough to classify. I certainly didn't know what it was and I have been faking it the last few weeks, acting like I did. Even worse, I cannot pronounce it! So I decided to do some basic Wikipedia-ing to find out! Here is what I learned:

The "disease" was brought across the Atlantic from the States to Europe in the late 1850s and it was first recorded in France in 1863 in Languedoc. The aphid (insect) that caused the damage, however, was known to the French much earlier and was first discovered by the French themselves in their plantations in Florida in the 16th century. as they tried to plant grape vines there, but failed quickly. The Phylloxera is a pest that injects a venom that is very deadly to the European variety of grape vine. The toxin the bug releases targets the root structure of the vine and quickly corrodes it, allowing the bug to insert its feeding tube and extract the sap. The insect then moves on as soon as it has had its fill, making it hard for the vintners to discover the cause at first. But how did it finally cross the Atlantic? It is believed that the invention of the steam ship allowed quicker transport of American vines to Europe, which the Europeans had been experimenting with for years. The quicker journey gave the aphids better chances of surviving and led to their arrival in the mid 19th century. After trying many solutions, including positioning toads and fowl near the vines to get them to eat the insects, ultimately Americans and French together discovered that by grafting the European vines to the to the aphid-resistant American rootstock, they could save the European vine stock. The process / event of saving the European vines became known as the "reconstitution" by the European grape growers. In modern day, there is no known cure for the blight, and the only way to prevent it is to use grafted vines. The only exception is a vine that grows in Santorini, however, people believe it has more to do with the volcanic ash in which the vines are planted, and not the roots themselves. While most European vines are now grafted, some still remain ungrafted and untouched by the blight, sparking a debate as to which produces better wines. Bollinger is one such vineyard that uses ungrafted vines. I say, let's test them all and find out!

Canned Wine

After finding myself once again coming to the defense of canned wine this past weekend, I felt compelled to bring myself up to speed on the new phenomenon (as my friends can confirm, lack of knowledge rarely discourages me from picking sides). While still striking many as a novelty (Neilsen estimates canned packaging to only comprise ~0.2% of the US off-prem sales), the canned market has actually been booming over the past couple years (+59.5% YoY in 2017). [1]

I was first introduced to canned wine about 12 months back in my local San Francisco grocery store, and was immediately struck by its convenience: its portion size was perfect for a Saturday afternoon at Fort Mason (admittedly, the back of the can says 2-2.5 servings), and it was easy to carry / dispose of without the added headache of a glass bottle.

While beer and other beverages have been retailed in cans for some time now, canning still wine has required a recent step-forward in material science. In addition to a specially designed resin liner on the inside of the can (you never want the wine to touch the aluminum can), canned beverages need to be manufactured in a sturdy way. While beers and soda have the benefit of carbon dioxide (which creates a high pressure level inside a sealed can), wine requires liquid nitrogen (harmless to the health of the wine and consumers) to re-create equivalent pressure levels inside the can. Recent advances in cost-effective manufacturing techniques for both the resin liner and use of liquid nitrogen have allowed quality canned wine to become reality. [2]

In fact, there may also be quality and environmental benefits as well. As the packaging's (non-aesthetic) goal is to prevent the air and light from contaminating the wine, aluminum cans' UV resistant exterior and air-tight design are actually a cost-effective option for producers (particularly those small scale wineries looking to minimize packaging costs). Additionally, as canned wines reduce total weight on a volumetric basis, this also results in fuel cost savings for wineries (cans are also much easier to stack, which could drive additional transportation / handling cost savings through the logistics chain). [3]

If you're convinced, here's a list of top canned wine options: https://vinepair.com/buy-this-booze/10-best-canned-wines-2018/. In addition, I'm partial to West + Wilder as it's what I started off with (available at K&L in Redwood City).

Sources:
[1] https://www.nielsen.com/us/en/insights/news/2018/heard-it-through-the-grapevine-wine-trends-to-watch-for-in-2018.html
[2] http://palatepress.com/2015/12/wine/the-some-science-behind-canned-wine/
[3] https://www.chowhound.com/food-news/216899/is-canned-wine-the-new-boxed-wine/

Trendy like Orange Wine

Orange wine is having a moment. You're likely to find them on the menu at the hippest restaurants in Brooklyn, Berkeley, or Silverlake. Or maybe your cool, well-dressed, always effortlessly-beautiful friend opened a bottle the last time she had you over. The first orange wine I had was on a warm early-summer evening at a trendy veg-forward restaurant in Chicago, and I wonder if I've grown an affinity to orange wines simply because I loved that restaurant so much.

