Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Fever-Tree. How's your tonic?

Oh, we're actually recording. The tonic is good. It's drinkable on its own, as a matter of fact. I did want to point out that since we first published on this business, I think the stock price is down by two-thirds since you published the first piece of research on Fever-Tree. The broader context is that you've been looking at this business for 10 years now. It tastes good, but it's been a couple of rough years.

You're not making me feel great. Well, one question before we move on. Can you taste the difference between Fever-Tree and other tonics or similar drinks?

I can taste the difference compared to Schweppes. I've tried a couple of other premium tonics, and while the taste might not be identical, I would categorize them as good. I would drink them like tonic water, either alone or with some gin. I wouldn't drink Schweppes by itself.

I think it's interesting, coming from Berlin where you're based, I was surprised by the number of premium adult soft drinks available, even in small convenience stores. Interestingly, I didn't see Fever-Tree when I was there, but there were many small, high-quality mom-and-pop brands. This ties into my main question about Fever-Tree. It's not difficult to carbonate water, flavor it, and manufacture it. Many people have noticed the returns Fever-Tree had in its early days, with impressive returns on equity and profitability, which encouraged others to enter the market.

Our research on Fever-Tree focuses on the potential moat around its brand and distribution, especially in the US, which is its largest market. What initially attracted me to Fever-Tree is that there aren't many UK brands with the potential to become global brands. Many UK businesses fail when they enter the US market. Although Fever-Tree's stock price has dropped significantly in recent years, they are still growing rapidly in the US and remain the largest brand with a long runway ahead.

The long thesis is clear and still intact to some extent. Their catchphrase, "If 75% of the drink is mixer, mix it with the best," is a powerful marketing proposition. The business model has high cash returns on equity, low capital requirements, and a long runway for organic growth, driven by the premiumization of spirits. People are drinking fewer but higher quality drinks. Despite recent challenges like logistics issues, Covid, and glass pricing, I've revisited Fever-Tree because its stock price is at a three to four-year low.

It's close to a five-year low, I would say.

Yes, if not more. It's trading at roughly 14 to 15 times the 2026 operating income. For a global brand that can grow organically at GDP plus 3% to 4%, high single digits, over the next decade, it's not expensive. They have over 10% of their market cap in cash, likely to be returned as a special dividend next year, which mitigates the risk of losing permanent capital. However, I've thought this way for the past year, and the price keeps dropping. This has triggered our recent research on the company.

How have you approached conducting fieldwork on this business, especially over the last three or four years?

The majority of our work has focused on disproving the thesis that Fever-Tree has a distribution moat and has built brand equity over the last decade through its first-mover advantage, mainly. Because, as you just mentioned, you can't really taste the difference when drinking a premium Double Dutch tonic versus a Fever-Tree tonic, even straight. Let alone when you mix it with gin or vodka. There might be some brand equity, and let me talk about off-premise. There might be some placement, shelf space, and consumer recognition that drive a higher rate of sale, signaling brand equity.

However, from a product and taste perspective, it's hard to argue that Fever-Tree is a superior product compared to other premium mixers, whether that's Q Mixers in the US or anyone in Europe. As I mentioned earlier, it's not too difficult to carbonate water, flavor it, put it in a nice shiny box, and spend some marketing dollars. The challenge lies in distributing it and managing the brand equity. So, a lot of our research has been focused on understanding, mainly in the US because it's the biggest market, how they distribute the product off-premise and on-premise, and how that compares to other players, mainly Q Mixers and Schweppes. This might determine a greater rate of sale, distribution moat, and, as I said, a longer organic runway.

How have your views evolved as a result of this investigation over the last four or five years?

I've been examining spirits and wine distribution in the US for years, mainly due to Fever-Tree, but also because of the larger spirits companies. It's a complex field, with each state having different regulations. The three-tier system in the US for liquor distribution is intricate, which makes Fever-Tree potentially interesting.

