The Business of Champagne

TH: Hello, I’m Tom Hosking. Welcome to Global Infusions, an investment podcast from the Liontrust Global Fundamental team that takes a long-term view of today's stories.  

 

Last episode we chatted about the business of Housing from planks of wood to green belts. In this festive episode we’re looking at Champagne – from exploding bottles to drunk spies. If your taste buds are tickled or you have any questions for our next episode, please do send them in via your client contact or through the contact us link on the Liontrust website. 

 

So sit back, grab a glass of bubbly, and remember that when we talk about individual companies we are not making a recommendation to buy or sell shares and that some of these companies may not be held across Liontrust’s global fund range. 

 

Right, I'm delighted to introduce this episode's guest co-host, Tinger Wen. He and I have worked together for 6 years now I believe. He has an unsatiable appetite for not just great investment ideas but food and drink too. Welcome Tinger.

 

TW: Thanks Tom, pleased to be here. And it was great to hear the seasonal jingle return to the podcast. I'm feeling very Christmassy now.

 

TH: Well as it's our festive Christmas episode we thought it would be fun to choose a lighter topic. We've gone from property bubbles to Champagne bubbles.

 

TW: what a great idea! Champagne is such a classic drink for both Christmas and the new year to toast the festive season with family and friends.

 

TH: And despite drinking it every year at this time, not to mention birthdays and weddings etc. I really didn't know much about it before researching it. It's been fascinating.

 

TW: Yeah, It's big business, the region of Champagne in North eastern France produces about 300m bottles each year, of which about half are exported around the world.

 

TH: And Where do most of those exports go?

 

TW: Well actually the British are big drinkers of the stuff and we were the largest export market until 2021, when the US took that crown and has maintained first place ever since.

 

TH: I'm surprised the British account for so much, although I suppose it makes sense given the strong historical ties. And presumably the big houses dominate the export market, you know the likes of Moet & Chandon.

 

TW: Yes  they do but you know, it's actually pronounced Moet!

 

TH: Really?

 

TW: Yes monsieur Moet was actually Belgian so you really should be pronouncing the T.

 

TH: Ah how interesting I didn't know that. So Moet they are the biggest producer aren't they? It's 10% of annual production.

 

TW: Yes that's right they produce 30m bottles a year. But that understates their influence a bit because they are owned by the luxury conglomerate, LVMH.

 

TH: Where the M stands for Moet. It's the second most valuable company in Europe by market cap, only recently usurped by Novo Nordisk, the maker of diabetes and weight loss drugs.

 

TW: Indeed. And LVMH owns many more champagne houses. They own Veuve Cliquot, Krug, Mercier and Ruinart just to name a few, but the star of the show is of course Dom Perignon.

 

TH: Wow so all of those houses are owned by one conglomerate!

 

TW: Yes exactly, LVMH's market share, through all of its different brands, is actually around 20%, though it would never seem that way given the number of different brands they operate. And, they are quite acquisitive, always searching for more brands to add to their collection. recently, they bought a 50% stake in Armand de Brignac, the champagne house 50% owned by Jay-Z!

 

TH: As if Jay-Z didn’t have enough ways of monetising his fame!

 

TW: Yes, but the jewel in Moet's crown is really Dom Perignon, it's the premium brand and is named after the Benedictine monk who invented Champagne. The story goes that when he first tasted it, he called out to his fellow monks "Come quickly, I am tasting the stars"!

 

TH: Well Tinger it's funny you should say that because most historians now believe that Dom Perignon didn't invent champagne at all. And that It's a myth created in the 19th century which has been pounced upon by clever marketeers at LVMH.

 

TW: Really? They certainly had me fooled! So who really invented it then?

 

TH: Well let's start from the beginning. Wine has been produced in the region since roman times. But up until 1500 they were still wines. So no bubbles. The wines were favourites of the French court because it was much easier to transport them to Paris down the Marne River than it was to get wine from the south of France.

 

TW: OK interesting, so originally, the wines were flat. What changed?

 

TH: Well two things. Firstly, temperatures fell in northern Europe. Remember, this was back in the times when the Thames would freeze over. And this change in climate was a problem for Champagne because the yeast no longer had enough time to convert all of the sugar from the grape juice to alcohol during the warm months. During winter, the yeast would go dormant and not awaken until the Spring when the it would reactivate and continue working on the remaining sugar.

 

TW: But by spring, the wine would already be in their casks right? So if the yeast "woke up" that would produce some carbon dioxide that couldn’t really escape.

