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Constellation's wine sale to Gallo – It had to be you – analysis

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In keeping with the wider wine strategy to pursue value at the expense of volume, Constellation Brands' divestment of around 30 lower-end brands this week comes as little surprise. Nor does the identity of the buyer, according to one analyst, with E&J Gallo "uniquely positioned" to take on Constellation's unwanteds.

At US$1.7bn, E&J Gallo Winery has taken on a raft of Constellations wine brands for much less than many expected

At US$1.7bn, E&J Gallo Winery has taken on a raft of Constellation's wine brands for much less than many expected

In a note to clients following the announcement yesterday, Bernstein's Euan McLeish made the case for Gallo being the only viable acquirer for wine brands such as Arbor Mist and Cooks. McLeish also flagged that, as the wine market leader in the US, Gallo will only get stronger as a result of the transaction, despite declining demand for sub-$11 wines in the country.

"The company is uniquely positioned to extract value from the acquired portfolio via idiosyncratic synergies," McLeish wrote. "They will access increased economies of scale in their in-house packaging supply chain operations and, in a number of segments, Gallo will attain dominant positions as a result of the acquisition."

To back his claims, McLeish noted that in fruit wine, Arbor Mist, which leads the segment with annual sales of around 3m cases, will join number two brand Wild Vines in Gallo's portfolio. "We expect them to switch Arbor Mist from a wine-based alcohol to a malt base in order to cut COGS and tax," McLeish said.

Over in sparkling, where bottle prices are around $5-$6, Gallo will welcome Cooks through the door – that's 2m more cases to add to the volume pile. "We see scope for them (Gallo) to drive pricing on these products as a result, "McLeish adds.

"Gallo's increased scale advantage in the low-end wine segments should augment Gallo's share of voice and sway with distributors and retailers."

And, what of Constellation? According to McLeish, the group had to throw in a few sweeteners to make the deal worthwhile for Gallo, with some premium brands that retail at $14 to $17 per bottle also making the move. "To get the deal done," he wrote, "Constellation also had to include … the successful Black Box brand that has been growing volume at an 18% CAGR. Losing this weakens their customer proposition in our view."

Bonnie Herzog at Wells Fargo was more upbeat on Constellation's post-transaction prospects. "We view Constellation's sale of its low-end wine portfolio as a positive catalyst that will ultimately warrant a higher multiple, given Constellation's remaining business should generate faster top-line & operating income growth as well as better margins in the next several years," she said yesterday. "We continue to believe Constellation's valuation is attractive especially because investors can buy its fast-growing beer business today at a market price-to-earnings multiple and get a free call option on cannabis, in our view."

Of course, the numbers have made the headlines: At US$1.7bn, the offload looks cheap – one analyst had estimated that $2.3bn was a sensible valuation, while reports last year suggested a $3bn price tag.

Put the price together with its existing capabilities, then Gallo looks the perfect home for these brands.


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