Glenboden M & A Originations

The M&A future for a de-leveraging Diageo

Priority Rating priority rating 4
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Origination Status proprietory origination, January 2011
Asset candidates include Moet Hennessy, Beam Global (large), Castle Brands, Blavod (small)
Buyer Diageo plc (UK), global no.1 spirits group
Seller LVMH (Moet Hennessy), Fortune Brands (Beam Global); shareholders of Castle Brands and Blavod
Buyer Rationale portfolio enhancement, global consolidation, opportunistic, new frontier
Seller Rationale acceptable valuation, financial problems
NBs Diageo generated a record >€ 2 bln in free cashflow in 2010
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Analysts predict that Diageo is de-leveraging in order to prepare itself for a major acquisition in 2011. We ask whether that's the case, and identify both big and small deal targets for the group in spirits.

Recent history of small-scale M&A ...Since participating in the break up of Allied Domecq in 2005, Diageo's acquisitions have focused on smaller deals, involving new geographies, or single brands that fill gaps in its portfolio or are perceived as 'new frontier'.

New geography deals include the purchase of Serengeti Breweries in Tanzania, and a majority stake in Quanxing super premium white spirits in China, in 2010.

As for new brands, we can cite the joint-venture over 'Ketel One' super premium vodka in 2008; also the stake taken in the Nuvo ultra premium French sparkling spirits start-up in 2007.

... de-leveraging to presage bigger deals ? ...In FY2010, Diageo generated over € 2 bln in free cashflow, and reduced its net debt to about € 7 bln (that's around x2,2 EBITDA).

The question is whether the group will use this new muscle to make a big acquisition, or whether it would rather continue to make smaller deals, and return its record free cashflow to shareholders.

Intriguingly, in 2010 Diageo used over € 1 bln of its free cashflow to pay dividends, and only € 0,5 bln of it to reduce debt. So it's not clear whether big -ticket M&A is a priority for the group.

... MH and Beam as big deal options ...If Diageo does go for a big deal in 2011, then leading contenders are Moet Hennessy, owned by the French luxury group LVMH, and Beam Global, the US spirits group that's to be de-merged from Fortune Brands.

MH would fill gaps in Diageo's portfolio in the champagne and cognac categories, and lift the share of super-premium brands in the group's sales (see chart). But it could be a very expensive deal (see related origination).

Beam would be more affordable for Diageo (see valuation), and bring strong bourbon and tequila brands to the group. However the split-up of Fortune Brands will take time, and the Beam portfolio has some overlaps with Diageo's.

... young or distressed assets insteadAlternatively, Diageo could continue to focus on returning cash to shareholders, and on smaller acquisitions; perhaps new frontier brands, or spirits groups that have financial issues and could be bought cheaply.

In new frontier, examples include Blavod Wines & Spirits, in the UK, with its quirky Blavod black vodka and Blackwood's 'vintage' gin. Its sales grew by 40% in value terms in 2010.

In troubled, examples include Castle Brands in the US. After operating for 10 years, it has nearly US$ 100 mln in accumulated losses in 2010, and a low gross profit margin. Its portfolio includes Gosling's rum and Jefferson's bourbon.

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Size (€ mln) 7.500
Sector spirits
Asset Quality no.5 global branded
Seller large plc
Buyer large plc
P/S 4,0
P/Ebitda 20,0
Type enterprise value estimate
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