 

TH: Exactly – Champagne's wine started to have a slight fizziness. And secondly, in the 17th century, wine was increasingly bottled rather than stored in barrels.

 

TW: Oh right, and that would lock in all of the carbon dioxide, rather than allowing some to escape through the cask walls.

 

TH: Yes, that's when the fizziness became really noticeable. Everyone hated it; they thought it was bad winemaking. Champagne gradually lost the market to its great rival Burgundy, where transport links to Paris had greatly improved.

 

TW: I see, so competition had increased too. This must have been a pretty tough time to be a winemaker in champagne with all of this mysteriously bubbly produce!

 

TH: Yes. At this time, the catholic church was a big landowner in Champagne and was losing revenue, so it appointed a monk to fix the problem of the bubbles… one Dom Perignon.

 

TW: Oh wow!?! So he was actually trying to get rid of the bubbles?!

 

TH: Yes! He was undoubtedly a great winemaker and introduced quite few innovations, most notably the art of blending different grape varieties…but making the wine sparkling wasn't one of them.

 

TW: Oh ok, So who actually first embraced the fizz instead?

 

TH: Well this where the English come in. Merchants would import the wine barrels from northern France and add sugar to it before bottling it because the English had a sweet tooth.

 

TW: Ok and That would have been extra food for the yeast right?, so more bubbles.

 

TH: Exactly. The other dimension is Cider-making had become popular in 17th century England so you had these west country cidermakers starting to apply their methods to these wines to produce bubbly champagnes.

 

TW: So the English actually invented Champagne?! No wonder we like it so much right?

 

TH: Yes how about that for a bombshell! Or at least they were the first to produce it on purpose. In 1662, an English scientist called Christopher Merrett, presented the so-called Champagne method to the Royal Society of London, and that was at least 30 years before it was used in the Champagne region.

 

TW: And Champagne's newfound popularity in London's high society saved the region’s industry.

 

TH: Yes pretty much. For the French this was fabulous news. The monks were told to scrap the old plan and instead produce as much bubbles as possible to sell to the English!

 

TW: How funny! Why did it take them the 30 years start using the same methods in the actual region of champagne?

 

TH: They lacked the technology initially. They didn't have access to English glass which was strong enough to withstand the internal pressure inside the bottle.

 

TW: I've read about this. The English were the first to develop coal-fired furnaces for glass making back in the fifteen hundreds because wood-fired ones had been banned after an English admiral expressed concern in parliament that there wouldn't be enough wood to make the Navy's ships. These coal furnaces were eventually able to produce much stronger glass and in much higher quantities than the previous methods.

 

TH: Ah- that makes sense now. Well the French had weaker glass so their cellars became quite dangerous places. It was compulsory to wear iron wired masks over your face as protection. Sources at the time say that on average half the bottles in the cellars would explode!

 

TW: Haha! That doesn’t sound like a very safe workplace environment.

 

TH: Yeah. Needless to say, the French soon caught up with new bottles, new corks etc. They industrialised the Champagne process and perfected it.

 

TW: And exported it to the rest of the world. My favourite story of this is that of Charles Heidsieck. He was the first producer to sell Champagne to New York, but just as his business started to take off, the American civil war broke out. In the chaos, his salesman started to embezzle money.

 

TH: That's poor behaviour.

 

TW: Well, Heidsieck went to New York to sort it all out. And unfortunately, as he tried to investigate where all the money was going, he was accused of being a Confederate spy and thrown in jail.

 

TH: Oh no, this business trip not going well.

 

TW: Yeah well, It eventually required a letter from Emperor Napolean the third to President Lincoln to get him out of jail. But when he eventually got out, he DID manage to save his import business and was a key driving force that helped to popularise the drink in North America and that's where the phrase 'Champagne Charlie' comes from, from this guy Charles Heidsieck.

 

TH: Wow what a story, that should be made into a film.

 

TW: Well actually Tom, he has apparently been portrayed 3 times on TV. Most recently by Hugh Grant in a film called Champagne Charlie. I haven’t seen it but it has an IMDb rating of 5.4/10 so I'm not really in a rush to watch it any time soon.

 

TH: Ha! Anyway, after Champagne became popular internationally, people started producing it internationally too.

 

TW: But of course that can't be called champagne, it has to be called sparkling wine.

 

TH: Some estimates suggest that 10% of wine grown worldwide is sparkling now, which would put production at 3bn bottles a year. So the Champagne region is actually quite small, just accounting for 10% of that.

