Case Study Calaveras

Calaveras Vineyards Company Valuation

Gavrilenco Nicolae Sabic Ada Saric Amela

1. Company Overview Calaveras Vineyard was originally established in 1883 as a family-owned business, since when it expanded to production of table wines to retailers and restaurants. Moreover, their products are categorized into 3 main quality categories in which 5 product categories can be found: Estate wines High-quality products

Super-premium category

Selected vineyard wines

Medium-quality products

California wines Selected-vineyard-programs Generic wines

Lower-quality products

Special-accounts

Special-programs

Figure1 Product Categorization Throughout the years, the company had changes in the ownership structure, but also improvements in the brand quality and market position through major capital improvements and upgrading of machinery, which lead to an increase in the average wholesale price. The main strategy from 1987 was broadening the company’s position on premium brand category, which was successful. The new strategy consists of recruiting the West-Coast marketer Winston Fendall, who will provide them a strong mechanism to secure cash flow position due to the paying arrangement between those two companies. We based our further analysis of the company on set of assumptions including the historical and forecasted data in which an optimistic sales trend is included. Moreover, sales are forecasted to grow on average 9% over next five years due to the assumption of increase in demand for wine products, increase in real prices and increase in production per ton of grapes and yield per acre. (Figure 1 and Figure 2) The preferences of the US population are expected to shift towards a more consumption of wine, meaning that it is expected that the market will grow at a higher rate than the increase in prices within the market. Based on these assumptions the forecast shows us that some of the product groups will generate sales in a significantly increasing amount whereas other of the product groups will have a smaller share of the sale.

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1.1 S.W.O.T Analysis STRENGHTS: Company with long tradition Strong brand position Variety of products category Differentiated and strong distribution channel Skilled and experienced management and owners

WEAKNESSES: Limitation of sales volume Unstable COGS The cost per unit of product is unstable and the revenues (profit) are harder to predict Supplier relationships The long average processing time of final production

OPPORTUNITIES: Strategy towards increase in prices and utilization of low-quality products Strong position in the higher quality products category Increase of sales in supermarkets with volume remained unchanged New marketing strategy Strong mechanism to secure cash flow position by the marketing company Improvements of quality and capital Nation-wide demand increase for wines Expansion towards international sales

THREATS: Strong competition in the higher quality products category Cash flow limitation for covering expenses Supplies of grapes depends on many factors, therefore unpredictable Limitations in capacity

2. Calaveras Vineyard Valuation The quantitative analysis of market value estimation of the company we started by using the DCF model, and in order to obtain the continuous value we are using the value driver model. Furthermore, we estimated WACC for a long-term horizon and included the risk free rate corresponding to the interest rate of 30 years T-bond. (Table 1) Therefore, we also incorporated the geometric mean for market risk premium in order to exclude autocorrelation in returns. But, the main concerns in this estimation are regarding the comparison of Calaveras with the competitors (Canandaigua, Finn&Sawyer, and Frogg's Jump), which brought us to the conclusion that they are not optimal comparable companies since they significantly differ in market strategy and even more important in the amount of sales. Consequently, we divided our products into 3 product lines and computed their shares in our sales, which we then multiplied with the respective Page | 3