One of the most fascinating insights recently is how unique premium mixers are as a category. It's a peculiar and distinct category. A Q Mixers seller who sold to Kroger mentioned that the mixer category is the second smallest at Kroger in terms of SKUs. Off-premise, what is a premium mixer? It's non-alcoholic but paired with alcohol. It can be consumed straight, but it's typically paired with alcohol and is double the price of a soft drink. So, it's a premium soft drink.

The challenge is where to place it in supermarkets, especially in the US where liquor laws vary by state. Some grocery stores can't sell liquor, affecting the distribution method to off-premise locations. This leads to different placements in aisles and supermarkets. Unlike energy drinks, which have a dedicated aisle, premium mixers don't have a consistent placement, making it hard to train consumers on where to find and how to consume Fever-Tree.

In the US, spirit companies can't market directly to customers, yet premium mixers need to be marketed alongside spirit products. Achieving consistent shelf space or product placement across supermarkets is challenging, leading to varied experiences by state. This complexity might have partly hindered growth, as it's harder to activate customers compared to other beverage categories, which don't face the same placement issues due to liquor laws.

We've published over 20 interviews on this business in recent years, mostly by you and some by our partners. Recently, we launched a company learning journey, curating years of work. I want to discuss how you've structured this learning journey, which is visible to subscribers and free-tier users who can view the article index.

We have categories on the business's history, its relationship with Schweppes, Fever-Tree's ties with spirit brands, and a detailed segment on distribution both on and off-premise. Fever-Tree vs. Monster has its own category. There's also a segment on gross margin and other topics. Explain why you structured the learning journey this way and what it reveals about the content format.

The majority of the focus is on an important part of the thesis, which is how the product is distributed, mainly in the US. It's split between on-premise and off-premise channels. Both distribution channels are supported by Fever-Tree's brand and relationships with spirit brands.

For example, the distribution method into grocery channels, which accounts for the majority of beverage volume sold, varies by state due to liquor laws. This affects aisle placements and shelf space across the US. Q Mixers and Schweppes are typically distributed with Dr Pepper or Coca-Cola, and sometimes Suntory, depending on the region. They are owned by various conglomerates worldwide, including some in Europe, which means they lack a cohesive brand story.

Q Mixers, for instance, is distributed by Sysco and other food distributors. Imagine if you're Q Mixers and you want to market your product on a grocery store shelf, but you're selling via Sysco, which also sells baked beans and crisps to Kroger. Sysco doesn't prioritize merchandising your product as Q Mixers. This means you're unlikely to get prime end-of-aisle placement that markets Q Mixers with a spirits brand or informs the consumer on how to use the product.

This highlights the challenge for premium mixers. It's not clear how to achieve a high rate of sale or how to consume the product. Fever-Tree addresses this by selling directly, not through all-in-one food distributors that handle both food and soft drinks. Fever-Tree sells directly to Kroger and maintains a relationship with Southern Glazers, supported by their brand relationships.

In the US, Fever-Tree has an exclusive relationship with Southern Glazers for merchandising. Fever-Tree will distribute products directly to Kroger, but they will also work with Southern Glazers for merchandising. This means they decide on product placement, like being in a specific aisle or alongside brands like Maker's Mark, Jim Beam, or Grey Goose. Southern Glazers will merchandise Fever-Tree as their exclusive mixer with their portfolio of spirit brands.

This strategy is quite different from what Q Mixers or Schweppes do. Schweppes, for example, is marketed with Coca-Cola or Dr Pepper and is typically bundled in the soft drink category. This difference in strategy is significant. It raises questions about brand equity, merchandising effectiveness, and the willingness of spirits companies to partner with Fever-Tree. The price competitiveness of premium mixers like Fever-Tree compared to Schweppes is also a factor.

This uniqueness in the category is something we explored in our research. We looked at how distributing these mixers differently can lead to better product placement, a better understanding from customers on how to use the product, potentially higher sales rates, and more market share. This creates a feedback loop, off-premise. On-premise strategies differ, and we delve into that as well.

