A Bubbly Look at How Tariff Wars Affect Business Valuations
The valuation of businesses either for business or divorce transactions is a bit like alchemy. You look at prior economic data or related transactions and then try to predict the future. It’s a challenging game premised upon reasonable predictions.
I recently helped teach a seminar on this topic for an arm of the state bar association. That was in November when the election had just concluded. I was just asked to kind of proctor a replay of that seminar and answer questions from the attendees. It prompted me to think about how difficult the business world has become.
To make it interesting, I gathered some data published by the Wall Street Journal on March 14 concerning the liquor business. Let’s assume for a moment that you are trying to buy, sell or value in divorce (a) a retail liquor store or (b) a California winery that makes champagne. Yes, I know champagne comes only from France, but play along with me.
As we all know the U.S. is immersed in a series of skirmishes if not outright war over tariffs. The percentages, the target countries and the waivers/delays are changing daily. Meanwhile, you are sitting in your liquor store scanning your inventory on hand and what you need to order for your retail customers. You see news that the U.S. has threatened to impose 200% tariffs on alcohol imported from the European Union. That’s a problem. Even the Wall Street Journal put the story on page 1 on Friday.
Today, $50 will buy you a bottle of Veuve Cliquot Yellow Labet or Moet & Chandon Imperial. Our friend behind the register typically pays about $20 for it. If a 200% tariff is imposed, that fellow now pays $60 a bottle. The importer is keeping $20 and $40 goes to the U.S. Treasury. As he pulls it out of the case, our merchant looks around. He’s paying rent, insurance, the employees he trusts to stock the shelves with cheap U.S. wines and spirits and myriad other expenses. He called the landlord and conferred with the employees about rent and pay cuts to help out in a world where a $50 wine sale is a $10 cash loss. No help there. He can’t call the insurer because in this crazy world the insurance company might not write a policy anymore. Too many losses.
So, when I taught our business valuation course in November, our merchant had a margin of $30 a bottle to pay rent, insurance, the employees and to advertise his hooch in the local papers. And, let’s not forget, there was a piece of profit for the risk he takes being in business. To keep that going, November’s $50 Moet may soon have a $90 sticker.
Let’s jump back to the customer side of the retail counter. May is your wedding anniversary and when you were first engaged you celebrated with a then $20 bottle of Moet. You bounce into the store ready to experience auld lang syne at $50. You might even go for a case since your daughter graduates college in June. Now, you pull the bottle down and it says $90. That’s $1,000 a case with a small discount. Our merchant sees you grimace and then ask him what has he got in stock from California.
Here there are plenty of options, albeit not from Champagne. It’s good news for our California grower, except no one told him that demand would rise by 20-30% because of the tariffs eclipsing the market in Europe. You don’t just toss some seeds in the Napa Valley and get grapes 4 months later. Wine merchants all across America are calling to double their domestic shipments but our friend Mr. Korbel can only get so much juice from the existing vines. Net effect; the $18 bottle of Korbel is likely to go to $30 and you can bet that Mr. Korbel won’t be sharing that advantage with his retailers.
Korbel might decide to plant more grapes IF he has land in Napa that is sitting fallow. But even if he does, he has to acquire and plant new grapes and endure California’s increasingly sketchy weather for three years before he will get his first harvest. That’s millions invested before dollar one can be “pressed” into action. And should the trade war end and the tariffs be repealed, who will be left holding the “skin”? Our wine maker and his lenders.
Now to finish, let’s put on your prudent investor costume. You want to retire and buy a liquor store. You go see your merchant and notice empty shelves for which he is paying handsome rent. No point stocking European inventory. Even Jaegermeister is now more than $30 a bottle. You ask your retailer for his 2024 income statement. It looks pretty good. But if 30% of his inventory is going to see the cost double before the product gets on the shelf, what do you think will happen to sales. Sure, you can just order more Fireball but that’s not the same. And just as with the bubbly stuff, distillers can’t just double production. What was a sound retail business with reliable profit and recent growth (Americans love booze infused with stuff or stored in wine casks) now looks as attractive as buying shares in Target or Kohls.
The manufacturing side is equally at sea. The world loves Bourbon. But if you are responsible for North American sales for Maker’s Mark, what do you think will come of the Canadian market at $60-70 a bottle when the exchange rate is already $1.44 to the Canadian dollar? So now you have inventory on the shelf that isn’t going to move even if we can get past the comments about 51st state and “Governor” Trudeau. Do you want to start a distillery or buy one in a world where your competitors/sellers have 100,000 or more bottles of liquid gold that won’t ever cross the Canadian border? Methinks not.
Business deals and investment generally are built around incremental changes. What we have today is a bar fight without a foreseeable end in sight. When a business is valued we look at both industry volatility and individual business investor risk in deciding a capitalization rate. The higher that rate (a large piece of which is risk) the less the business is worth. This isn’t just going to affect consumers. People making American products of all kinds don’t know what to do. And that makes markets quiver. If you produce or use any product in the tariff world, volatility will prevail and risk will multiply. True for booze. True for any product or business involved with it.
Post Script: The March 20, 2025 Philadelphia Inquirer led with two stories that will inevitably affect local business valuations if they remain in effect. The General Services Administration controls 2.5 million square feet of federal space in Philadelphia and has already identified 50,000 square feet in Center City it plans to abandon. Also announced was the suspension of $175 million in grants to the University of Pennsylvania because of its tolerance of a trans-gender athlete. If you own a business near Penn or the buildings slated for abandonment, the grant income and rental values of the area are inevitably affected in the same way that tariffs affect what inventory is at the liquor store. Estimate for revenue growth which typically drive an element of business valuation may yield to elements of business contraction.