Nikhil Shamapant Crimson Wine Group-A Spinoff With Possible Hidden Value (OTC: CWGL) As a result of their impending

merger with Jefferies Group, Leucadia has been required to spinoff its winery business. Jefferies believes that the winery is worth no greater than approximately its book carrying value, and Crimson Wine Groups book value is roughly 190M, so we can expect the business to begin trading at below 200M. With Leucadia trading at a market cap of 6.7B, Crimson Wine Group is likely to be treated by Leucadia shareholders as nothing more than a 3% special dividend. Crimson Wine Group is also not going to be listed on any exchange(it will trade on the OTC). Moreover, shares of Crimson Wine Group are going to the wrong group of shareholders. Crimsons entire shareholder base will be Leucadia shareholders who are used to owning a company with consistently high returns above cost of capital and relatively recession resistant. This shareholder mindset doesnt match the cyclicality of the wine business. Due to the likely lack of liquidity and insignificant % holdings of Crimson Wine by Leucadia shareholders, it is possible that we will see significant selling and disinterest in Crimson Wine shares, making Crimson Wine Groups value proposition significantly more interesting. Understanding the Industry and the Business Crimson believes more people are drinking wine than in the past- Form 10, Crimson Wine Group. The US is the worlds largest wine market, with around 300 million cases of wine consumed per annum, and while the US is a major wine producing country, it is also the worlds largest importer of wine.- 2012 Annual Report, Treasury Wine Estates. The wine industry is intensely competitive and highly fragmented. In the US, 3 major wineries account for 60% of the case volume. By case volume, Treasury Wine Estates has 5% market share, and Crimson Wine Group has less than 1% market share. Generally speaking, the beverage industry(alcoholic and non-alcoholic) hasnt been a fixed price industry. This tends to give wineries a little bit of pricing power, so you can expect wine prices to rise to at least keep up with inflation. However, Crimson Wine notes that recently it has made a recent strategic shift to higher growth low price wine segments, a bet that higher volume will make up for lower prices. This focus on low price wines doesnt eliminate pricing power, but it puts pressure on Crimson to keep prices lower even while there is clear upward pressure on selling/promotional expenses, squeezing operating margins. Crimson has adjusted its strategy to address lower consumer spending levels, and has been successful in selling its wine at price points in the fast growing $14 to $25 range. However, if conditions worsen and Crimson is forced to reduce prices further, it may not be able to do so profitably. Even so, I like this move because on its face it seems to be a move towards reducing the intense cyclicality of Crimsons business. While high price wines are only enjoyed in the best of times, lower price wines are comparatively more recession resistant(even if not too much more resistant).

Nikhil Shamapant

Apart from the mere cyclicality of the business, the wine business is also intensely competitive. Crimson gets its sales by fighting for shelf space in retail stores and marketing focus by its distributors. Everyone in the business wants the consumers attention, so promotional expenses are constantly under upward pressure. In addition, wine quality matters as no distributor is going to include a low quality wine in their portfolio when they have so many different products from which to choose. Crimson Wine clearly owns top quality wineries. Seghesio Family Vineyards, for example, is #12 on Wine Spectators top 100 list. On Yelp.com, Seghesio Family Vineyards has a 4.5 star rating with 116 reviews. Perhaps even more impressive is that on many of the more recent reviews(some as recent as this January), a Seghesio Vineyard employee has personally replied and thanked the customer for spending their time with them. The customer service goes a long way towards improving the economics of the business. I've never had a red wine from Seghesio that I didn't like, which is why I signed up for their wine club last weekend. Looking forward to getting my dose of Seghesio delivered directly to me 4 times a year! -Yelp Reviewer From this customers insight into the economics of the Wine Clubs, we can see that Wine Club membership is a very solid source of recurring revenue for Crimson Wine Group. Moreover, revenue from direct sales to customers(wine clubs, tasting rooms, and the internet) make up 43% of sales and are made at much higher margins, very important to the business. The quality of wines isnt unique to the recently acquired Seghesio Vineyards. Pineridge Vineyards also received a 4 star rating on Yelp.com amid 100+ reviews. The direct to consumer sales are much less volatile, primarily occurring through wine tastings(recurring via the wine tourism industry) and wine clubs( a way they make each new visitor a recurring revenue source). Moreover, since 50% of direct consumer sales are through wine clubs, 1/5 of Crimsons Revenue is from wine clubs, a high quality recurring revenue stream. Combine the low volatility of this stream with the higher margins, and they significantly improve the economics of Crimsons business. However, scaling this part of the business up is significantly more difficult(investing to increase direct customer transactions means literally developing a new winery and promoting it heavily to , so Crimson is likely to edge towards distributors in the future. Expansion: Crimson Wine has a lot of room for potential expansion of their sales and wine production as they clearly arent fully utilizing the capital they have on hand and are simultaneously making growth-related capital expenditures. The issue to keep in mind is that during recessionary times, we saw that Crimson had high levels of inventory writedowns as it seems people were saving money instead of buying fancy wines(probably a good life choice, but not the best for Crimson!). If Crimson expands production, while we might see increased sales now, Crimson is also at risk for high levels of inventory writedowns in the future.

