2.

0 Executive Summary
Goldengate Capital was approach by NationsBank’s Managing Director Tom Howell
with an investment possibility. NationsBank would like Goldengate to participate in the
Calaveras’ management proposal to purchase the property for $4.5million. Goldengate
been the third largest financial institution in the United States has participated in two
very profitable deals with NationsBank. Wine sales in supermarkets have grown by
7.4% in 1992, while beer sales have grown only 2.2%, less than inflation. One of the
explanations for this increase in sales could be the operators increased in their
selections of quality wines with higher price points as well as an improvement in the
brand image and market position through a strategy of careful quality control, market
segmentation, and capital improvements on the part of the Calaveras management.

As a smaller producer in the California wine industry, Calaveras Vineyards is somewhat

complicated to compare to other, larger competitors. In analyzing the company, the
estimated value of the company stands to the tune of $2,636million. Its growth rate of
2% is considerably smaller than that of identified competitors. The liquidation value of
the company is estimated at $3,664million almost double that of its estimated value.
Many of the values of the company are greatly influenced by the market to book ratio of
its equity. This estimate is greatly influenced by the market to book ratio of equity of the
competitors.

Although it is true that Calaveras Vineyards is smaller than the majority of the current
competitors that are in the wine business, it appears that they had a lot of positive
growth in spite of constant change in ownership. If a company is still able to main its
growth and brand image during challenging times, it appears that much growth can be
expected when the company finally gets owners that wants to invest and stay.

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The recommendation suggests that Goldengate Capital should invest in Calaveras
Vineyard. This position is informed on several factors such as the Net Present Value of
the firm, the projected sales and the projected growth of the company within the market.
Currently, CV was being held on Stouts Plc books at $7million and the purchase price of
$4.5million would be considered a significant discount. All of these factors and more
pointed toward going ahead with the loan.

2.1 Background
Calaveras vineyards a smaller producer in the California wine industry occupies 80% of
a total 220 acres in Alameda valley, California was founded in 1883 by Esteban
Calaveras whose family continued to own the vineyard until the 1970s. During these
periods, Calaveras has improved on its brand image and its market position which
encouraged the owners to aim at the premium brand segment of the market. As
Calaveras executed its strategy of introducing premium wines with higher average
prices, sales increased from $2.4million in 1990 to $2.8million in 1991 and 1992
respectively. However, sales dropped to $2.5million in 1993 due in part to lack of market
representation.

Looking at the prevalent market conditions that might impact the future performance of
the company such as the market economy, the industry and likely government policy
changes, it seems the operation condition are favourable which brought about 7.4% in
sales growth in supermarkets while beer sales grown only 2.2% less than inflation rate.
Possible explanations could be as a result of research report which linked consumption
of wines to the lowering of the heart attack risk also known as “French Paradox”.

The wine industry has a common practice of segmenting demand Gardner, N. (2010)
for wine into six categories by the price range. The six categories are the low price, the
economy, the popular, the premium, the super premium and the ultra premium. There
were only fragmented competition in the super premium and premium wine segment
which is one of the categories Calaveras Estate wines and selected vineyards wines fall

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in. California wine is world renowned with sales volume increasing every year since
1993 which accounts for two-thirds of all wine sales in the United States.

2.2 Qualitative Analysis

Although it seems Calaveras is smaller than most of its competitors such as Clos du
Val, Cakebread, Acacia among others, it appears that the company have had a
significant positive growth in spite of the constant change in ownership although
Calaveras had a drop off in sales in 1992 this was partly due to lack of marketing
representation during this period but despite this setback, reported growth was achieved
through a careful implementation of quality control strategy, market segmentation and
capital improvements (such as converting from redwood to oak cooperage, upgrading
the winery with a bladder press, and installation of sprinkler system) which brought
about 67% increase in average wholesale price between the period of 1989 and 1993
no wonder Dr. Lynna Martinez was hired in 1987 by Calaveras to develop and
implement a strategy to achieve this objective. However, competition in the super
premium and premium wine segments were highly fragmented. Through the 1970s,
demand for California wines grew and the entry of large corporations in the production
of California wines increased dramatically which enabled most of Calaveras competitors
such as Gallo, Heublein to benefit from this growth by posting double-digit profits in
1991. However, beginning from the 1990s, nationwide demand for alcoholic beverages
stagnated and unit sales of spirits declined but wines sales in supermarket had grown
by 7.4% in part because the operators increased their selections of quality wines with
higher price points.

In recent years, domestic sales of table wines were fuelled by premium California
varietals, although American consumers have increasingly been moving away from the
generic wines popular in the 1970s to the higher quality varietal wines but this could be
attributed to the so-called French Paradox.

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It is also important to emphasize the credentials of Clemens who has the business skills
and credit history required to make the proposal a success due to his previous
involvement in a similar financial deal. Upon acquisition of the vineyard, Winston-
Fendall will take over the company and treat it as its flagship. In addition to handling the
marketing operations, Wiston-Fendall will equally provide collection and will also pay
Calaveras any receivables left unpaid after 90days. In view of this, the management
believed these requirements would relieve Calaveras of any associated credit risk.

