News of Constellation's bid for fellow North American winemaker Vincor should not have caught the industry off-guard, argues Chris Brook-Carter. Not only are the businesses a good fit but the move is part of a long-term strategy that has reaped significant benefits for the world's largest winemaker.

Constellation Brands' thirst for acquisitions continues to surprise even the most seasoned industry observer. But last week's move on Vincor was well in keeping with the US giant's recent strategy and, despite Vincor's protests, the Canadian group looks likely to become the latest prize for the world's largest winemaker.

Following Constellation's successful bid for struggling Mondavi last year, the timing of the Vincor bid should certainly have been no surprise. A disappointing set of first- quarter results at Vincor in August was quickly followed by a fall in share price.

Constellation saw an opening into a company it has now admitted to having its eye on for some time and called for a meeting with Vincor CEO Donald Triggs on 9 September to discuss a potential sale. However, the talks came to nothing and Constellation CEO Richard Sands significantly increased the heat on his opposite number last week by going public with an offer.

Constellation has offered US$26.45 (C$31) per share, valuing the Canadian-based wine company at US$1.2bn.

In a statement, Sands said: "We are disappointed that the Vincor Board has refused to engage in meaningful discussions with Constellation regarding our premium proposal. This transaction is a unique opportunity for Vincor and its shareholders to receive a significant cash premium for their shares despite the very difficult operating conditions Vincor faces in markets such as the US, the UK and Australia where it lacks scale."

Vincor has come out fighting by effectively putting itself on the auction block after spurning the Constellation offer. Sources suggest at least five alternative bidders have been contacted after a new investor presentation, posted on Vincor's website, called for suitors. Both Merrill Lynch and BMO Nesbitt Burns are working as Vincor's investment bankers in its search for a buyer.

"We view this as an opportunistic and inadequate approach by Constellation," said Mark Hilson, one of Vincor's independent directors. "The initial analysis by management and our independent advisors strongly suggests that Constellation's approach grossly undervalues the growth prospects in Vincor's core business and does not take into consideration the significant synergies that an international wine company like Constellation could achieve."

Constellation's bid of C$31 per share is a premium of about 39% over Vincor's closing share price on 8 September. However, Vincor's objections that this is opportunistic do seem to carry some weight, with shares at a 52-week low.

"Vincor had said the timing is opportunistic and, fair enough, it is," Ross Turnbull, an analyst with Odlum Brown, was quoted as saying in the Canadian press this week. He added: "Investors should hold out for a higher offer. Management is indicating they are willing to co-operate at some level. They have built what I think is a good business with great long-term prospects. Certainly the next 18 months don't look so good for them in terms of the wine glut and some other issues. Longer term, they have a great story and they have a good management team."

According to Vincor's presentation, the company believes that Constellation can afford to pay in the region of C$37.87 to C$41.20 per share or even more once synergies are taken into account. Furthermore, Vincor's chief executive, Donald Triggs, believes he knows there are at least four other bidders with C$80m or more of synergies a year.

But, despite all the fighting talk, Constellation's position in this takeover battle looks compelling.

It is of course early days, but there are so far no signs of a rival bid emerging from a list of potentials that could include Gallo, Diageo and Castel. Moreover, should one appear, then Constellation is well set for a bidding war. It clearly has funds available, as demonstrated by its unsuccessful attempt to acquire the much larger Allied Domecq business earlier this year, and it is just as well if not better placed to reap the rewards of any potential cost synergies from Vincor.

"We could see other bidders emerge - although we consider this unlikely," said Legg Mason beverage analyst Mark Swartzberg, adding that "an 'ego' premium (ie that amount necessary to satisfy Vincor's management and board that they have added value in negotiating a sale) may push the price up another 10% to 15%, a level built into our preliminarily positive read on the proposed acquisition."

In fact, Constellation has also already hinted that it is prepared to increase its bid.

Sands said in a conference call last week: "We are committed to completing this transaction with Vincor quickly, and I emphasise quickly. We will make all our resources available to achieve that goal.

"It's really a two-part proposal," he added. "We will pay C$31 a share for a negotiated transaction without any additional information. Alternatively, we would prefer that Vincor share information with us so that we can pay additional value as that information warrants."

That Constellation is willing to dig in and fight for this business should be no surprise, despite Vincor's recent financial troubles. Vincor has a strong portfolio of branded wines and a very healthy position in Canada, while its UK business - some recent bumps aside - is inherently attractive.

Perhaps just as importantly however, the Vincor acquisition fits Constellation's business strategy, a strategy that has reaped enormous rewards in the last five years. And, in that sense it is too good an opportunity for Sands & Co. to pass up.

"The proposal appears to fit Constellation's strategic and financial objectives to grow via acquisition," Swartzberg said. "Specifically, we believe it is likely to provide significant cost synergies while also presenting the company with at least two main strategic opportunities - (i) a major platform in Canada, attractive in its own right and a major new outlet for distribution of its existing portfolio and (ii) a major business in the UK, which is facing difficulty and would likely benefit from Constellation's market know-how and number-one position."
He continued: "Each potential acquisition is unique and carries risks, but we believe this transaction's profile - strategically, financially, and in terms of viability - is typical of an acquisition strategy that has been the single biggest driver of more than US$5bn in value creation [for Constellation] over the last seven years."