The Pepsi-fication of Penfold

Introduction

On Friday 22nd of April, the board of Southcorp recommended the acceptance of an offer of $4.26 per share from Fosters. This essentially signs the death knell of Southcorp as we knew it. You can't stop progress, but this is indeed a very black day for those involved in the wine industry and those who appreciate fine, quality wine.

From a financial perspective, history shows that not all consolidations and takeovers work as planned. Two of the last three takeovers have caused a great deal of heartache and angst. The only one of the three that went off without a hitch was the acquisition of BRL Hardy by Constellation. The other two caused a huge amount of financial indigestion for all parties involved, indigestion that they are still trying to get over.

To make matters even more interesting, the two previous players involved in major takeovers that didn't go according to plan were Fosters, with the takeover of Beringer, and the reverse takeover of Southcorp by Rosemount. Now we have a situation where the same two players are about to repeat history and I have no reason to believe this takeover will go anything other than badly. In fact, if Foster's share price was totally dependent on the wine business, I would be willing to bet that over the next two years the price would drop.

When Rosemount and Southcorp got together, it resulted in a $923 million loss in 2003 and in 2005 the company is still trying to “fix the problems” - although they are definitely headed in the right direction now. After the merger, market share for the combined organisation dropped substantially!

Fosters wine CEO Trevor O'Hoy is part way through their indigestion with a plan to restore earnings growth at the Beringer Blass Wine unit after difficult times with their takeover. They also wrote off millions.

Brand Portfolio - Southcorp

Penfold, Rosemount, Lindemans, Wynns, Devil's Lair, Leo Buring, Rouge Homme, Edwards and Chaffey, Tollana, Secret Stone, Ryecroft, Seaview, Little Penguin,  Queen Adelaide, Minchinbury, Matthew Lang and a heap of others.

Brand Portfolio - Beringer Blass

According to the Fosters web site the following brands are owned by them. Wolf Blass, Jamiesons Run, Yellowglen, Saltram, Beringer, Chateau St. Jean, Chateau Souverain, Castello di Gabbiano, Meridian Vineyards', Stag’s Leap, Matua Valley Wines. There is no mention of Metala, St Huberts, Annies Lane, Greg Norman Estate, Black Opal, Yarra Ridge, Rothbury Estate, Ingoldby, Maglieri and a bunch of others.

The list of the brands here is huge and covers everything from sparkling rotgut to world standard premium wine. The brands listed in black are mainly sold in the US, but can you imagine a local rep walking into a small bottle shop with this portfolio of wine? And don't forget, within each brand you have multiple labels. In the Penfold brand there are 21 red labels alone. How many hundreds of wines will the combined company have to deal with?

This huge portfolio of brands will cause nothing but confusion for the new Blass sales force. You can bet your bottom dollar, major brand rationalisation will occur and will occur swiftly. Fosters has a reputation for being run by bean counters and anything that is not profitable or returning an adequate return on investment is given the chop. Many of the boutique brands will go and God knows what will happen to historical entities like Seppeltsfield and their fortified wines.

If you think the cries from wine lovers were bad when Southcorp ditched wines like Tollana (only to bring them back later due to the negative press and feedback by consumers) it will be nothing like the howls of protest when Fosters have gutted people's favourite brands. However, this time I'm willing to bet the howls of protest will fall on deaf ears.

In a previous press article, Trevor O’Hoy has already stated low-end winemaking will be contracted out. The organisation feels it can save money with this move. What this will mean to the quality of low-end wine is anybody's guess, but generally speaking, when you save money making wine it shows in the bottle.

Southcorp was already in the process of closing wineries and consolidating parts and of their operations. The Blass wine division was doing a similar thing. This will not just be a matter of continuing along with the two existing plans. It is the combined operation will be much greater, the magnitude and scope for “streamlining will be much greater.” For example, Foster's has already stated that if the takeover went ahead, they would outsource manufacturing of low-end wines.

One of the greatest assets that any organisation has is always it’s people. The quality of the people will make or break any company. In takeovers like these, it is an unfortunate, sad fact of life that a number of eminently qualified and higpy gifted people wind up being casualties. To make matters worse, in many instances the selection of who stays and who goes is political. Frequently those decisions are made by executives who hold the upper hand in the company that is doing the takeover. The decisions can be based on friendship, politics and for personal reasons rather than assessing who has the best talent to do the job. Old scores are settled, new alliances are made and generally speaking, the people in the company being taken over get the short end of the stick.

While it's not pretty it is a fact of life, but unfortunately many good people lose their jobs; and many political animals with a propensity for a brown nose manage to survive, even though they are not necessarily as good as the people they have replaced.

It is for this reason that frequently, staff will start to churn in 12 to 24 months after the consolidation, as the true worth of the employees who are left start to surface. This can happen at all levels. Look what happened at Southcorp!

Penfold, Lindemans, and Wolf Blass all had one thing in common. They all started life as wine companies. Southcorp wound up being a wine company, but it was not too many years ago that they will also in the water heater business, owning Dux, Australia's largest manufacturer of hot water services. Fosters is certainly not a wine company. Fosters is an Australian-based multinational beverage company. Their web site says:

“Foster's emphasises excellence in manufacturing, technological innovation, the development of superior brands and working collaboratively with our customers and key suppliers to build brand equity. These attributes, combined with Foster's business philosophy of building long-term growth through this clear focus on brand equity, margin management and capital efficiency, are driving Foster's to generate increased shareholder value and maintain its status as a leading global investment choice.”

They have no loyalty to wine; it is just one of a number of beverage divisions. Their objective is to “increased shareholder value” and the way they will achieve this is by the development of “superior brands.” That is the way big business operates, it's a fact of life. How different is that to a boutique winery whose objective is to produce great wine, and it is the successful production of great wine that will make them a profit.

In the former case, the objective is to make money and the vehicle can be almost anything. In the latter case, the objective is to make great wine which will produce a profit. Two very significantly different approaches to the same business.

So who will be the winners and who will be the losers?

In the short term, I can't see many winners, (except possible drinkers of low-end wines and maybe bargain-hunters as inventory is quit post-merger,) however, in the long term the economies of scale will pay dividends to Fosters.

The list of potential losers is lengthy.

* There is likely to be an initial loss of market share

* Loss of employment opportunities and jobs

* Loss of experienced winemaking talent that will wind up on the scrap heap (or may wind up bolstering the competition)

* Deletion of many brands

* Downgrading of quality and product realignments

* Further concentration at the top end which will provide growers with even more grief

* Increased power will make it more difficult for smaller players to get retail shelf space

There will be difficult times ahead for both Fosters wine division and the industry as a whole as a result of this takeover. If history is anything to go by, there will also be many dissatisfied serious wine-lovers who will wind up switching brands.

Well this worry Fosters? Not in the slightest, as long as they can see the dollars rolling in from the masses buying the low-end wines kept cheap by depressed grape prices and bulk manufacture.