The FTC has challenged Diageo and Pernod's takeover of the Seagram drinks business. The sticking point is Diageo's dominance of the US rum market. It already owns number three brand Malibu, and would get number two Captain Morgan too.

Even though there is still a legal battle raging over Diageo's rights to Captain Morgan, the UK firm would do best to sell Malibu and keep the larger, trendier, faster-growing brand.

The FTC voted on Tuesday to challenge the acquisition of the Seagram drinks business from Vivendi (NYSE: V) by the UK's Diageo (LSE: L.DGE) and France's Pernod Ricard (FR: 012069). The regulator decided by a 5-0 majority that if Diageo controlled both Seagram's Captain Morgan rum and its own Malibu (the number two and number three rum brands in the US), the rum market would effectively be a duopoly.

This rejection is unlikely to cause serious harm to Vivendi or Pernod. The FTC only authorized a preliminary injunction on Tuesday, which would imply it is looking to negotiate a solution that would allow the deal to go ahead.

In any case, the rum issue is the only area in which the FTC has expressed concern, leaving Pernod's side of the acquisition intact. At worst, the deal will take longer to complete.

However, it creates a headache for Diageo. The UK company seriously wants Captain Morgan, which is seen as a premium, high growth brand. It would also provide the company with the opportunities to market premixed Captain Morgan-based drinks alongside its ultra-popular Smirnoff Ice brand.

Although Malibu sells well, its image is much less strong, it is a smaller brand and its growth is slower. Divesting it (an option Diageo has said it will consider) would satisfy the regulator.

But Diageo may not actually get the rights to Captain Morgan. Destileria Serralles, which licensed the rum to Seagram, claimed the sale invalidated the licensing agreement and negotiated a new deal with Diageo's archrival Allied Domecq.

The two UK giants are currently battling in the Puerto Rican courts for control of the rum. If Diageo sold Malibu and then lost the Captain Morgan case, it would be left without a rum brand.

But while this is theoretically a problem, in practice the chances of Allied winning the case are extremely low. If divesting Malibu is the only way to satisfy the FTC, Diageo should go ahead. It would lose more by delaying the deal.

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