Paddling furiously? What next for Duckhorn

What will a private Duckhorn be like beneath the surface?

Set against the torrent of negative press and depressed sentiment in the California wine space in 2024 it’s hard not to see the announcement of Duckhorn’s nearly $2bn take private as a welcome sign of hope. A sign that winning brands, with traction in the market and real equity behind them can still find investors willing to open the checkbook.

It’s a 2024 flavor of hope, let’s say ‘hope-lite’ for sure -> with the $11 a share valuation still around a 30% fall from the 2021 IPO pricing and well down on the $24 it traded at in the summer of 2021. However, for shareholders that had seen “NAPA” trading down below $6 this certainly feels like a win.

But a few months on it feels like a good time as Duckhorn is set to step off the public stage to take a step back and look at the insights from it’s likely final public quarterly filings and also to ask what kind of future to expect from it once the transaction completes.

In terms of the story painted by “NAPA’s” numbers - 3 things stood out to me:

1. DtC is tough right now for everyone: The challenge of finding DtC growth extends through to successful premium and luxury brands. Duckhorn’s trailing 12 month DtC revenues of $56.5M were down 6% on Duckhorn’s DTC business back in 2021
2. NAPA is weighed down by excess inventory: Despite a flexible sourcing model with a majority of fruit sourced under contract and a market beating top-line there are signs of inventory build up here. Looking at inventory levels vs trailing 12 months cost of sales we see:

• Q4 FY22 - 1.5x
• Q4 FY23 - 1.7x
• Q4 FY24 - 2.4x

3. Public markets and chasing growth has driven costs and complexity: Against a tougher outlook SG&A costs could well need a review. SG&A as a % of revenue is approaching 30% (29.5% Last 12 months); up from just 21.7% in the period prior to Duckhorn’s listing. Costs are growing well ahead of revenue -> perhaps reflecting the need to drive the top line with acquisitive growth in the absence of organic options as well as the costs of public listing

Which leads us to the question of what next for Duckhorn?

Butterfly’s acquisition is being financed by the US Farm Credit System with the Financial Times reporting that “the unusual funding group includes such names as American AgCredit, Compeer Financial, Farm Credit Services of America and Farm Credit Mid-America…not particularly experienced in public company M&A”1 Financing sources aside one can safely assume that the newly private Duckhorn will have a substantial level of debt.?

Duckhorn’s debt burden likely to be substantial

Details of the leverage in the transaction haven’t been made public, but we can make an informed guess at the range. Assuming a conventional level of leverage in the transaction and incorporating existing debt its likely that Duckhorn could have debt levels ranging from $1.25bn at the conservative end to close to $2bn. Assuming interest rates in the range of 4-5% and that would equate to an annual interest bill of between $50m and $100m a year

Set against a business that has seen declining cash generation

Whilst Duckhorn has consistently reported stable debt cover as a public company on a Debt: adjusted EBITDA basis it has seen a substantial decline in operating cash generation over recent years (see below). Operating cash has diverged substantially from the adj EBITDA measure Duckhorn favors and it’s clear substantial action will be needed to ensure cash generation top cover interest requirements

Duckhorn adj EBITDA and Operating Cash Generation by Financial Year...with less than $5m generated in the last 12 months

2021: aEBITDA $117.2m / Operating Cash $131.9m / ratio 1.13x

2022: aEBITDA $127.6m / Operating Cash $68.8m / ratio 0.54x

2023: aEBITDA $144.5m / Operating Cash $70.1m / ratio 0.49x

2024: aEBITDA $155.0m / Operating Cash $4.2m / ratio 0.03x

A newly private Duckhorn is likely to need to address inventory overstock and cut overheads to improve cash generation

With the topline excluding impact of Sonoma Cutrer having moved negative it seems highly likely that Duckhorn will need to take some tough decisions to drive improved cash generation. In bad news for suppliers addressing the growing inventory levels would appear a priority. Despite a flexible supply model inventory on hand now exceeds $450m

Beyond that it appears likely that there may be pressure on SG&A with particular pressure to drive rapid synergy from the integration of Sonoma Cutrer.?

New owners Butterfly Equity have stated that they see opportunities to continue the growth story of Duckhorn, potentially with further M&A activity…but it remains to be seen if that turns into reality or if Duckhorn will need to adopt a more defensive posture to service its increased debt levels.?

For sure many at Duckhorn will be glad to see the end of the public scrutiny and volatility of running a listed wine business but new challenges are likely on the horizon