Why Diageo is a Good Deal for Treasury

British drinks company seeks to unload Chalone brand, production space and vineyards

by Paul Franson
Napa, Calif.—To no one’s surprise, Diageo put Chalone Vineyards up for sale shortly after agreeing to sell most of its wine interests to Treasury Wine Estates in a $552 million deal.

Diageo said it was planning to sell the Chalone brand as well as the winery and vineyard, which has operated in Monterey County for nearly a century.

Diageo bought Chalone, plus its associated wineries and brands (Acacia, Carmenet, Edna Valley, Jade Mountain, Provenance, Sagelands and Canoe Ridge), in late 2004 for $260 million. At the time, Domaines Barons de Rothschild (Lafite) owned 45% of Diageo, which was building its wine business in California and Washington via a series of purchases.

Diageo sold some of these brands in the first quarter of 2010 (Moon Mountain in Sonoma, Calif., to a private investor; Echelon to Winery Exchange, and the Sagelands and Canoe Ridge properties in Washington state to Precept Brands).

Under Diageo’s ownership, Chalone sales jumped from 30,000 cases to more than 200,000 cases as it added lines using Monterey County grapes to those from the legendary mountaintop Chalone Vineyards.

That growth was driven by Chalone’s Chardonnay wines, which now represent nearly half of the brand’s volume (the winery also makes Pinot Noir, Sauvignon Blanc, Cabernet Sauvignon and other varietals). Treasury apparently spurned Chalone because it has plenty of Chardonnay brands and production.

Chalone has suffered the past few years, and in 2014 it dropped nearly 15% to 116,000 cases, according to Shanken Daily News.

Why there’s little land involved
Treasury did not buy the Chalone brand or property, nor the Acacia real estate in Carneros, but it did buy the Acacia brand.

The Australian beverage company also bought the Beaulieu Vineyard, Acacia Vineyard, Provenance Vineyards, Rosenblum Cellars and Sterling Vineyards brands, but few hard assets. That’s because Diageo had already divested many of them.

Diageo sold 17 of its prime Napa Valley real estate holdings, including Beaulieu and Sterling wineries (along with 400,000 square feet of wine production, retail and hospitality space connected to the two wineries) and 2,000 acres of vines to Realty Income Corp. in 2010 for $269 million under a long-term, triple-net leaseback agreement.

A 20-year lease gives Diageo the option to extend the lease for up to 80 years. Treasury is assuming the leases, but they remain guaranteed by Diageo.

Though Diageo sold the two iconic wineries, the company continued to manage and operate the properties and retain “ownership of the brands, vines and grapes, which remain a strategic part of Diageo’s wine business,” a news release stated at the time of sale.

Ownership of the vines doesn’t include the land, however.

The sale occurred after a review of business that “resulted in a reduction in the workforce and may also include the sale of non-strategic brands,” according to the statement, which added, “The benefit to free cash flow in the year ending June 30, 2010, is expected to be in the region of $200 million. The transaction will also improve the return on invested capital of the Diageo Chateau & Estate Wines business.”

Acacia Vineyard in Carneros and Provenance Vineyards in Rutherford (both in Napa County, Calif.), as well as Chalone Vineyards in Monterey County, Calif., and the large Blossom Hill production facility and vineyards in San Benito County (also then owned by Diageo) were not affected by the deal in 2010.

Escondido, Calif.-based Realty Income Corp. said at the time it anticipated that Diageo would become its second-largest tenant, generating 5.7% of its total revenue, or $327.6 million.

With growth in RIC’s portfolio during 2014, the Diageo operations dropped to 2.6% of its portfolio.

Why the deal makes so much sense for Treasury
Treasury bought the Diageo brands with hardly any spending on expensive hard assets such as wineries and vineyards. In a recent presentation to investors, Treasury noted that Diageo operates a capital-light supply chain model, with only 1% of U.S. grapes coming from owned vineyards and all U.K. volume sourced from bulk wine suppliers.

Diageo has had access to 4,800 acres of mostly leased vineyards in California (excluding grower contract-related acreage) including some of California’s most prized winegrowing regions in Napa Valley and the Central Coast, but not the Chalone estate vineyard or part of a vineyard co-located with the Acacia winery.

With the addition of Diageo’s grape sources, Treasury will have access to twice the Napa Cabernet and 64% more Sonoma Pinot Noir in the luxury category, as well as 221% more Cabernet from the Central Coast in its “masstige” (mass prestige) category.

All of Diageo’s U.S. wine volume comes from Californian, while 85% of U.K. volume is from California and the rest from Italy, Spain and France for fiscal year 2015, according to an investor presentation.

Summary of Diageo’s owned and leased supply assets
Selected plantings by variety Acres
Rutherford (Napa Valley)  500
Napa Valley (excluding Rutherford) 1,600
Central Coast and other California 2,700

Excludes 3,600 acres operated through grower contracts, the Chalone estate vineyard and part of a vineyard co-located with the Acacia winery.

Wineries and packaging facilities
3 Napa Valley wineries Provenance, Sterling, Beaulieu Vineyard
1 Central Coast winery Paicines for Blossom Hill
1 bottling plant (includes warehousing Sonoma

In other relevant news, Treasury recently sold its large Asti Winery and 275 acres of vineyards to E. & J. Gallo Winery for an undisclosed price.

Diageo is primarily a liquor business, and its wine sales accounted for only about 4% of the company’s total sales. It is also rumored to be considering selling its Guinness beer operations, once a key part of the business, since Diageo was formed by a merger of Guinness and Grand Metropolitan in 1997.

Also of note, Diageo owns 34% of the Moet Hennessy drinks division of French luxury goods company LVMH, which produces famed Champagnes and Domaine Chandon and Newton Vineyards in Napa Valley.

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