 

TW: And with that Mr Hosking, it is time for a Christmas quiz… I say the name of a sparkling wine and you have to guess from which country it's from. To those listening from home, please do play along!

 

TH: Ok, sounds like fun.

 

TW: Question number 1: Espumante.

 

TH: Oh no this is actually going to be difficult. I was hoping you would say Cava or something. I don't know but your pronunciation sounds Portuguese so I'll go with Portugal.

 

TW: Correct. Question number 2: Pezsgö

 

TH: No idea. Sounds Slavic so I'll go with Poland.

 

TW: Incorrect. The answer is Hungary. Question number 3: Sekt

 

TH: Is that Germany?

 

TW: Correct. And last one: Crémant

 

TH: Oh that's a trick question because it's France.

 

TW: Nice! Correct! Thats 3 out of 4. Not bad. Of course Crémant is made using the same traditional champagne production method but comes from other regions of France.

 

TH: It's the smart purchase isn't it. In many cases you are getting similar quality to Champagne but you're not paying the premium for the name.

 

TW: Well how will Champagne keep its price premium? Just researching all these sparkling wines, there is so much competition out there.

 

TH: A lot of them use supposedly less sophisticated production methods so there’s arguably an inferiority there.

 

TW: Ah yes, like with prosecco, the second fermentation doesn’t happen in individual bottles like it does with Champagne, it happens in a great big steel tank.

 

TH: So it’s more industrial. Which is why it’s cheaper and why it’s easier to scale production.

 

TW: Exactly. It’s one of the reasons why Prosecco has boomed. 10 years ago the prosecco DOC produced 240m bottles p.a. But production has increased by over 160% to 640m bottles last year which if you recall is over twice the annual champagne production.

 

TH: Wow that is a lot. And for the sparkling versions that are produced like Champagne, you are relying on the brand name and the terroir, characteristics of the land and Climate where the grapes are grown.

 

TW: And even that isn't durable because of climate change. The Champagne region is getting warmer and that's to the benefit of Southern England which will gradually have a climate more like Champagne has or even had.

 

TH: Yes that's the bull case for English Sparkling wine. The chalky soil in many places in the south is similar to that found in northern France. And there are some really good producers: the likes of Nyetimber, Ambriel and Chapel Down.

 

TW: So Tom, how do you think that Champagne producers can keep up with climate change and all of this competition?

 

TH: Well in the short term, the competitive strategy for the region is to premiumise further. In particular, the trend is towards so-called grower Champagnes.

 

TW: What's that?

 

TH: This is where one farmer will make a champagne but just from their own grapes. Remember the big houses don't own all their grapes. For example LVMH owns less than a third of the hectares required to produce its champagnes. For a variety of reasons this is how the industry developed. 

 

TW: So they buy a lot of their grapes from small producers.

 

TH: Yes. And the problem with this is that you don't know for sure if the grower is giving you their best grapes. How can you charge such a high prices when you don't know the provenance of your ingredients? And this is especially the case when you get to Moet's size.

 

TW: Ah I see. Whereas the small boutique producers have the advantage that they can say the exact plot of land where the grapes were grown.

 

TH: Exactly. And because plot of land is small, the production is limited and that means there's rarity to these champagnes and that is what makes them exclusive. Some are becoming very fashionable: the likes of Ulysse Collin, Tarlant and Selosse. Sorry to our french listeners for my pronunciation!

 

TW: Ha! This sounds a lot like the luxury industry. Whether it be Hermes releasing a limited line of handbags or Nike with a special edition shoe. You can charge more for something that has scarcity, whether it's artificially created or not.

 

TH: Yeah, people love collecting things that are rare as we spoke about on our Collecting episode. But it's much more difficult to create that excitement when a vintage has a run of millions of bottles as it would do with Moet.

 

TW: It sounds like Champagne is becoming more like fine wine, very terroir-focused. It's a bit like Burgundy with bubbles!

 

TH: Yes that's exactly what is happening at the top end of the market. In fact these single-estate champagnes often recommend that you drink them in a normal wine glass, they also use less added sugar or even zero sugar, they have fewer or finer bubbles. This is so that drinkers are more able to taste the underlying complex flavours.

 

TW: Speaking of bubbles, do you know how they form in the flute?

 

TH: Um.. Do the trails of bubbles form where there are imperfections in the glass?