beta of the compared companies. (Table 2) We have discounted the FCF by a WACC for each correspondent year because of the capital structure difference of Calaveras for each year. For the longer forecast we computed the industry average capital structure. Due to the fact that smaller companies bear higher risks for potential failures, we have used the particular method for calculating beta, which gave us more reliable results. For that reason, the adjustments have been made in order to smooth the size gap of Calaveras and the competition, which may bias upwards the estimated value. Having in mind that a smaller company has higher risk and also higher levered beta, as a result it leads to higher WACC and also the value of the company is correspondently lower. In order to compute the continuing value of the company we have assumed a perpetuity growth of 3% which already takes into account the inflation rate and, we also assumed a RONIC equal to WACC in order to exclude abnormal returns. Whatsoever, based on the faces that Calaveras faces a strong competition and its own limitations in capacity we excluded the abnormal returns. As a result we estimated the enterprise vale to be at a WACC of 10.4% the value of Calaveras Vineyards was calculated to be $6.6 million. (Table 3) Since the key value drivers in our case are growth, RONIC, and WACC the sensitivity analysis shows us various scenarios of the behavior of the value of the company. The conducted sensitivity analysis explains how the value of the company is affected by an increase in growth of 5p.p, a rise in 1% in RONIC, and 1% in cost of capital. Thus, we may say that having RONIC lower than the actual WACC we observed that together with the increase in growth rate we have a decrease in the value of the company due to the accelerating effect. What is more important is that, Calaveras is more sensitive to increases in the cost of capital than to increases in capital intensity. (Table 4) In line with our expectations, alternative methods for estimating the value of the company gave us much lower results. The lowest value of the company was anticipated with the book value, which can be interpreted as a lower bound for intrinsic value. According to it the value over a 5 year period increases from $1.3 million to $3.9 million. Considering the multiple method it is important to add that the multiple ratios for Calaveras were computed consistently as the computation of beta in the DCF model. Thus, the value of the company is estimated to be $4.3 million for 1994, which can be taken only as the benchmark of the value. The liquidation method shows $ 3.8 million in value of the company in accordance with the expectations of the financial institution. The alternative methods compared to the DCF method, do not reflect all available Page | 4

information. Each of them is based on assumptions and conditions which considerably lower the value of the company.(Table 5) 3. Credit Analysis and Financial Ratios The debt repayment for Calaveras Vineyard show a shortage in liquidity compared to the demonstrated leverage. Therefore, we claim that the company could have difficulties to meet the obligations of the loan, which is also illustrated by the graph showing the forecasted quick and current ratio, which are below the industry average. (Figure 3 and Figure 4) In accordance with that we assume that the risk premium of the credit could be increased, meaning higher interest costs for Calaveras. Upon that, current liability and total liability to net worth are significantly higher than the average industry, with the peak in the year of taking the credit and as the repayment proceeds so is a decreasing stream visible in the years after 1994. (Figure 5 and Figure 6) Alternatively, the efficiency and profitability ratios compared again to the industry average lie between the upper and median quartile, which means sales boost and enough cash to meet its obligations. From the Du-Pont analysis we have drawn a conclusion that the overall profitability is lead by ROIC and spread, while the leverage is expected to decrease. (Figure 7 and Figure 8) This tells about the increasing operational activity of Calaveras and at the same time a decrease in liability. This signals management commitment for stable investments and improvement of the financial health of the company. 3.1 5 C Analysis Capacity: For the capacity of Calaveras to repay the debt, we have taken into account the mechanism to secure cash flow by the contract with Winston-Fendall to collect all receivables and remit to Calaveras. Taking into account the increasing amount of FCF and the return to sales ratio that compared to the industry average is suited in the upper quartile; we believe that Calaveras will have enough cash flow to repay the debt. (Figure 9) Collateral: Considering assets Calaveras has on the balance sheet including the equipment, accounts receivables and inventories, we can say that the company is covered by an adequate amount of assets in order to ensure the collateral for the loan. Looking at the PP&E we conclude that for the term loan is secured by an equally amortized and sufficient amount over the next 5 years. Page | 5

Capital: We incorporated the facts of entrepreneurial intentions of the owners and their commitment to engage in sustainable investment activities as very positive signs. Moreover, the general manager of the company, who at the same time has the required education, skills and experience in the company, intends to buy 85% of total equity, and the remaining 15% are intended to be purchased by the vice president of the company. This tells us that the compatibility of the management with the ownership structure is a positive signal of confidence of the management into the business. Therefore, the motivation for active engagement in value generation of the company is present, meaning that we expect that they will remain or increase the volume base of the business.

Conditions: Calaveras Vineyards operates under favorable conditions regarding the nationwide increase in demand assumptions and the long tradition of the company in the activities of producing wines. The tradition for over 100 years tells a lot about the brand that survived under different circumstances and succeeded to stay in business for such a long time. Additionally, it has strong relationships with its suppliers that ensure them stable sales over a longer horizon. The diversity of supplier relationship enables them to concentrate on both lower and higher quality wines. Gigantic Airlines stated a demand of minimum of 16500 cases for the next periods including the hotel chains to increase the demand considerably. And in general considering that Calaveras Vineyards are located in California, the strategic location for tourism, we can say that it is a plus in terms of creating new customer relationships with the hotel chains.

