Diageo: Could An Acquisition Be In The Cards?

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Diageo (NYSE:DEO) is the worldwide leader in alcoholic beverages, with iconic brands such as Johnnie Walker, Smirnoff, Baileys, and Guinness in its portfolio. Between 2009 and 2013, the company saw revenues grow at about 4-5% a year, leading the stock value to almost double over the same period. However, things turned around in 2014 for the company against a slower U.S. spirits market, “anti-extravagance” in China, and unfavorable currency movements in other key markets, leading the stock price to decline almost 15% over the past year. Recently, the news of a potential acquisition surfaced, with Brazilian billionaire Jorge Paulo Lemann and his private equity firm 3G Capital formulating a bid for a potential take over of the alcoholic beverage giant. [1]

3G has historically been known to have a voracious appetite for acquisitions, especially in the consumer brand space. In the past few years, the company was involved in taking over notable names in the consumer and retail sector such as H. J. Heinz & Co. (NYSE:HNZ) and Burger King (NYSE:BKW). [2]

A similar story could hold for Diageo in the event that the merger comes through. While Diageo has historically performed well, 2014 proved to be rather difficult, with revenues falling 8% and profits declining 18%. In the event that the company is taken over, Diageo could recoup profits against major cost synergies from a merger, given that 3G has a major stake in the leading beer company, Anheuser-Busch InBev (NYSE:BUD). AB InBev has industry-leading operating margins of approximately 32%. In this case, combining operations, marketing muscle, and distribution channels with Diageo could translate into cost advantages for the company, apart from making the post-merger entity a ruling force in the alcoholic beverage market.

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However, from these very synergies arises possibilities of a merger not panning out. For one, a merger between the likes of Diageo and Anheuser-Busch InBev, who are both global leaders in spirits and beer respectively, could form a body that may be extremely hard for other players to compete against. On these grounds, the deal may not be given regulatory authority at all, or could involve major divestitures, which could potentially erode the profitability of the deal for 3G. Secondly, 3G has always followed a philosophy where “every expense must be newly justified every year, not just new ones, and the goal is to bring it lower than the year prior.” [3] Keeping this in mind, most of their turnover stories have involved major cost-cutting strategies, as evidenced by the 1,400 job slash at Anheuser-Busch in 2008. These strategies are hardly compatible with the spirits business, which involves significantly higher costs of distilling and marketing in comparison to beer. Those in the spirits business often try to boost profits through higher sales, where a cost-cutting strategy may not be a good fit. Third, according to analysts at Bernstein, the merger indicates strength only in developing markets such as Nigeria that are big markets for Diageo’s stout beer, Guinness. While Diageo’s beer brand could benefit from Anheuser-Busch’s expertise, spirits may be another ball game all together, that Anheuser-Busch may have little to contribute to. Lastly, the possible bid required to acquire Diageo may not be in line if one took 3G’s earlier bids into account. Jefferies quotes a price tag of $73 billion for the company, which may be way off the $3 billion or $4 billion that the company put into Burger King and Heinz, respectively. [3]

Although a number of factors make the chances of an acquisition bleak, the news managed to create positive expectations in the market, against which, Diageo’s stock price ramped up an 8.7% increase last week. In conclusion, an acquisition of this sort may not be in the cards at all, since the U.K. takeover rules requires companies to inform the Takeover Panel of any potential mergers or acquisitions, in the event of “material or abrupt movement” in share price. [4] Since Diageo made no such disclosure, the news of an acquisition has just been mere speculation (so far). However, this indicates the possibility of M&A activity in the alcoholic beverage space, that could alter market dynamics for all the players, going forward.

Trefis has a $116 price estimate for Diageo, which is in line with the current market price.

See Our Complete Analysis For Diageo Here

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Notes:
  1. Diageo possible takeover target for Brazil’s richest man – reports []
  2. 3G Capital Partners All Set In The Acquisition Mood)) For many, 3G has acted as the turnaround champion by reinvigorating sales and cutting costs. For instance, in 2010, they bought out the then troubled Burger King for $3.3 billion and used a number of outward strategies, including further M&A activity, to revive market shares for the company. When Burger King made it back to public markets, the stock gained momentum the very first day and went on to almost double in value since. ((4 Takeaways From Burger King’s Whopping Tim Hortons Play []
  3. Analysis – Diageo takeover unlikely as 3G rumors swirl [] []
  4. Diageo Shares Climb on Takeover Speculation []