Earlier this year, Southcorp brought in John Ballard, a veteran Australian consumer-products executive, to forge a turnaround. Among his restructuring efforts: writing down $882.5 million ($617.8 million U.S.) in goodwill and equity on Rosemount Estate, which Southcorp acquired two years ago for $778 million, replacing key managers, and tightening financial controls. He also apologized to investors for the company's results last year, which he called "unacceptable."
So when will Southcorp pop open the champagne to toast a successful turnaround? On Oct. 24, I met in Manhattan with Ballard and Thomas Burnet, head of Southcorp's North American operations, to discuss the company's prospects and the overall wine market. Here are edited excerpts of our talk:
Q: Southcorp has had a tough year. What happened?
Ballard: The explanation is depressingly simple. It has nothing to do with our vineyards, our wineries, our capabilities in making wine, and nothing to do with the U.S. market, where the business has continued [to perform] very strongly and is very well-run. What happened in the U.K. and Australian markets is that the people running [things] revved up the business, revved up sales, and loaded up [inventory] massively.
Q: Do you mean that the retailers and wholesalers ordered too much stock?
Ballard: No, this was us doing it ourselves. [Wine distribution elsewhere] is quite different from the U.S. [distribution system]. In the rest of the world, winemakers can go direct to retailers with sensational deals -- and retailers make what are euphemistically called "investment buys," bringing their purchases forward. What [the winemaker] is really doing is making next year's sales today. Inevitably, you can't push [all the inventory] through.
What happened is that in fiscal 2002, we overloaded [sales by] about 1.5 million cases [in the U.S., vs. Southcorp's worldwide annual sales of about 20 million cases of wine]. It was just painful. [Working off excess inventory] took the annual operating profit down from [analysts'] original expectations of north of $300 million ($210 million U.S.) to $132 million ($92.4 million U.S.).
Q: But most of the loss came from the writedown of Rosemount, didn't it?
Ballard: When you have a loss, it's very sensible to write down goodwill, which we did. But those writedowns, which produced the massive loss, were noncash. They're just taking an opportunity to clean up the books and set the company up for the future.
Q: There must have been significant problems at Rosemount to require such a big writedown.
Ballard: The difficulty was that the sales in [fiscal 2003], when we severely [cut prices] to get rid of excess stocks, didn't justify the carrying value of the [Rosemount] brands. My view is that if we did the same exercise in two year's time, [sales] would justify the carrying value.
Q: But didn't Southcorp pay too much for Rosemount?
Ballard: I don't believe we did. When the business was acquired two years ago, wine shares were riding high, price-earnings ratios were at record levels, and the values put on wine companies were exceptionally high. Today, wine companies have become unfashionable [with investors]. In two years' time, that business undoubtedly will have recovered quite strongly. I suspect that the value on it [then] will be close to what we paid for it. We bought at the top of the cycle. Today, we're at the bottom of the cycle.
Q: Would you have been in favor of buying Rosemount two years ago?
Ballard: Definitely. The Rosemount business brought not just a great [brand] but some fabulous vineyard properties, very good technology, some very talented people, and some very innovative thinking in terms of new ways of managing vineyards which we're now adopting throughout Southcorp.
Q: Is there anything to the rumors that Southcorp might become a takeover target?
Ballard: The share price has recovered modestly. I'm happy with that [because] one of my great concerns with a depressed share price is that in the unlikely event of a takeover attempt, the shareholders wouldn't get good value.
I don't [expect a takeover bid] because the top three Southcorp shareholders collectively hold 40% of equity. I know that they share the view that the best way for them to get value back from their shareholdings is for us to turn the business around. I'm pleased to say that at this stage, they have a lot of confidence that we're doing that.
Q: In the Wine Market Report newsletter, Tom was quoted as saying that Australian wine sales in the U.S. will be soar 50% this year, to 15 million cases. Can that kind of growth continue?
Burnet: My instinct is that the category still has a lot of room to grow. Today, out of 100 bottles of wine sold in the U.S., only six are Australian. But the growth [will have to] moderate over time. The law of large numbers would indicate that. [But] I still see very strong growth.
Q: What's the deal with Yellow Tail wine? It's already the fastest-selling new wine ever in the U.S, and its U.S. distributor is saying sales will hit 4.5 million cases this year.
Ballard: It's a brand that [cooperative Australian wine producers] put together for the U.S. market that hit the spot in terms of being very contemporary [with] colorful packaging, a slightly sweeter flavor that appeals to [U.S. tastes], and a [relatively low price].
Q: Can Australian winemakers overtake the Italians to become No. 2 in the U.S. market behind domestic producers? You've already overtaken the French to take the top position in the British market.
Ballard: It was a huge shock to the French. I think we'll [take] the second position in the U.S. Our labels are in English and understandable. And more important is what's in the bottle: Australian wine stylistically is different from California wines, but it's [closer] than Old World wines. Because of that, it's more on the button with U.S. consumer tastes.
Q: Is there a limit to how much market share the Australian winemakers can take in the U.S. market?
Burnet: [Measured as a share of total dollar sales,] we now have about a 9% share of the U.S. market. But it's important to keep in mind a couple of statistics: California produces about three times [as much wine] as the total production of the Australian wine industry, and the U.S. is just one of the markets Australian winemakers sell to. You can do the triangulations. Peterson is a contributing editor at BusinessWeek Online. Follow his weekly Moveable Feast column, only on BW Online