Nikhil Shamapant In any case, Crimson owns 4 wineries: Pine Ridge Vineyards, Archery Summit, Chamisal Vineyards, and Seghesio Family Vineyards. Pine Ridge: Demand continues to exceed our ability to produce Pine Ridge Chenin Blanc Viognier -2011 Leucadia Annual Report Pine Ridge is currently only able to use 63% of allowed production capacity due to current fermentation and processing capacity. If need be, it wouldnt take much to create large increases in production at Pine Ridge by expanding fermentation and processing capacity as is being done at Seghesio. Archery Summit: Able to use only 70% of allowed capacity b/c of fermentation and processing capacity. Like Seghesio, this could easily be expanded. Chamisal Vineyards: planted/producing grapes in 76% of acres. In 2013, expect to complete a project that will increase permitted capacity by 2.3x. Chamisal will then roughly equal Pine Ridge+Archery Summit, to give you a picture of size. Capacity will increase to 100,000 cases of wine from ~40,000 cases. Seghesio Family Vineyards: Recently acquired in efforts to expand. Currently permitted 170,000 cases, but fermentation and processing capacity =120K cases. In 2013, theyre completing a project to get processing capacity up to 170,000 to fully utilize Seghesios assets. Note on Seghesio Acquisition: The acquisition of Seghesio didnt simply expand revenues. For only 1.36x tangible book value, Seghesio brought in a lot of the higher quality recurring revenue(wine clubs), and more importantly, Synergies with the rest of the business: The acquisition of Seghesio Family Vineyards significantly increased Crimsons export salesCrimson is currently expanding the export of products from its other wineries through Seghesios international distribution channels. Form 10, Crimson Wine Group Double Canyon Vineyards: 462 acres, of which 87 are planted and grape producing. Crimson continues to evaluate the best use of the remaining acres. Potential source of value? the Company entered into a contract to sell a nonstrategic vineyard for $1,850,000 that had a book value of $1,039,000 at September 30, 2012. This might imply that the book carrying value of Crimsons vineyards are significantly above book carrying value, especially as this non-strategic vineyard sold for ~1.8x book value.

Nikhil Shamapant Management: Key management has been with the company for many years as part of Leucadia and has a lot of experience in the wine business. Crimsons CEO has 25 years of experience in the wine industry and its CFO has worked at large wine companies like Robert Mondavi Corp and later Constellation Brands. Managements experience in the industry and with industry heavyweights shows that they are very capable of competing. Insiders(chairman and a director) own 18.4% of the company. (CEO has 25 years of experience in wine industry and CFO has worked at large wine companies like Robert Mondavi Corp and later Constellation Brands). Its a young management team, all under 50 years of age. Moreover, the management team has proven their worth with the recent strategic acquisitions(including the Seghesio vineyard) which are paying dividends in the increased revenues now. 2013 Incentive Plan: http://www.sec.gov/Archives/edgar/data/1562151/000093041313001086/c72829_ex103.htm Incentives are based upon fundamental metrics such as operating income, ROE, expense management, profit margins, market share, and other metrics that seem very reasonable and well thought out. Shareholders might hope this is a sign that management will act in shareholders benefit just as Leucadias management has in the past. It is important to note, however, that all option pricing is based on current market prices, so management has incentive to keep prices low until they can issue option awards. Financial Statement Insights and Valuation According to Jefferies Group, Crimson Wine is worth no greater than book carrying value(1.04x tangible book value). However, Crimson Wine was significantly different from Leucadias core business and only represented a 3% dividend to Leucadia shareholders. Clearly, Jefferies Group had little incentive to look further into Crimson Wine Groups potential valuation. As a capital-intensive vineyard business, the best way to measure Crimson Wines value is by the value of its balance sheet. However, there is a lot of hidden value and many potential catalysts in Crimson Wines earnings that may serve to realize a higher valuation, so we begin by evaluating Crimsons earnings power.

