Diageo's announcement that it will not be exercising its option to buy the New Zealand wine company Montana from Pernod Ricard has raised questions over the company's commitment to wine, while allowing Pernod Ricard to retain what it sees as a significant asset. Ben Cooper reports.

Diageo's decision not to exercise its option to buy the New Zealand wine company Montana from Pernod Ricard took the industry somewhat by surprise. In the summer, Pernod sold Bushmills Irish whiskey to Diageo and gave the group an option to buy Montana, in return for Diageo agreeing not to involve itself in any counter-bid for Allied Domecq.

At the time, it seemed like good business for both companies, and analysts saw Montana as a useful addition to Diageo's portfolio. Now it appears that, having taken a closer look at Montana, Diageo does not concur.  Diageo's CEO, Paul Walsh, said: "We have now examined the opportunities that the Montana business presents and we have concluded that it does not fit our investment criteria and have decided not to proceed."

As Diageo's original move for Montana seemed to confirm a renewed enthusiasm for the wine sector, the company's decision not to exercise its option has not surprisingly led some to question the group's commitment to wine.

In contrast, Pernod Ricard's unequivocal response to Diageo's announcement suggests it has no doubts about Montana's merits and the opportunities the wine sector can offer. Pernod Ricard's joint managing director, Richard Burrows, had hinted in September that the company would be looking to keep Montana if Diageo decided not to buy it, and the group duly announced that it would be retaining the company.

"Montana is a strong company that logically fits into Pernod's Australasian commitment to the global wine industry with Orlando," said Robert Nicholson of the US-based wine consultancy, International Wine Associates.

The fact that Pernod has retained Montana is significant. It indicates that it would have preferred not to have offered the option in the first place, and only did so to ensure Diageo kept away from Allied Domecq. Now that Pernod can retain what it clearly sees as a significant asset, it appears the French group achieved its objective at an effectively lower cost, another canny manoeuvre by a company increasingly seen as a smooth operator in the mergers and acquisitions field.

However, it has also been suggested that Montana is more attractive as an asset to Pernod Ricard, with its existing strengths in Australasia, than it is to Diageo,  something that would certainly appear to be borne out by events.

Matthew Jordan, analyst at Dresdner Kleinwort Wasserstein, sees it as a straightforward financial decision by Diageo. "They simply found that the returns were not good enough to warrant the acquisition," Jordan told just-drinks. "They agreed a multiple back in the summer that was too high on reflection." The Montana returns would have beaten the cost of capital within five years, which was reportedly too long for Diageo.

However, according to Jordan, this does not signify a change of emphasis in Diageo's approach to wine, as has been suggested in some quarters. Moreover, the fact that Diageo has eschewed an acquisition at the middle-to-high end of the market should not be taken as an indication that the group is now looking for a mass-market brand. "They definitely told me they do not want a mass market wine," Jordan said, "and that they are only interested in wine acquisitions at the high end of the market."

If that is the case, speculation that Diageo may be planning to launch a counter-bid for Vincor International, currently the subject of a hostile takeover bid from Constellation Brands, would seem to be unfounded.

Diageo's general commitment to wine was underlined by Paul Walsh. "We recognise that wine is a growing category and that our scale can deliver top and bottom line synergy benefits for wine acquisitions," Walsh said. "We will add selectively to our wine business, especially within the premium segment, as we have done with our recent Chalone acquisition."

The Montana decision suggests that Diageo's renewed interest in the wine market - and the premium end of the market - will always be balanced against value for shareholders, but Robert Nicholson does not believe that it has put the group's overall commitment to wine in question. "I do not think that this is a change in the Diageo wine strategy," Nicholson said. "They have proven their commitment to wine as a significant part of their portfolio through their recent acquisitions."

However, profitability and return on capital have always been sticking-points for major drinks companies looking to invest in the wine sector. This decision appears to indicate that finding the kind of value Diageo is looking for in a wine acquisition remains no easy task.