 

TW: Well that is a common misconception. They are actually born on impurities on the surface of the glass. These are cellulose fibres cast off from paper or cloth that floated onto the glass from the surrounding air or remained after wiping the glass dry after washing.

 

TH: Oh ok, so what would happen if there was no dirt or dust from the surrounding air?

 

TW: In a perfectly "clean" glass, there would be no bubbles at all in a glass of Champagne!

 

TH: What? Really?!

 

TW: Yes Moet did an experiment in their lab, and the sure enough the champagne looked just like still wine.

 

TH: Interesting. And just to finish off on trends in champagne. The other trend is towards organic and biodynamic champagnes. One of the first houses to do this was LeClerc Briant, their champagnes are excellent and basically more and more producers are following their lead.

 

TW: I’ve heard of them. They are the people who aged their some of their bottles under the sea. It is a champagne that they call The Abyss. We actually had the pleasure of trying it a few weeks ago didn’t we Tom? It was very generously shared with us by a very kind listener while we were researching the podcast!

 

TH: Yeah yeah thank you very very much. It was a great experience. There’s something quite cool about pouring from a bottle that has barnacles and seaweed on it.

 

TW: It’s clever marketing if nothing else.

 

TH: It’s more original than what Bollinger do, for the last 40 years they have sponsored James Bond. Those who watch the films closely will have noticed that the spy has drunk Bollinger in every single film since Moonraker in 1979.

 

TW: That is on brand product placement. But the ultimate marketing effort in the industry goes to Mercier. Cast your mind back Tom to 1889 and Paris’s Exposition Universelle.

 

TH: Isn’t that the expo when the Eiffel Tower was revealed to the world.

 

TW: Good knowledge, yes it was. But there were two star attractions. And the other was the Champagne barrel from Monsieur Mercier. It was the largest in the world.

 

TH: How large was it?

 

TW: The Barrel had a capacity of 42k gallons or over 200k champagne bottles and was so large that it took 12 oxen and 18 horses to drag it from Champagne to Paris.         

 

TH: Wow that’s a big barrel.

 

TW: Mercier also hired a branded hot air balloon for the fair, but the balloon accidentally broke loose of its tether and sailed north util it eventually landed in Belgium. Mercier was then fined for having illegally imported Champagne into the country, but didn’t mind, saying it was the cheapest publicity he ever paid for!

 

TH: That’s a good lesson in how to turn everything into a marketing opportunity. And with that, let’s move on to the news. Tinger what have you got for us this episode?

TW: Netflix had a bit of a mic drop moment, releasing viewing hour numbers for all of their shows and films for the first half of 2023. Tom, can you guess how many hours of viewing time that amounted to? For reference, there are about 8,700 hours in a year.

TH: Oh yeah I saw that too but didn’t add everything up, presumably its some ridiculously high number, I know for sure that Netflix has hundreds of millions of subscribers.

 

TW: Yeah well you would be right! Subscribers spent a total of 93bn hours watching Netflix in the first half of 2023. This equates to about 350 hours spent per subscriber over the six months, or 2 hours a day.

 

TH: Wow, that really is a lot of time to spend watching Netflix! The other interesting thing was the distribution of hours spent wasn’t it. The top 5 shows accounted for just over 3bn hours of watch time, with time spent per show dropping off significantly from massive viewership numbers from the biggest hits.

 

TW: Ok, And what were those big hits?

 

TH: Well, in first place was The Night Agent with 812M hours viewed, second was Ginny & Georgia Season 2 with 665M hours viewed, in third place was season 1 of The Glory, a Korean language psychological thriller, with 620M views, followed by Wednesday and Queen Charlotte: A Bridgerton Story in 4th and 5th place.

 

TW: That's interesting, but tell me Tom, how many of the 5 have you actually seen?

 

TH: Well somehow I’ve managed to have missed all five of them!

 

TW: Ha! I've actually only seen The Night Agent, and have missed the other four. Maybe we are not as cool and trendy as we think.

 

TH: Indeed.

 

TW: The other interesting thing about this dataset is how far down you have to look before you see any older releases. I think of the top 50ish shows, there are very few names in there that were released before the back end of 2022. and most of those older shows are earlier seasons of the newly released mega hits. It isn’t until the 70s and 80s that you start to see these massive catalogue shows that Netflix focus so much on like Breaking Bad and Suits. I had a quick look and found it really hard to find shows more than a year old that were not mega hits. I'm thinking something like SnowPiercer Season 1, which I loved by the way, but it was released a few years ago and came in at number 1,700.

