29
Aug
2016

My Fever-Tree Story

A few years ago I played cricket for a team called The Penywern Taverners’ (named after Penywern Road near Earl’s Court in London). Batting higher up the order was a chap named Tim Warrillow. I’m not so good with faces, but I tend to have a good memory for names and Warrilow is a memorable name. So I’m rather impressed that my former team mate has co-founded a company that is now worth just over a billion pounds: Fever-Tree. Tim owns just under 7% of the company – at current market price that’s worth £73m.
Obviously you need to co-found a company to make that kind of money. But if I had invested in Fever-Tree when it listed on the stockmarket in Nov 2014 at 165p I would have done rather well: the value has increased by 6 times.

The shares have been a 6 bagger in just under two years.

I like to ask my friends who work in bars why they think it has been such a success. One mentioned the quality of the product. When Tim and his co-founder started looking into how tonics were made, they discovered that most contained sodium benzoate or similar substances, while cheap orange aromatics such as decanal and artificial sweeteners (such as saccharin) were widespread. My friend told me that the only other tonic that is drinkable is Schweppes – but that is a global brand, owned by Coca Cola. And increasingly discerning customers don’t like global brands like Coca Cola. Hipster’s drink the obscure brands of ethical Ethiopian coffee, not Coca Cola.

Another friend who worked at a bar told me that some people ask for “Fever-Tree” by name. Drinkers will actually pay more for a brand they trust. But often it is served in the bar, because bar tenders like to stock quality gin, and it makes sense to serve it with a high quality tonic. The tonic is ¾ of the drink after all. And people are happy to pay the premium. Plus the bottles are smaller, people don’t like to drink flat tonic poured from a large bottle that might have been opened several days ago.

From the investor side, a value investor friend of mine loves it, pointing out that it is very rare for a UK company to do well in the US. Revenue is growing 66% year on year to £40m as of H1 2016. The company reports a gross margin of 55% – ie there is huge mark up between what the product costs to make and what Fever-Tree can charge for. It is generally a good idea to invest in companies that make products that customers are prepared to pay a premium for. Anyone can win market share by cutting prices, but if customers appreciate what you are doing, they will pay what you ask.
For my part, I think a good deal of the success of Fever-Tree is Tim Warrillow’s background in luxury food marketing. The Fever-Tree drink is all about the story associated with the brand. From their website:

A 15 month journey. Days in the British Library researching quinine sources from as far back as 1620, trips to find the purest strains of this key ingredient and 5 iterations of the recipe were tasted before Charles and Tim were happy with the result and the first bottle of Fever-Tree FIndian Tonic Water was produced in 2005.

This marketing nugget reminds me of Joseph Campbell’s archetypal “hero’s journey.”  

A hero ventures forth from the world of common day into a region of supernatural wonder: fabulous forces are there encountered and a decisive victory is won: the hero comes back from this mysterious adventure with the power to bestow boons on his fellow man

Still, I find it hard to accept the Fever-Tree valuation. Fever-Tree is a great story, with high growth and high returns. But like the drink itself, the share price is expensive. The current market valuation is 15x historic sales and 40x historic profits. How easy would it be for someone else to copy the product? Coca Cola have the resources to make a premium tonic very easily – although if the reason why hipsters drink Fever-Tree is because they don’t like Coca Cola then perhaps not. Could another start up compete? Perhaps fritzt-kola shows that it can be done? Started by two friends after scraping together a few thousand euros of start-up capital, in 2002 they founded fritz-kola in their student digs in Hamburg. They created a new kola and took on the big soft drinks companies successfully. A real David v Goliath story.
So annoyingly I missed Fever-Tree. I tend to avoid investing in companies coming to the market in an IPO, because most don’t do very well on average, but just occasional you get spectacular multi-bagger returns (like SuperGroup, Hargreaves Lansdown, Admiral, Ryanair and now Fever-Tree). This is similar to the economics of films, where most films lose money on average, but occasionally you get a “Star Wars” or a “Titanic” which makes outsize returns – there is good money to be made telling a heroic story. The distribution of film returns is not normal – mathematicians call it kurtosis.
It is interesting to note how few of the mining and oil exploration stocks on AIM have been “multi baggers.” Gold mines particularly tend to make poor returns. This has been known for a long time, almost two hundred years ago Charles Darwin, when he travelled around Chile on the Beagle in the 1830s quoted a rule of thumb:

“A person with a copper mine will gain; with a silver mine he may gain; but with gold he is sure to lose.”