On-premise in the US, Fever-Tree has a unique relationship with Southern Glazers. In the US, manufacturers cannot distribute liquor directly to retail; they must go through distributors like Southern Glazers or RNDC. Fever-Tree is run by people with backgrounds in liquor and advertising. The US operations are led by a former LVMH executive who managed the Moët Hennessy portfolio.

Our research aimed to understand the distribution intricacies both off and on-premise. Spirits companies can't market directly to on-premise accounts like Hilton, Marriott, or Four Seasons. They can't subsidize them directly either; it must go through distributors and agencies. Fever-Tree acts as an intermediary, facilitating co-marketing between spirit companies and on-premise brands, such as top restaurants and hotels.

For example, Fever-Tree might organize a trip to Jim Beam or Maker's Mark for Hilton or Four Seasons, including tasting sessions. Fever-Tree facilitates these activities, allowing spirits companies to use Fever-Tree as a conduit for co-marketing. This results in Fever-Tree being placed on menus at places like the Four Seasons, co-marketed with the spirits brand. Schweppes, on the other hand, benefits from being associated with Coca-Cola or Dr Pepper.

These soft drinks are typically sold in every account, whether on the gun or in bottles, mainly on the gun. They come with a very different merchandising strategy. We try to highlight these differences in how the product is distributed and what that might mean for Fever-Tree's long-term growth opportunities and overall moat. This strategy is very different from Q Mixers, which was built mainly off-premise. They don't have many on-premise people trying to sell and build menus with top hotels, which has been a struggle over the last few years. They have lost key on-premise people, making it challenging. It will be interesting to see what happens over the next few years in the US with Fever-Tree to test if this distribution moat actually exists. Having a different strategy is one thing; the next step is ensuring it's the right strategy.

One thing I want to highlight is this tension - perhaps we can call it tension - regarding company learning journeys. You have specifically driven this. We have a framework for analyzing businesses, examining everything from the market structure, who holds power in the value chain, and the competitive possibilities the market structure affords different components or players within the value chain. We then delve into business model mechanics, exploring why something exists, how it's distributed, how the product goes to market, and relationships with different stakeholders in the value chain. We consider all these aspects, and then you distill this work into the company learning journey. As we've discussed, this isn't a 150-page initiation of coverage document. It is your best attempt to consolidate years of work into something that can be read in less than an hour and a half. It is your bet on what matters most.

I say all these things about how Fever-Tree is trying to differentiate itself and whether this actually matters. The gross margin of Fever-Tree has decreased from 50% to 32% over the last eight years. Why does this matter? I cover the gross margin and economies of scale, particularly in the US, logistics, and bottling.

Part of the gross margin pressure is due to these factors. Fever-Tree messed up logistics for years. Most of their volume is sold in glass bottles, not cans. The Russia-Ukraine war increased gas and glass prices, and they weren't hedged correctly. They used to manufacture and distribute globally from Somerset in the UK, using one bottling company that was also a shareholder pre-IPO. They had huge economies of scale, even when distributing from Somerset.

They then opened logistics on the US East and West coasts, which led to issues. They had to change their bottling partner, resulting in diseconomies of scale. Moving from Somerset to the US meant underutilizing facilities and increasing fixed costs, lowering gross profit per unit. They were also affected by high gas prices and freight costs from Covid, hitting shipping from Somerset to the US. That all rolled up into really hurting the gross margin.

The question is if and how this can improve, and whether the distribution strategy can drive organic growth and recover gross profit per unit or margin. This is a key question for the next few years. Another aspect is the pricing power question. In 2020 and 2021, they reduced pricing by 14% per liter in the US because the gap between Schweppes and Fever-Tree was too large compared to the UK.