Nikhil Shamapant A Discussion of Crimson Wine Groups Earnings Power Even in good times, it is difficult to make estate wineries profitable Leucadia 2010 Annual Report While Crimson Wine Groups business seems extremely cyclical, revenue has been remarkably consistent. Revenue from 2007 to 2010 was between 21 and 23 million, and after the Seghesio Family Vineyard acquisition in 2011, revenue has ballooned to 39M and 48M in 2011 and 2012 respectively. Substantially all of the revenue growth in 2012 and 9.6 of the 16M increase from 2010 to 2011 were due to the Seghesio acquisition, which is clearly paying off in the huge revenue growth Crimson has recognized since the acquisition. What % returns is Crimson getting from Seghesio? Moreover, while Crimson Wine Group has had huge revenue growth, it also has very high quality revenue. In 2011, 43% of Crimsons revenue was from direct sales to customers, which are much higher margin sales. In fact, at least 21% of Crimsons 2011 revenue was from wine clubs, a recurring and high quality source of revenue (customers buy wine at least four times/year and as members of the wine club, you can already be certain that they enjoy the wine). While sales are quickly increasing, gross margins are also improving. Gross Margins in 2010 and 2011 were 38% and 40% respectively. However, in the first 9 months of 2012, Crimson Wine had Gross margins of 52%. Crimson explained the increase in gross margins as due to lower cost per case. Why the lower cost per case? In 2007, Crimson planted 87 acres of vineyards. In November 2010, a quick frost( just 90 minutes at -7 degrees F) decimated the grape harvest for those acres(representing roughly 12% of Crimsons 2011 vineyards). According to Leucadias 2011 Annual report, Crimson expected those crop yields to return to 75% in 2012. In 2011, 35% of Crimsons total grape supply was Crimson controlled. In 2012, with the increase in crop yields, Crimson was likely able to use a significantly higher amount of their own grapes in the production of their wine and significantly reducing the cost of goods sold. According to an industry report, grape prices increased 31% from 2011 to 2012. Moreover, grape prices in July 2011 were the highest July prices since 1995. Upwards pressure on grape prices could easily have a negative effect on a winerys gross margins, so Crimsons ability to vertically integrate and increase gross margins significantly improves the economics of Crimson Wines business. This increase in gross margins should be both sustainable, and a long-term trend. As those damaged crop yields should increase from 75% in 2012, we might expect gross margins to continue increasing in the near-term. In the long-term, Crimson typically develops 4-6% of their vineyard acreage annually and it takes 4-5 years for vineyards to reach maturity. However, these vineyards last 25 years before replanting is necessary, so over time we can expect an increase in gross margins as more and more of Crimsons grape supply is taken by their own vineyards.

Nikhil Shamapant Growing sales and improving gross margins understate the magnitude of improvement in Crimson Wines earnings. Crimson Wine Groups business is structured with immense operating leverage. This means a small increase in sales can precipitate a large increase in operating income. From the first 9 months of 2011 compared to the first 9 months of 2012, Crimson Wine Group had a 34% increase in sales cause a 345% increase in operating income. That is roughly 10x operating leverage. This operating leverage makes a lot of sense when looking at financial results. Crimson Wine was running net losses until 2011 when the huge increase in volume from Seghesio was able to tip the scale and allow Crimson to run a profit. Suddenly, a small increase in sales was resulting in a large increase in profits. Why? This happens because a large majority of Crimson Wines annual expenses are fixed costs. In 2011, Sales and Marketing Expense excluding Seghesio increased by 1M. 0.7M of that was fixed expenses related to growth and 0.3M was variable expenses. These 0.7M fixed expenses were increases in compensation, travel, and other overhead costs related to growth. What is telling, however, is that these are all costs of human capital. 70% of the increase in SG&A was related to fixed cost increases in human capital. This human capital is being used to distribute the wine and can increase its scale dramatically as long as the wine is available to sell. Therefore, when Crimson Wine can produce high volumes of wine, it has heavy operating leverage as expenses are somewhat limited to the fixed human expenses, and Crimson produces plenty of profits. However, when Crimson produces fewer cases of wine, it must still pay its fixed costs as it has very low variable costs, so it will run losses as long as it is unable to sell a high enough volume of cases. So why is this operating leverage important? Sales are high quality and increasing with improving gross margins. Income from operations will increase at multiples of this sales growth, however. Crimson Wine sold 212,000 cases of wine in 2011. In 2013, Crimson expects to complete projects that will increase capacity by 108,000 cases. Crimson clearly expects a huge increase in case volume, which should precipitate a large increase in sales, and for Crimson Wine Group, investors will underestimate the magnitude to which operating income will increase with any sales increases. Clearly Crimson Wine Groups business structure and the strategic decisionmaking of management alone is set to increase Crimson Wines earnings dramatically in the short term; However, Crimson Wine stands to increase earnings significantly in 2013 simply by becoming a separate public company.
Crimson Wine Group Capitalization