Darwin tells his readers that the owners of the goldmine lose great quantities of precious ores, for no precautions can prevent robberies. Nowadays I suspect that management of many small mining companies tend to be the ones extracting the value from the owners of the shares in the company.
The opposite is that it is well known that investors often make high returns from soft drinks companies (not just Coca Cola, a favourite of Buffett, but also stocks like Britvic, AG Barr favourites of Nick Train and Nichols a favourite of Lord Lee). Amazingly – you would think the barriers to entry would be much higher in mining, and so the expected returns should be the other way around. Except the barriers to entry are high in soft drinks because although it is easy to get started, it is hard to build a successful brand. Thousands of films get made a year – there are no barriers to entry, but only a few are actually successful – there just aren’t enough hours in the day to watch all the films that get made. An even more extreme example is bands. Hundreds of thousands of bands get formed, and yet the successful ones enjoy excess success far above the average. Kurtosis.
Economists like to think about barriers to entry – how hard is it to set up and compete as a rival company. But this framework of thinking misses something. A business is not just the capital invested in it (FeverTree required just £1m to get it going in 2005…a thousand bagger for co-founder Charles Rolls!)  Waterworld and Titanic both cost about $200m to make, but only the latter went on to return more than 10x that cost at the box office.  Similarly many musicians practice for 10,000 hours, but they can not possibly be as successful as the Beatles.

Instead, great brands are almost like a form of art. People appreciate sharing quality experiences by word of mouth.  They also appreciate something with a well told story behind it.  But most of all I think, most people appreciate success when the probability of failure is high.  They appreciate something that triumphs against the odds. Whether it is films, music, a sports team or a simple gin and tonic.

6 Responses

  1. Do private investors ever get an allocation at popular IPOs? I looked at McCarthy & Stone thinking that demographics were so favourable that it couldn’t miss. The institutions swallowed the whole thing and a 20% premium. Amazingly, a profit warning swiftly followed such, apparently, is the unique talent of management. Cue Schadenfreude.

    1. Bruce Packard

      The corporate financiers don’t really like involving private / retail investors in IPO’s because administratively it is a hassle. Given that many IPOs by Private Equity sellers tend to be poor performers, I’m not sure it matters that private investors are disadvantaged?

  2. Ronan Lynch

    Bruce- great read that ranges across post-colonial Britain (G&Ts, India, cricket, quinine!) How much of this phenomenon is to do with authenticity? There’s been much talk in Ireland lately about the revival of whisky-making, which once supported hundreds of individual distilleries across the country – until Ireland became independent and lost its entire market (ie the British empire). Most distilleries closed down and the remainder clubbed together to operate one single distillery which branded its product as Jamesons. But whisky making is coming back with lots of startups though no product as yet. In turn, Gin has returned in a big way due to the growth of distilleries that have to produce something fast (gin) while waiting years for their first batch of whiskey … So Fever Tree could be on to a good thing.

    Re quality non-alcoholic drinks, It’s striking how widespread is the market for non-Coca Cola non-alcoholic drinks in places such as Germany (thinking of Fritz Cola as you noted, but also eg Bionade and Club Mate which seems to be huge successes but haven’t been replicated other places).

    1. Bruce Packard

      Yes – I have a thesis that the growth of artisan / hipster drinks brands emphasizing authenticity is a reaction against these global brands like coca cola. As the drinks industry consolidates, it sows the seeds of competition, because people are turned off by global brands. Perhaps the same could be said for the global banking industry…

  3. Andrew latto

    Very interesting read. I like the quote from Charles Darwin and the problem with mines is that they always run out of the material being mined. On Fevertree an interesting question would be to ask is: how could it have been spotted as a potential success at the time of the IPO? Probably the market potential and the group’s position in the market were the two key elements i.e. premium mixers and Fevertree’s leading brand in this area.

    The nature of the product purchase showed that people would be willing to opt for premium products. Gin is not a necessity but is consumed for the “feel good factor” and as such isn’t driven by price. Related products would also not be driven by price but by quality. The market backdrop in the mixer space had previously been driven by a race to the bottom with groups like Schweppes making cheap bottles of tonic water.

    Consumer loyalty is a tough one to assess but consumers will latch onto a brand and stay with it due to familiarity and the risk of changing to something else. If they find Fever Tree and it works for them why change?

    On the competition front there is another company called Double Dutch (started by two Dutch women) that aims to offer a similar product: http://doubledutchdrinks.com/ Interesting on Fritz Cola’s success in Germany. There is a smaller niche brand in the UK but it probably isn’t as successful: http://karmacola.co.uk/

    On the history front my understanding is that tonic water was developed as a way to ward off Malaria in Asia.
    https://en.wikipedia.org/wiki/Tonic_water. The idea was that quinine by itself is very bitter and as such is best consumed with other products.

    Overall thoughts on Fevertree are that we need to figure out how it could of been spotted ahead of time in order to find other potential investments. It seems that doing the leg work on a company’s market position and the market prospects is critical. Headline valuation metrics can be a poor guide with Britvic, for example, the cheapest soft drinks group in the UK but also the one that has performed the worst in recent years.

    Britvic has suffered from competition from the discount supermarkets for its Robinson’s squash brand and has appeared to not have done well on the innovation front. Squash appears to be in large part driven by price unlike premium mixers such as tonic water.

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