Diageo plc (NYSE:DEO) (LON:DGE) shares fell on Tuesday after it cut off acquisition discussions with Jose Cuervo.
After reaching an all-time high on Monday at 1,887 pence in London, shares dropped 1.6 percent on the end of negotiations. Its fall also weighed down the FTSE 100, taking three points off it, after seeing 9-month closing highs on Monday reported Reuters.
Manoj Ladwa, head of trading at TJ Markets, said to Reuters, “The news of the (Cuervo) acquisition not working out could be the catalyst for Diageo to come down to more realistic levels.”
Diageo plc (NYSE:DEO) (LON:DGE) had been interested in Jose Cuervo as an addition to its collection of premium drinks. The deal reportedly had a $3 billion value, but the Mexican tequila company said no thanks.
The possible acquisition came about as Diageo’s distribution agreement with the company will end June 2013. Diageo had been clear it wanted an equity share that would eventually end with ownership, but the long talks to make it happen broke down with the family-owned company.
Bernstein analyst Trevor Stirling wasn’t surprised by the dissolved talks, reported the Wall Street Journal, as he saw getting a family-owned business to sell would be be tricky.
Stirling said, “In all of these negotiations there is a complex mixture of emotion, pride, and price. Clearly the balance wasn’t right when it came to Diageo.”
But Shore Capital analyst Phil Carroll had a different take. He noted “good capital discipline” by Diageo to just let the deal go, but he sees the company putting in an additional investment because of its distribution contract.
Accroding to Reuters, Diageo plc (NYSE:DEO) (LON:DGE) has traded at 18.1 times its expected earnings for the next year and offered a 2.5 percent dividend yield, which has come in line with the STOXX 600 food & beverages index; this is trading at a 18.3 multiple and a 2.7 percent yield.
So what’s next for Diageo?
The company will not hold a major tequila brand within its offerings after the middle of next year, so analysts think the company could look at BEAM Inc (NYSE:BEAM). The company sits as the No. 1 bourbon producer in the world and No. 4 as the largest liquor company. It has a number of American bourbons and the No. 2 global tequila brand, Sauza.
Stirling commented via Wall Street Journal, “It does make Beam directionally more attractive for Diageo,” while Carroll noted, “Going after the Sauza brand is probably the next logical position. But you have issues over valuation.”
Another name in the mix has been Japanese brewer Suntory Holdings. Diageo plc (NYSE:DEO) (LON:DGE) has not commented on reports that it has been in talks with the company to make a joint $10 billion bid for Beam.
Analysts at Raymond Rames note that Diageo did not want to renew the distribution agreement with Cuervo but wanted to own a stake in the brand in order to have the freedom to invest in it. The main reason mentioned by the group explaining the end of negotiations is the fact that the two parties did not agree on the valuation of Cuervo and according to the press release “it has not been possible to agree a transaction which delivers value to Diageo’s shareholders”.
Diageo would have needed to put a lot of resources into the brand and estimates that Cuervo would not have reached economic profit
breakeven before year 4. The group estimates that the impact is below 2p/share on EPS, which is very small.
Tequila represented 3% of Diageo’s net sales in 2011-12 (£323m), of which Cuervo generated sales of more than £300m. The group, which is now losing Cuervo, still owns the Don Julio tequila brand, which is much smaller (less than £10m in net sales) but much more dynamic than Cuervo (up 23% in 2011-12 while Cuervo was declining by 5% in organic terms).