Lindemans bought by Penfolds

So it’s a final goodbye to the PLO and Come on Down the POH! For decades the Australian wine industry’s three big names were Penfolds, Lindemans and Orlando, although Lindemans have slipped their market share in recent years relative to other firms. But in early January, Lindemans was swallowed by the biggest fish in the water, Penfolds, ending over a decade of speculation that its erstwhile owner, Phillip Morris, was going to concentrate solely on tobacco.

The announcement however, stunned Lindemans staff all around Australia, who had grown used to years of repeated denial by Phillip Morris that the company was ever for sale.

Tack onto the equation the fact that Orlando has just bought the Wyndham Estate group and Hardys now own Chateau Reynella, Houghtons, Moondah Brook and others – and haven’t things changed? Australia’s major wine companies are now Penfolds, Orlando and Hardys and there’s quite a gulf to the next biggest.

Ian Mackley, Managing Director of Penfolds, puts his company’s new share of the national retail trade around 27-32 with the Lindemans takeover. Informed wine industry estimates put Orlando’s share of the wine market between 18-21 and Hardys around 12-14.

In a rationalisation process that began in 1986 which many believed was primarily designed to make the company a more saleable proposition, Lindemans have streamlined their management, vineyards, number of wines produced and reduced their staff numbers. Each year since the process began has shown a steady improvement in profitability, but 1989 was by far Lindemans’ best year yet in terms of operating income.

Many people are deeply concerned at the polarisation occurring within the wine industry, with the giants at one end and the small or ’boutique’ wineries at the other. But Lindemans’ Managing Director, Peter Barnes, expects the domination of the wine industry by the three large companies of Penfolds, Orlando and Hardys to clarify the existent uncertainty surrounding the future of Australian wine.

“From now on,” says Barnes, “every wine company will need a good reason to be there. The smaller companies must be specialists, with distinctive skills, styles and other marketable advantages such as the qualities and reputation of their wine region. They must be known for something that stands out.”

Barnes believes the middle-sized companies will also need to find their niches. “Wolf Blass has his niche and Seppelts have their sparkling wines and Woodleys”, he continues. “Most companies will not be big enough to take on the broad-range companies like Penfolds and Orlando.” But it’s not price that will make it tough, he argues, but the sheer cost required to mount ventures and to stay in the wine industry, where returns on capital invested are famously low.

Many have suggested that Australia’s medium-sized wine companies, such as Mildara, Wolf Blass and Seppelt, may have to combine to meet the expected challenge and power of the big three. “There is no need for Mildara to look around just because of the merger”, says its Managing Director, Ray King. “But if there is a good reason for us to get together, we should talk. Mildara, and presumably the others, will wait and see if the Penfolds-Lindemans company does in fact improve its market share.”

At present King sees no reason for concern and is eyeing the possibility that Mildara may benefit as a result. “Retailers will either approve or disapprove of the takeover. Some will look for less business with Penfolds, fearing the company has become too powerful; although those already doing a good business with the company may even do better.”

King isn’t too concerned at all and says that people should put the merger activity into perspective. “I’ll take the maverick’s view. It’s not all bad, and may even be a good thing”, he says. “I’ve been in the wine business for twenty years. Every five to six years there’s huge panic, saying that by the end of the decade there’ll only be ten wineries left in the country. I’ve heard it all before. There are five times are many wineries in Australia now as there were in 1970.”

Ray King doubts the “mega-merger” will exert leverage in the market above which the two companies were able to achieve as individuals, in either determining grape prices for growers or in terms of forcing retailers into better deals at the expense of their competition. “Their bark is probably worse than their bite”.

Despite this, there have been objections. John O’Neill, Senior Assistant Commissioner at the Trade Practices Commission is conducting a preliminary examination of the case. Although he is yet to receive objections in accordance with Section 50 of the Trade Practices Act, which forbids an acquisition if it creates or enhances a position of dominance, he has however, received complaints from the United Farmers & Stockowners of S.A. Wine Grape Section and another grape growing association in Victoria, concerning the increased power available to Penfolds in their negotiation of grape prices. The Trade Practices Commission has received no complaints from wine retailers.

Ian Mackley, Managing Director of Penfolds Wines, puts down the South Australian complaint to internal politicking. He remarks that Penfolds grow around a third of the grapes they use, have a third on long-term contracts and buy the remaining third on annual contracts. To date, he says, only a single grower has cancelled a contract.