Character: This is one of the strengths of Calaveras vineyard, since the management team has the relevant experience not only in the industry but also in the company; it understands very well the market and has a strong will for expansion towards a more strengthening market position because of their aim for ownership.

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4. Conclusions and Recommendations Since we base our analysis on assumptions of optimistic trends, meaning that we have included significant increase in sales, after a drop in the year 1993. Moreover, the sales forecast is based on increase in demand and a successful marketing strategy that will lead to increase in case sales and prices due to the orientation towards high quality wines. Therefore, we expect that these assumptions will not deviate extensively and according to it we can conclude that Calaveras will be able to repay the debt. In case of any larger deviations towards decrease of case sales followed by increased competition in the market or unsuccessful marketing strategy in terms of highquality wines, it might happen that the goals of achieving required levels of sale would not be met. This would have a negative impact on the ability to repay the debt. As Calaveras Vineyards are limited by the supply chain, it should focus on the improvements of production and increased contractual securities in order to guarantee supplies. Moreover, the increase in the wine market is a great opportunity for Calaveras to strengthen their market position especially in the wholesale market, where the company has secure brand position and stable relationships with the distributors. This brings us to the conclusion that Calaveras has big opportunities to expand its market share. Another advantage Calaveras is its ability to be present in both the markets of premium wines as well as in the private-label wines for hotels, resorts, and airlines, and in servicing the higher-volume wine. The last but not least advantage of the company is the special agreement with Winston-Fendall, which is believed to relieve Calaveras of credit risk. Hence, based on all this we can say that Calaveras is a company worth investing in and according to the conditions proposed by Goldengate the company is able to repay the debt. However, Goldengate may consider increasing the interest rate up to 12 %, and at the same time increasing the frequency of paying the interests up to 4 times a year. This alternative is supported Page | 7

by the Debt-Service-Coverage-Ratio, where 1.2 is the lowest admissible level. (Figure 10) Anyway, increasing the interest rate represents the worst-scenario case that will hedge Goldengate against deviations from above stated assumptions. Nevertheless, our final remark on the proposal is that Goldengate should participate in the offered deal accepting the given conditions.

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5. Appendix Projected revenue from wine types per sales channel / annum 2,000,000 1,500,000 1,000,000

1994

500,000

1998 1996 1994

1996 1997 1998

Winery

Special Accounts

Generic

California

Select Vineyards

Estates

-

1995

Figure 1 Sales by type of products

Sales $6,000 $5,000 $4,000 $3,000

Sales Volumes

$2,000 $1,000 $1994

1995

1996

1997

1998

Figure 2 Sales (thousands $)

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Weighted Average Cost of Capital

risk-free rate market risk premium beta

5.85% 7.40% 1.17

Tax Rate cost of equity cost of debt

37% 14.50% 9.50%

Debt/Total Asset

WACC

1994

1995

1996

1997

1998

71.9% 8.4%

64.6% 9.0%

55.0% 9.8%

44.4% 10.7%

31.0% 11.9%

Industry

Table 1

Product line / Comparable Premium/Finn & Sawyer Generic/Canandaigua Specialty/Frogg's Jump Weighted average unlevered beta

Calaveras % 74% 9% 17%

100%

Comparable's Unlevered beta 1.312 0.54 0.867 1.17

Table 2

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48%

10.4%

Free Cash Flow

1994 $

EBIT

1995

929.66

$

1,084.51

37%

Tax rate

1996 $

37%

1,223.62

1997 $

1,300.59

37%

1998 $

1,420.36

37%

37%

Depreciation

$

116.00

$

283.00

$

499.00

$

766.00

Amortization of org. costs

$

60.00

$

60.00

$

60.00

$

60.00

CAPEX

$

366.00

$

533.00

$

749.00

$

1,016.00

$

1,332.00

Change in Net Working Capital

$

149.02

$

301.98

$

200.73

$

215.45

$

152.19

Free cash flow

$

246.66

$

191.26

$

380.16

$

413.92

$

492.64

$

281.34

Present Value of FCF

$

Total PV of FCF

$ 1,232.47

Base for CV RONIC g Continuing Value Present Value of CV

$ 921.67 10.4% 3% $ 8,830.58 $ 5,375.39

227.60

$

160.98

Base for CV

$

287.07

$

$

WACC

275.48

$

1,082.00 $

-

507.42 10.4%

g

3%

Continuing Value

$

6,822.63

Present Value of CV

$

4,153.10

Enterprise Value of $ Calaveras 6,607.86 $ 5,385.58 (we show two methods of computing the Continuing value, but throughout this analysis we used the value driver model )

