Wine in China: Nurturing the vine

When The Carlyle Group acquired Australia's Accolade Wines from CHAMP Private Equity for A$1 billion ($770 million) earlier this year, the deal said much about one of Asia's most complex high-end consumer categories. Although Accolade's growth under CHAMP generated the GP a return in excess of 5x, Carlyle's willingness to pick up such as hefty baton in a competitive niche segment was attributed to confidence on a broader level.

Ostensibly, the plan is to exploit the wine industry's rapid growth in China, which is supported by familiar middle-class consumption drivers and a local taste for imports. Although this narrative has not been a large part of the Accolade story so far, it came into focus in recent years with a parallel build-out by Melbourne-based competitor Treasury Wine Estates (TWE).

TWE, the maker of Penfolds among other household brands, brushed off a takeover bid in 2014 from TPG Capital, KKR and Rhone Capital, citing a more promising outlook in its in-house growth plan. This included a strong focus on China, which is now said to account for half of TWE's Asian sales and 80% of its growth in the region.

The company was posting net losses when its PE suitors began circling but it has seen a dramatic turnaround in the meantime. Profit more than doubled during the 2017 financial year to A$132.2 million. Asia was the strongest performing geography by far with earnings up 75% year-on-year. 

"When we started looking at Accolade nine years ago, the China thematic wasn't as strong as it is today, but as TWE had its success in that part of the world, it provided a halo effect to wine companies," says John Haddock, CEO of CHAMP. "As we were going through our investment and as Carlyle was doing its due diligence, one would have to look at the TWE story and draw some positive conclusions about the opportunity in Asia and China."

TWE's hard-fought footprint in China will not be easy to replicate. The company was an early-mover in the 1990s and paid its dues navigating difficult legal hurdles in carving out a Chinese-language brand with "Ben Fu," a transliterated name for Penfolds. Still, the prize is getting too big to ignore.

Big target

According to IWSR, a London-based research firm focused on alcoholic beverages, China is only the fifth largest wine consumer globally, but it is expected to grow by 40% between 2016 and 2020 to take the number-two spot behind the US. Within five years, Chinese wine consumption is expected to be worth $23 billion a year.

Private equity appears set to carve out a bigger piece of this pie, but the effort will require some creative maneuvering. While entry barriers to China's wine market are not particularly high in terms of regulations or logistical practicalities, effective marketing is difficult, especially given the fledgling nature of wine culture locally.

One prevailing characteristic of the new business models taking that plunge is a focus on the brand of the distributor rather than that of the wine itself. Traditionally, this approach would include umbrella wineries with a large range of labels such as Accolade, but it is increasingly encompassing wholesalers that curate themed portfolios, and clubs that rebrand wines from various producers with carefully stylized marketing strategies.  

Vinomofo follows the latter of these models. The Australian e-commerce start-up brokers wine from a number of vineyards with an insouciant attitude and a clear focus on young demographics unfussed by the segment's traditional refinements. The company received A$25 million from Blue Sky Venture Capital in 2016 with a view to expanding into China, Hong Kong and Southeast Asia. At the time, it was said to be Blue Sky's biggest investment yet. 

Eddie Wong, director of China Wine Business, a marketing services provider for international brands, is working on a comparable idea but with a tighter focus on mitigating China-specific headwinds. Taxes and costs related to a notorious web of importers and sub-distributors can increase the retail price of a bottle of wine more than sevenfold in China. At the same time, wine as an unfamiliar but desirable lifestyle product is still considered to be going through a culture shock phase in the country.

The plan is to set up a first-of-its-kind distribution channel that directly faces end-users both online and offline and cuts the price paid by the consumer in half by streamlining procurement. This would be supported by an ambitious rollout of physical "experience centers" aimed at promoting a more culturally infused – and therefore more sustainable – industry expansion. A number of investors are said to be in negotiation to support the project.

"You can invest and open 1,000 shops but if more than 99% of the customers that walk in don't know anything about it and can't tell if the price is fair, then how can you survive as a retail business by selling to less than 1% of the customers," Wong says. "Most of the China wine community is only focused on making money and doing whatever it takes to sell as much as possible. But this is not like other fast-moving consumer goods – you have to deliver more than the wine."

Fragmentation factor

Education is seen as an essential part of the China wine equation because it is expected to effectively harness the segment's popularization into more professionally manageable sales channels. Industry figures vary, but the rule of thumb is that less than 10% of wine sales are conducted online and less than 10% of in-person sales are made at formal retail chains. 

Much of the fragmentation in the wine space plays well to the instincts of private equity, including a string of logistical intermediaries ripe for consolidation and an end-customer shopping environment predominated by slipshod regional convenience stores and wholesalers. Supply chain partnerships are not prohibitively difficult to establish, but they need to be cleaned up.

Industry participants concur that the biggest challenge in this process will be reining in China's rampant trade in counterfeit wine. Although fakes do find their way online, they are much more prevalent in the less formal outlets of neighborhood grocers, liquor stores and direct distributors.

Technology investment is expected to play a major role in addressing this issue. Shanghai-based VeChain, for example, is already using blockchain to help customers authenticate wines at the point of sale. The company claims to be backed by Tim Draper's DFJ Venture Capital.

"Most of the technology will be used by the producers themselves because at the end of the day, they are the only ones responsible for their brand," says Guillaume Deglise, CEO of Vinexpo, a wine events organizer. "They will have no choice but to invest in technology and protect themselves from copycats."

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• Topics
• Greater China
• Australasia
• Consumer
• Buyouts
• Trade sale
• China
• Australia
• CHAMP Private Equity
• The Carlyle Group