Is The Purchase Of Casamigos A Shot Worth Taking For Diageo?

Diageo (NYSE:DEO) has agreed to buy super-premium tequila Casamigos in a transaction that would value the brand at up to $1 billion; an initial consideration of $700 million, with a further potential $300 million if the brand meets certain undisclosed performance measures over the next ten years. Casamigos was created in 2013 by George Clooney, Rande Gerber, and Mike Meldman, and since its inception has received “numerous awards and accolades from tequila experts, taste makers, and influencers across the US.” The brand has witnessed tremendous growth, a CAGR of 54% in the last two years, reaching 120k cases in 2016, and is on track to cross 170k cases by the end of 2017. While the founders will continue to have an active participation in the brand following the takeover, being a part of liquor giant Diageo will ensure not only continued momentum in the US, but also realize the growth opportunity from international expansion. The transaction is expected to close in the second half of 2017, with the company expecting the acquisition to be “EPS neutral for the first three years and accretive thereafter.”

Is Diageo Overpaying?

Shares in Diageo have fallen 2% on the NYSE since the acquisition announcement on June 21st, as analysts were concerned about the premium paid by the alcoholic beverage maker. While Casamigos has been touted as the fastest growing super-premium tequila brand in the US, it is still in a relatively nascent stage. As per analysts at Credit Suisse and Citigroup, the price that Diageo has agreed to buy the tequila company is approximately 10 to 20 times the sales. However, Reuters has stated that the average purchase price in the category is only about four to six times sales.

So Then Why Is Diageo Overpaying?

Among a number of reasons, the chief one is possibly the tremendous growth being witnessed in the super-premium tequila market in the US, where Casamigos primarily generates its sales. Americans can’t seem to get enough of Mexico’s native spirit. Since 2002, tequila volumes have grown by 121%, at an average rate of 5.8%. In 2016 alone, 15.9 million 9-liter cases were sold. What is even more impressive is that while the volumes of value and premium tequila grew by 93% and 72% during the aforementioned time frame, those of high end premium and super premium tequila shot up by 292% and 706%, respectively, according to the Distilled Spirits Council (DISCUS). Meanwhile, supplier revenues have increased by 308% and 641% for high end premium and super premium categories, versus, 68% and 50% for the value and premium brands.

DISCUS defines premium tequila as one which costs between $90 and $160 per case (a case is nine liters), high end premium ranges from $160 to $240, while super premium is anything above $240. Hence, the per bottle price would be less than $10 for value tequila, between $10 and $17.78 for premium, between $17.78 and $26.67 for high end premium, and over $26.67 for super premium. As the price of Casamigos falls between $45 and $55, it falls in the super premium category. Its presence in this lucrative market makes it poised to carry on its enormous growth.

Diageo has also had considerable success following the purchase of another super premium brand – Don Julio. In the six months ended December 2016, the brand reported a net sales improvement of 35%, with organic volume growth of 22%, and organic sales growth of 17%. Double-digit growth was reported in its biggest market – the US, while in Mexico, the brand grew nearly three times faster than the category. Tequila represents just 2% of Diageo’s sales. However, its organic sales growth of 18% in the aforementioned time, outstripped the numbers witnessed in its other categories. Diageo is also now the second biggest player in the tequila market in Mexico, by value.

While Diageo’s existing presence in the super premium category, by virtue of Don Julio, may dishearten stockholders with regards to the imminent purchase of Casamigos, one should consider the heights the liquor giant will be able to take the latter to. Casamigos does not have much of an international presence. Hence, given Diageo’s massive distribution network, and immense marketing capabilities, it will be able to capitalize on the significant international potential of the brand.

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