We are talking big numbers. That’s why wine has been so expensive lately. Last year riverland irrigated chardonnay fetched $1500 per tonne. This year Penfolds have offered $800. But before the company is condemned, this is exactly the price proposed by the grape growers in the large irrigated Riverina area of New South Wales around Griffith. A major grower at Griffith has denied that Penfolds forced the price or are at fault. “The growers can still have their fast cars”, he joked.

Ian Mackley says the merger makes no difference to grape growers, saying they must understand that a grape is only worth what a winemaker can get for it. “Prices have been ridiculously high over the past two vintages and now there is a surplus of wine. In actual fact while the prices were are offering this vintage are not generally as high as they were last year, they are higher than they were in 1988.”

Mackley concedes that while Penfolds are digesting their new company in the short term, their total demand for grapes may fall. However he expects Penfolds to show positive market growth and says the total demand for grapes by Penfolds-Lindemans will be higher than ever before in the near future.

The Lindemans purchase brings to the Penfolds stable a number of valuable assets, including the huge state-of-the-art Karadoc winery at Mildura, the excellent Rouge Homme winery in Coonawarra, the massive and proven high-quality vineyards at Padthaway and Coonawarra south-east South Australia, Clare and in the Hunter Valley, to the highly profitable cellar door operation in the Hunter.

Tack on to this Lindemans’ superior export network in the United Kingdom, United States and Canada, Lindemans’ excellent white wine portfolio and reputation Penfolds are justly regarded as Australia’s leading makers of red wine, Lindemans the best with whites, Lindemans’ superior market penetration in New South Wales and generally in wine casks and the price of between $110M – $140M nobody’s saying exactly what looks a genuine bargain. And let’s not forget Lindemans’ huge goodwill factor and excellent reputation.

Despite this, Mildara’s Ray King questions whether or not the Penfolds-Lindemans merger makes economic sense, while accepting the general view that it will produce a stronger organisation. “Whatever I buy must be earning a required return. Assets are only valuable if I can sell them to someone else. The business cemeteries are full of those who have purchased assets without being able to cover the interest. It will be difficult for Penfolds to get the sort of return that John Spalvins will be after.”

King suggests much will depend on how Penfolds manages their distribution system. “Unless they get rid of all the Lindemans sales team, they will find it hard to justify the purchase”, he says. “I believe they have to increase the profitability of Lindemans by two or three times to make it work, so somewhere they have to save a lot of money.” Ian Mackley broadly agrees with that assumption, but says he will make significant savings by operating out of one premises in each state, sharing common winemaking equipment and with the inevitable personnel casualties.

King estimates there is a potential $8-10M to be saved if the Lindemans sales network is disbanded, but that in itself will put excessive pressure on the Penfolds sales team, whose portfolio of products would increase to a potentially unmanageable number. Could they maintain their sales level? If not, companies like Mildara would clearly benefit.

“We’d never remove all the Lindemans staff”, says Mackley. “We’ll need more legs on the ground and we’re taking a very close look for the best people. After all, they’re the scarcest resource.”

Another possibility would be for Penfolds to reduce the number of Lindemans product lines, or to decrease the number of brands to sell. There is, however an army of very loyal Lindemans consumers. If lines are removed, one can’t assume that purchases would automatically revert to the existing Penfolds brands.

“We’re not getting rid of any of the Lindemans brands”, says Ian Mackley. “Rouge Homme, Leo Buring, Matthew Lang, Lindemans, etc. will all remain, but we’ll examine the range within the brands. Any wine between $5-$7 and selling only 2,000 cases would have to be considered for removal.”

Fortunately Penfolds will keep specialist wines like St George Cabernet Sauvignon sacrosanct and specific to that particular individual vineyard. But a brand like Rouge Homme, already made with fruit taken from several Coonawarra vineyards, allows more flexibility. Remember, Penfolds own Wynns and the old Penfolds’ Coonawarra vineyards, which with the Lindemans vineyards must account for approximately half the area under vine in that most prestigious of Australian wine regions. The potential to gain full value out of a brand such as Rouge Homme is therefore enormous.

To complete the picture, Ian Mackley believes the future for Australian wine future excellent, although many others would like to say that. He expects strong growth in export and expects to arrest the decline in the local market with lower wine prices once grape prices become more rational.

“Export is particularly important for Australia. If Penfolds and others are successful, the smaller companies can ride in on the back of larger firms”, he says.

“The economies of scale given us by the merger should be sufficient to arrest the decline in the cask market, which would also be in the interests of the grape growers. The retail price for a good four-litre cask should be between $6.99 and $7.99. Once we recover to that, the wine industry will be on track again.” Please login to post comment