But what are orange wines?

To state the obvious, they're not made from orange grapes, just like how how rosé isn't made from pink grapes. In fact, orange wines are kind of the opposite of rosé. Where rosé is made from red grapes with minimal skin contact, orange wine is made with white grapes with maximal skin contact. Orange winemakers effectively coax tannins out from white grapes. The longer the skins sit with the wine, the deeper orange color the wine takes on.

Just as in white, red, and rosé varieties, the flavor of orange wines varies drastically from bottle to bottle. But to generalize, orange wines tend to be tart and bold. They're dry with hints of sweetness. Orange wines are bolder versions of their white wine brothers and sisters.

Still, as much as I read about wines, I learn the most from actually drinking them. So if anyone wants to do an orange wine tasting night soon, hit me up.

And that first orange wine I fell in love with? 2015 New York Miscreant.

Wente Vineyards and... Jane Austen?

I was scrolling through old Facebook photos (as one does) and stumbled across a collection from my last trip to Wente Vineyards. As you can see below, there's something a little odd about my group's choice of attire.

As we've seen in several cases, investing in tasting rooms or hospitality can be a good move for wineries looking to improve profitability by driving direct-to-consumer sales. Wente has a gorgeous tasting room and outdoor picnic area, making it a perfect event venue. So it's not surprising that when the Bay Area Costumers' Guild wanted to host a Regency-era picnic and wine tasting, Wente made the shortlist of potential locations (despite not being quite old enough to fit into the Regency period -- but then again, neither is the state of California!). We had a wonderful time chatting, tasting wine, and playing Jane Austen-themed games, and an awful lot of visitors to the winery ended up taking photographs with us. I can also confirm that we were good for Wente's business, as we purchased plenty of wine in addition to our tastings!

Organic, Biodynamic, Sustainable, and Natural

Consumer preferences are shifting towards more natural and sustainable products across the board, especially in food and beverage. I've heard the terms organic, biodynamic, sustainable, and natural thrown around in reference to wine, but didn't quite know the details. After a bit of research, here's an overview:

Organic

• This one is simple. The stipulated conditions for organic wines are the same as those for organic foods. Namely, no chemical or artificial fertilizers or pesticides are used.

Biodynamic

• Like organic vineyards, biodynamic vineyards eschew pesticides and fertilizers. In addition, they take it a step further and engage in a set of farming practices that focus on the vineyard as a full ecosystem. The goal is for the entire farm or vineyard to be self-sustaining and farmed following the ecosystem's natural cycles. Biological diversity is a key component and at least 10% of farm acreage must be set aside as a preserve. Many of these farms keep animals whose manure is used to fertilize the soil. Some biodynamic farmers incorporate lunar cycles and astrological influence into their practices.

Sustainable

• A bit vague and all-encompassing. Both organic and biodynamic farmers are likely to consider themselves sustainable. In addition to the above, sustainable wineries may focus on energy efficiency or water conservation.

Natural

• While the first three groups look at how the grapes were farmed, natural wine refers to how the grapes are processed. Natural wines are low-intervention wines. They tend to be hand picked, juiced without machines, and hand-pressed (rather than mechanically-pressed). These wines lack added acid, sugar, enzymes, or sulfites.

Wine Cellars - The Billionaires and the Rest of Us

Before coming to the GSB I work in a small cybersecurity company in Seattle, WA. One of the founders of the company had previously work on for one of Seattle's billionaires (I won't mention who, but there are only a few so you can take a guess). During our time working together he told me a story about his former employer that I found unbelievable. The story is retold below:

The employer hired a custom wine cellar maker to renovate a massive wine cellar at this person's home. The cellar was gorgeous and my friend remarks to a member of the employer's staff about what an a great job the craftsman had done. The other employee agreed that it was very nice and would serve the upcoming party well.... and then it would be torn down and redone again!

I've never personally been custom wine cellar shopping, but this story did get me think about the amount of money people pay to store their wine. I recently stumble across this article that claims to list 10 of the worlds most amazing wine cellars. Fair warning, they are incredible, and way over the top.

For those of us who aren't installing 2,000+ bottle cellars, I'd like to hear how you all store your special bottles? Do you simply keep them on a shelf or have you invested in one of the small wine coolers/fridges? Something else?