This raises the question of how premium Fever-Tree really is if they have to reduce pricing. The research piece explores whether Fever-Tree, run by people with liquor and marketing expertise, can leverage a differentiated strategy in the non-alcoholic category in the US. If there is a moat, how can it drive long-term organic growth and pricing power while balancing the damaged economics of the business in recent years? This defines the structure of the research piece.

As with all these pieces, we have a list of further research questions at the bottom. This will inform our subscribers about where the next 10, 20, or 30 hours of work and $10,000, $20,000 of fieldwork budget will be allocated. We have questions regarding the risk of Southern Glazers dropping exclusivity with Fever-Tree, among others. There are about seven questions we are considering.

If it's not clear already, the main point we want to emphasize is that while our approach to studying the business is relatively universal and has been refined over 10 years, the goal is to provide insights from the field on what truly matters for the business's value drivers in the shortest possible time.

With this company, it's challenging because every state in the US has different liquor laws. Every conversation needs to be taken with a grain of salt. You can see major differences in the philosophy or strategy of Q Mixers versus Fever-Tree. For example, in off-premise sales to Kroger or Walmart; Fever-Tree sells directly to these companies with a nationwide strategy, while Q Mixers is distributed through food distributors.

On the on-premise side, the situation can be completely different, like in California compared to Texas or Florida. Speaking to distributors and salespeople for these brands in different regions may yield completely different answers. Calibrating this information into the research piece is quite difficult, and there's always room to learn and explore further.

This is without even considering Europe or Australia. Fever-Tree has recently taken back ownership of distribution in Australia, moving from a third-party to owning it themselves. This change is reflected in their cost base, as they're employing more people and taking back distribution, which will increase the cost per unit in the short term without a corresponding increase in volume. It's an interesting business to study due to its complexity and the lack of a definitive answer.

It's a fascinating case study in moat building and distribution. It's a tricky category, which can deter many people. You haven't invested in this business for several years, at least six or seven, but it remains of interest as a "what if" scenario.

I want to emphasize to our listeners that this piece illustrates our evergreen approach to business case studies. We are willing to examine something for years without investing, purely for the sake of learning something we believe might be interesting.

Since we published this piece, I conducted an interview with a distributor in the UK, and the situation is completely different there. Fever-Tree, although the biggest mixer in the UK by far, is potentially being outcompeted. They've lost some market share to new entrants and companies that have been around for 10 years and are offering more discounts.

A significant risk I see with the company is that, as you mentioned earlier, it's hard to tell the difference in taste between Fever-Tree and another premium mixer. However, you can differentiate with representatives. The risk, particularly in the UK, is that the pitch to bartenders has been to pair a premium spirit with a premium mixer. This allows bartenders to increase the drink price by £3 or £4, gaining an additional £1 of gross profit, which boosts their gross profit by 30% to 40% just by using a premium tonic or mixer.

The question is whether the customer in a bar, restaurant, or hotel cares if they are served a Double Dutch bottle or a Fever-Tree bottle with their tonic and Grey Goose. If they don't care and Double Dutch is offering a 20% discount to the bartender compared to Fever-Tree, the bartender will sell the same amount of premium tonics and earn a higher gross profit per drink. The risk is that in the UK and possibly other regions without differentiated distribution strategies, anyone can carbonate water, flavor it, and offer discounts to bartenders.

If the bartender perceives it as a premium mix, it results in a better drink, higher gross profit, and the customer doesn't notice the difference. Fever-Tree may lose share on-premise in regions like the UK and Europe because bartenders, hotels, and restaurants might switch to a cheaper premium tonic or mixer for higher profits. This is something I will be exploring over the next few months, at least in the UK and Europe. I don't think this is the case for the US, which makes the company's situation quite complex. It's important to understand the long-term opportunity by assessing what truly matters for the business.

That wraps up our discussion on Fever-Tree for today. We'll be exploring Perimeter Solutions next week. Thanks for listening.

Enjoy your tonic.

As always, this is for informational purposes only and should not be relied upon for investment decisions. Please conduct your own research.