Table 3

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Sensitivity Analysis (Table 4) $ 6,607.86 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0%

2.0%

2.5%

$ 5,982.18 $ 6,219.66 $ 6,404.37 $ 6,552.14 $ 6,673.04 $ 6,773.79 $ 6,859.05 $ 6,932.12 $ 6,995.45

$ 5,776.49 $ 6,092.04 $ 6,337.48 $ 6,533.82 $ 6,694.47 $ 6,828.34 $ 6,941.62 $ 7,038.71 $ 7,122.86

3.0% $ 5,543.14 $ 5,947.27 $ 6,261.59 $ 6,513.04 $ 6,718.78 $ 6,890.23 $ 7,035.30 $ 7,159.64 $ 7,267.41

Growth

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

$ 5,276.16 $ 5,781.62 $ 6,174.76 $ 6,489.27 $ 6,746.59 $ 6,961.03 $ 7,142.48 $ 7,298.00 $ 7,432.79

$ 4,967.70 $ 5,590.24 $ 6,074.44 $ 6,461.80 $ 6,778.73 $ 7,042.83 $ 7,266.31 $ 7,457.86 $ 7,623.87

$ 4,607.30 $ 5,366.63 $ 5,957.22 $ 6,429.70 $ 6,816.27 $ 7,138.41 $ 7,411.00 $ 7,644.64 $ 7,847.13

$ 4,180.60 $ 5,101.89 $ 5,818.45 $ 6,391.70 $ 6,860.72 $ 7,251.57 $ 7,582.29 $ 7,865.77 $ 8,111.44

$ 3,667.49 $ 4,783.54 $ 5,651.57 $ 6,346.00 $ 6,914.17 $ 7,387.65 $ 7,788.28 $ 8,131.68 $ 8,429.30

$ 3,038.74 $ 4,393.43 $ 5,447.09 $ 6,290.01 $ 6,979.67 $ 7,554.40 $ 8,040.70 $ 8,457.53 $ 8,818.78

RONIC $ 6,607.86 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%

7% $ 11,856.86 $ 12,337.78 $ 12,938.94 $ 13,711.85 $ 14,742.40 $ 16,185.17 $ 18,349.32 $ 21,956.24 $ 29,170.09

8% $ 9,683.76 $ 9,905.70 $ 10,172.03 $ 10,497.54 $ 10,904.43 $ 11,427.57 $ 12,125.10 $ 13,101.64 $ 14,566.44

9% $ 8,150.18 $ 8,240.83 $ 8,346.59 $ 8,471.57 $ 8,621.56 $ 8,804.87 $ 9,034.01 $ 9,328.62 $ 9,721.43

10% $ 7,015.29 $ 7,035.27 $ 7,058.11 $ 7,084.45 $ 7,115.20 $ 7,151.53 $ 7,195.12 $ 7,248.41 $ 7,315.01

11% $ 6,145.34 $ 6,126.07 $ 6,104.39 $ 6,079.81 $ 6,051.73 $ 6,019.32 $ 5,981.52 $ 5,936.84 $ 5,883.23

12% $ 5,460.16 $ 5,418.95 $ 5,373.15 $ 5,321.98 $ 5,264.40 $ 5,199.15 $ 5,124.58 $ 5,038.53 $ 4,938.14

13% $ 4,908.75 $ 4,855.57 $ 4,797.08 $ 4,732.44 $ 4,660.61 $ 4,580.33 $ 4,490.02 $ 4,387.66 $ 4,270.68

14% $ 4,457.16 $ 4,397.95 $ 4,333.37 $ 4,262.64 $ 4,184.83 $ 4,098.83 $ 4,003.28 $ 3,896.48 $ 3,776.34

15% $ 4,081.92 $ 4,020.28 $ 3,953.51 $ 3,880.93 $ 3,801.75 $ 3,715.03 $ 3,619.64 $ 3,514.21 $ 3,397.07