Calaveras market strategy to move from the bulk-wine sales into the premium brand
market has been successful thanks to Dr. Martinez as the new market focus is to
implement a cautious price increase and develop special-accounts segments to fully
use wines of lesser quality.

By 1993 Calaveras’ estates wine category represents 26.9% of their revenues and
selected vineyards was 37.4%. The next largest category was special accounts having
16.6% of revenue followed by California at 10.1% and generic at 9%. Looking at the
projected cash sales in exhibits 10 and 11 showed that as Dr. Martinez had predicted
there is going to be a shift in product mix towards the white wine in the future although it
would not make an economic sense to get rid of all of their red wines products but will
be a good idea to keep an eye on the products that continue to do well and consider
changing or even letting go of the products that are not performing well.

Considering this market shift plus increasing in wholesale price of Calaveras Vineyards
over the past years due to a strategy of careful quality control, market segmentation and
capital improvements, it seems they are set to continue to grow. In trying to decide
whether Anne Clemens should agree to be part of the financial proposal, it is important
to consider how profitable the company is and can be in the future.

Looking at Exhibit 11, the forecast of case sales and price, the Chenin Blanc as well as
other category of products eventually die out altogether and lose demand. This is in part

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because Calaveras had decided to focus on their premium and super premium wine so
this category began to decline in importance. The Petit Sirah was forecasted to be
consistent in sales over the years but one thing the company should consider is to use
whatever acres it was dedicating to the California category to the estates category and
have Petit Sirah in the super premium category. Some possible advantage of this is that
it enables the company to concentrate their resources on four or three markets. This
strategic way forward could also free up some acres so that they can devote more
space and have more product available in their higher end market. The company can
only produce 110,000 cases a year but by getting rid of the California category they can
now use the cases that were to go to the California segment. This would amount to
5,000 – 7,728 cases a year for their super premium clientele. Revenue in 1994 would
be increased by 120,110 if the same amount of cases were sold but using the estates
products instead.

The disadvantage of eliminating the California category would be inability to estimate

the number of customers willing to purchase the excess estates wines that could have
been provided. Also when a product is discontinued, line customers can react very
harshly especially if the alternative product line is more expensive than the previous
product.

The other option could be looking at eliminating the generic wine category as well like
the California category that declined steadily every year from 1991 – 1993. The white
table wine has declined by 44% and the red table wine had declined by 50%. If we were
to use the 12,500 cases as estates wines the company could make around $339,758
more a year, depending on which wines was sold. Again the costs of goods for the
generic wines are about 50% cheaper, but the revenues might make this worth
considering. It might also be wise to use this extra capacity for the estates wines.

2.3 Quantitative Analysis

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The financial forecast income statement, balance sheets and assumption provided to
Goldengate capital as indicated in the exhibits suggests a conservative case sales
estimates and the three main factors considered in the estimates were case sales
trends and demand, Calaveras strengthening brand recognition. The first assumption
indicates that the price will increase by 2% before inflation and the production level per
ton of grapes and yield per acre will increase to 1992 levels due to the new market
strategies. Sales are expected to grow 13% in 1995 after which estimates of 12%, 6%
and 8% for 1996, 1997 and 1998 respectively show growth while recognising a shift
towards white wines. The tax rate of 37% and inflation rate of 2% is factored into the
forecast. Therefore the prices per case for each category has 2% price growth as well
as 2% inflation rate, totalling 4% was reflected in arriving at the forecast income
statement. Depreciation was calculation on a 5-year straight line basis while SGA was
constant at 14% of sales. The key drivers of these assumptions might be gross margin
on each of the five main product group, tax rate, inflation rate, real price growth level,
interest rate, inventory to COGS and accounts receivable to sales ratio.

In analysing the financial position of Calaveras vineyard, attention was focused on the
Proforma income statement and the balance sheet using the assumptions as mentioned
by using the weight of products and the comparable companies’ unlevered beta to
calculate the cost of capital, WACC was determined to be 16.01% as the Calaveras
vineyard cost of capital (Table 4 figure refers), the cash flow statement was formulated
for a period of 5 years. The account receivables plus the inventory minus the account
payable was calculated as net operating working assets. An organization cost of R60,
000 was amortized over the 5-year period. Using these values, free cash flows were
determined as shown in the excel spreadsheet. Also using these cash flows and
discounting them at WACC 14.43%, the value of Calaveras vineyard was calculated as
$2,636,468.44

The Orderly liquidation and Distress liquidation were methods used to valuing the
operation to determine the fair market value of Calaveras Vineyard and to mitigate risk

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in a case of forced liquidation Orderly liquidation value assumes that the enterprise can
afford to sell its assets to the highest bidder. It assumes an orderly sale process to sell
each asset in its appropriate season and through channels of sale and distribution that
fetch the highest price reasonably available as illustrated in (Table 3: Liquidation value).

Distress liquidation value is an emergency price, which assumes that the enterprise
must sell all its assets at or near the same time. Calaveras can sell Accounts
Receivable at 85% of face value, Inventory at 75% of book value and Equipment at
40% of book value in a forced liquidation as illustrated in(Exhibit 3: Liquidation value).