Nikhil Shamapant Prior to the Spinoff, Crimson Wine Group had a debt/equity of 5.75, indicating an extremely leveraged company. However, the wine industry is extremely cyclical and a clean balance sheet is important to a companys survival. Therefore, Leucadia, like a good parent company, cleaned up Crimsons balance sheet prior to spinning it off by changing Crimsons debt to equity capital and adding a 13M cash contribution to strengthen Crimson Wine Groups capitalization. After the spinoff, this leaves Crimson with a very strong balance sheet. However, more importantly, cleaning up the balance sheet improved earnings significantly. Previously, Crimson had been paying 3.5M to 4.5M in interest expenses to Leucadia. After the spinoff, however, if Crimson successfully arranges its 60M credit facility, it will likely be paying 600K at most in interest expenses. If you add in the new $900,000 annual costs of being a public company, Crimsons expenses have reduced by 2M to 3M. Considering that Crimsons 2012 pre-tax income is 5.38M, Crimson is achieving around 46% growth in pre-tax income simply from separating into its own company and cleaning up its balance sheet. Finally, after Crimson Wines pre-tax income increases significantly in 2013 and in years to come due to significant operating leverage, volume increases, gross margin increases, and the reduction in interest expenses, Crimson Wine doesnt have to pay taxes for the first few years. After distribution, Crimson Wine Group should have $41.478 Million in California NOLs and $15 Million in Federal NOLs, allowing Crimson Wine Group to escape paying taxes for several years. Crimson Wine Groups Value: An Asset Based Perspective While Crimson Wine Group has a dynamic income statement, its balance sheet is more difficult to interpret without knowledge of which specific patches of land Crimson owns or how much I would pay for a specific vineyard. The sale of a non-strategic vineyard for 1.8x book carrying value suggests that there might be at least 30M of hidden value if the vineyards are on book for less than their true worth. To value Crimson Wine Group by its assets, we need to compare it to another wine company. Treasury Wine Estates, a comparable winery, currently sells for 1.78x tangible book value. Crimson Wine Group has gross margins significantly above Treasury Wine Estates and yet only sells for 1.2x Tangible Book Value, indicating that Crimson Wine Group could have 50% upside. Potential Catalysts: 1. Growth in Case Volume+Operating Leverage+Use of NOLs could create a gigantic increase in bottom line 2. Uplisting to a major exchange might attract attention and analyst coverage, drawing attention to their growth and give them a higher multiple. 3. Strategic Evaluation of Double Canyon Vineyards 462 non-core acres. 4. Potential Acquisition candidate? High quality revenue(wine clubs), High quality wine. Lots of land and control of grape supply. 5. Institution of a dividend Note: According to a recent filing, Crimson expects to file its 2012 10K in March 2013.

Nikhil Shamapant Sources: Stockspinoffs.com Grape Report:http://wherefoodcomesfrom.com/article/6838/Grape-Report-ReducedProduction-To-Bolster-Prices#.UTAW4OsjpM4 Leucadia 2008, 2009, 2010, and 2011 Annual Reports Crimson Wine Group SEC Filings Treasury Wine Estates 2012 Annual Report Yelp.com -http://www.yelp.com/biz/seghesio-family-vineyards-healdsburg-2 -http://www.yelp.com/biz/pine-ridge-vineyards-napa