 

TH: Yes it does seem like these shows are very popular in the moment, but as the hype fades, the viewership numbers also fade pretty quickly.

 

TW: Exactly Tom, and this is actually the focus of quite a niche accounting debate among investors in Netflix.

 

TH: Ah yes, this is the debate over how long that Netflix can amortise their production costs. Currently they are amortising their production costs over 4 years equally in each year with the argument that the content is still relevant for 4 years.

 

TW: Correct, and some investors think that this is a bit aggressive and that Netflix is using this accounting loophole to smooth and slightly understate how much money they are spending in a given year.

 

TH: Another interesting piece of news that came out recently is the deal that Japanese MLB superstar Shohei Ohtani signed with the LA Dodgers. He has signed to play for the Dodgers for 10 years in a contract that is worth $700M.

 

TW: Wow! Now that is a lot of money. I know that baseball players tend to earn a lot but that seems extreme even in the MLB.

 

TH: Yes, it is an exceptional deal even in the world of sports megastars. This is because Ohtani is an almost unprecedented player. It turns out he is actually both an elite pitcher as well as an elite hitter. To be among the best in the league, in the two most important positions for a team is extremely valuable. Not only can he do it all, but having Ohtani frees an extra space on the roster for the Dodgers.

 

TW: Ok, well actually that does sound like it makes some sense. There is also something quite strange about the contract too right? In terms of the timing of the payments.

 

TH: Yes. While he is to be paid $700M for playing for 10 years, Ohtani will not actually be paid $70M each year. In fact, he will earn $2M per year for ten years and then $68M per year for ten years.  This is a really important aspect of the contract as it affects the net present value of the contract. By my calculations, a 10 year deal for $70M per year has a present value of about $460M. This is what an investor might pay to secure this cash flow stream. However, the way that the dodgers and Ohtani have structured this contract, the present value is about half of that, closer to $230M.

 

TW: This is a demonstration of one of the fundamental ideas in finance right, the time value of money. This is the idea that money today is worth more than money promised in the future. I wonder why Ohtani would agree to something like this.

 

TH: Well apparently his team were actually the ones that suggested it. It turns out that this strange structure could be beneficial to both sides. The LA dodgers pay less money up front, which frees up some of their budget cap to pay for other players, and apparently there is some tax manoeuvring that can be done on Ohtani's part that could save him a pretty big tax bill, so it sounds like a bit of a win win!

 

TW: Moving on to the final piece of news for this episode, last week, there were rumours that Macy's, one of the largest department stores in the US, is the subject to a bid from two private equity companies.

 

TH: Wow. That is pretty big news! Macy's and Bloomingdales which it owns, has a long history that is very well ingrained into American culture with things like the Macy's Thanksgiving Parade and amazing seasonal decorations at its massive flagship stores like the one in New York where I’m sure there is a spectacular display of christmas spirit right now!

 

TW: Its interesting you mention the flagship store. Because, It turns out that the joint bidders for Macy's, Arkhouse Management and Brigade Capital Management, are funds that historically have focused on real estate type investments and may actually be mostly interested in Macy’s real estate portfolio, the crown jewel of which is that massive Macy’s on Herald Square.

 

TH: That is interesting, so are you saying that the private equity buyers may mostly be interested in the real estate value of Macy's properties rather than the actual department store business?

 

TW: Yes exactly. The reports are that the consortium has offered about $5.8bn to acquire Macy's, on top of about another $5.5bn of debt that Macy's currently owes. This is only slightly above estimates for the value of Macy's real estate which some analysts have put at about $8 or $9bn. Within that, the Herald Square trophy asset is said to be worth around $3bn! With a portfolio of real estate that valuable, you don’t need to get the actual retail sales performance of Macy’s to do very much at all before seeing a pretty attractive return on investment.

 

TH: Yes this is a great example to show that companies can sometimes be hiding value in plain sight. Traditional analysis might focus on Macy's department store business and see an old world brick and mortar business struggling to compete with newer, more technologically savvy, competitors. However, there is a Christmas gift hiding in Herald Square for someone.

 

TW: And that gift is a $3bn building and a vast portfolio of properties in prime locations around the US.

 

TH: And on that festive note, we wish the listeners a very Merry Christmas. Thank you for listening to us this year. We hope you have enjoyed all our discussions as much as we have enjoyed having them. We will be back in the New Year. If you haven’t already, please do subscribe through Apply or Spotify and with that we wish you goodbye!

 

TW: Goodbye!