WACC

Growth $ 6,607.86 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0%

7%

8%

9%

10%

11%

12%

13%

14%

15%

$ 10,620.20 $ 11,500.30 $ 12,184.82 $ 12,732.44 $ 13,180.49 $ 13,553.86 $ 13,869.80 $ 14,140.60 $ 14,375.29

$ 8,401.34 $ 9,073.42 $ 9,596.15 $ 10,014.34 $ 10,356.49 $ 10,641.61 $ 10,882.87 $ 11,089.67 $ 11,268.89

$ 6,937.47 $ 7,472.32 $ 7,888.30 $ 8,221.10 $ 8,493.38 $ 8,720.28 $ 8,912.28 $ 9,076.85 $ 9,219.47

$ 5,904.20 $ 6,342.18 $ 6,682.83 $ 6,955.34 $ 7,178.31 $ 7,364.12 $ 7,521.34 $ 7,656.10 $ 7,772.90

$ 5,139.39 $ 5,505.66 $ 5,790.54 $ 6,018.45 $ 6,204.91 $ 6,360.30 $ 6,491.79 $ 6,604.49 $ 6,702.16

$ 4,553.00 $ 4,864.30 $ 5,106.42 $ 5,300.11 $ 5,458.59 $ 5,590.66 $ 5,702.41 $ 5,798.19 $ 5,881.21

$ 4,091.03 $ 4,359.02 $ 4,567.46 $ 4,734.21 $ 4,870.64 $ 4,984.33 $ 5,080.53 $ 5,162.99 $ 5,234.45

$ 3,719.17 $ 3,952.29 $ 4,133.62 $ 4,278.67 $ 4,397.36 $ 4,496.26 $ 4,579.94 $ 4,651.68 $ 4,713.84

$ 3,414.54 $ 3,619.11 $ 3,778.22 $ 3,905.51 $ 4,009.65 $ 4,096.44 $ 4,169.88 $ 4,232.82 $ 4,287.37

WACC

RONIC

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Calaveras Vineyards Company Value (thousands of dollars)

Discounted Cash Flow Method Total PV of FCF Present Value of CV Total Value of Calaveras

$ 1,232.47

$ $

5,375.39 6,607.86

$ $

4,153.10 5,385.58

$

Equity 1,392.85

Net Income $ 392.85

$

3,500.79

$

5,272.86

$

4,386.83

Multiples Method

Book Value Market Value Market to Book ratio Price/Earnings Ratio

2.51 13.422

Average Value

Liquidation Method

Recivables Inventories PPE Acres

85% 75% 40% 175

Book value $ 316,782.00 $ 2,332,241.00 $ 3,420,107.00 $ 7.50

Market Value $ 269,264.70 $ 1,749,180.75 $ 1,368,042.80 $ 1,312.50 $ 3,387,800.75

Book Value of the Company $ 1,393

1994

1995 $ 1,882

1996 $

2,477

1997 $

3,148

1998 $

3,934

Table 5

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Comparative Quick Ratio 1.40 1.20 1.00

QR Calaveras

0.80

Median

0.60

Lower Quartile

0.40

Upper Quartile

0.20 0.00 1994

1995

1996

1997

1998

Figure 3

Comparative Current Ratio 6 5 4

Upper Quartile

3

Median

2

Lower Quartile

1

CR Calaveras

0 1994

1995

1996

1997

1998

Figure 4

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Current Liabilities to Net Worth 180% 160% 140% 120%

Upper Quartile

100%

Median

80%

Lower Quartile

60%

Calaveras

40% 20% 0% 1994

1995

1996

1997

1998

Figure 5

Total Liabilities to Net Worth 300% 250% 200%

Upper Quartile

150%

Median Lower Quartile

100%

Calaveras

50% 0% 1994

1995

1996

1997

1998

Figure 6

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ROE 35% 30% 25% 20%

ROE

15%

Upper Quartile

10% 5% 0% 1994

1995

1996

1997

1998

Figure 7

ROIC 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

ROIC

1994

1995

1996

1997

1998

Figure 8

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Present Value of FCF $350.00 $300.00 $250.00 $200.00 $150.00

Present Value of FCF

$100.00 $50.00 $1994

1995

1996

1997

1998

Figure 9

DSCR

1.29

1994

1.46

1995

1.59

1.63

1996

1997

1.71

1998

DSCR Figure 10

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