In using the discounted cash flows, P/E ratios and the liquidation method, the
$3.665million seems to be a good price. The cash flows generated by the forecasted
revenues supports fully paying off the Term Loan by paying off principal payment of
60,000 per year for the next five years. Meanwhile at the end of the 5th year Revolving
line credit could be reduced to 0.4 million. The Debt Ratio was reduced from 75% in
1994 to 44% in 1998. This also allows the Calaveras to assume more funding in the
case of expansion and/or reduce the interest expenses while boosting the return on
investment as illustrated in (Table 3:)

Calaveras Vineyard’s character in terms of the ownership, management experience,

business skills, and personal and business credit history stands the company in good
stead of keeping financial obligation. The company has a good financial history and a
reputable business skills and track record held by Dr. Lynna Martinez who has been the
vice president/general manager and winemaker since 1987 and has purchased the 85%
of the equity. Dr. Lynna Martinez has been instrumental in the Calaveras’ successful
market strategy to move from the bulk-wine sales into the premium-brand market. The
new market concentration is to implement cautious price increase and develop special-
accounts segment to fully use wines of lesser quality.

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The credit history of the company indicates that the past outstanding debt and Debt/
Total Asset and Debt/Equity ratios decreased, a decrease in the outstanding debt and
Debt/ Total Asset and CL/Equity and TL/Equity ratios has been demonstrated.
Compared with the industry’s average, the CL/Equity in 1998 will be in Median and
Debt/Equity in 1998 will be between upper quartile and median as illustrated in
(Table 6: CV credit history).

The company could have a credit risk relieve with payments of any receivables left
unpaid after 90 days. The overall financial strength of the company based on sales and
asset utilization were analysed to examine how the company manages credit
relationships and the value of its assets. The calculations of key financial ratios of the
business were compared to those of its competitors in the industry to provide a relative
comparison of its business’s financial stability. The ratios indicate that the CV’s capital is
very good. Compared with the industry, the CV’s current ratio in 1994 is below the lower
quartile but its quick ratio is at the lower quartile. It indicates a higher risk and warning
that the company may not be able to pay unexpected expenses or carry new debt as
illustrated in (Table 5: CV Creditworthiness).

The collection period is much higher than the industry’s lower quartile. The cash flow
capacity of CV indicate that the company will be able to generate sufficient cash flow
from normal operations to meet future obligations as illustrated in (excel spreadsheet).

The analysis indicates that the company’s ROA and ROE and ROS would continue
increasing all being in the upper quartile is a good sign, compared to the industry.
However, the EBITDA/Debt ratios which are less than one means that the EBITDA
cannot cover the Debt, but it would be the trend of increase and in 1998 is closed to 1.
as illustrated in (Table 7: cash flows).

While the collateral is considered a secondary source of repayment for a loan, CV can
sell Accounts Receivable at 85% of face value and Inventory at 75% of book value and

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Equipment at 40% of book value in a forced liquidation. Calaveras’ liquidation is much
higher compared with the industry’s liquidation (655,037) as illustrated in (Exhibit 7:
cash flows).

The overall external factors that could impact the company e.g. the economy, industry
and government regulatory changes are favourable. The wine sales in supermarkets
have grown 7.4% in 1992, while beer sales have grown only 2.2%, less than inflation.

2.5 Conclusions and Recommendation

Having reviewed the cash flow statement and proforma income statement and balance
sheet, it is worth recommending that Goldengate Capital should acquire Calaveras
Vineyard. The ROA and ROE seems lucrative. This is evident at the sensitivity analysis
at no price growth.

It is recommended that Goldengate review Calaveras Vineyard financial health on a

quarterly basis while setting up with few covenants to guide through the initial years. As
reflected in the quick ratio and current ratio are lower than the lower quartile of the
industry. For improved operational efficiency, Calaveras should be encouraged to
streamline the fixed assets especially the non vineyard land and the idle assets to
improve the productivity of the operation. Covenants should be set forth to avoid
obtaining further debt by putting a cap on debt ratio of 55%. The equity level should be
improved and after paying off the term loan Calaveras should carry out the revolving
line of credit thus making efficient in WACC.

In addition, the Chief Financial Officer of Calaveras can use warrants which would be
more attractive to the bank than other methods proposed by the bank to Goldengate to
avoid being turned down altogether as warrant gives the bank the right to purchase
securities (usually equity) from the Calaveras Vineyards at a specific price within a
certain time frame. This might be considered as warrants are often included in a new
debt issue as a “sweetener” to entire investors.

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 References

Calaveras Vineyards Case Study: MBA5924 case study

The Course Team. 2009. Company Valuation: study guide for MBA5924.
Milton Keynes: Open University.
The Course Team. 2009. Cash Flow and Forecasting: study guide for MBA5924.
Milton Keynes: Open University
Gardner, N. 2010. Calaveras Vineyards available at http://www.papercamp.com
[Accessed 20 March 2011]

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