Diageo and Allied Domecq: Is New World wine the next battleground?

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With all eyes trained on the imminent Seagram sale, comments from the respective CEOs of Diageo and Allied Domecq on future wine acquisitions have gone almost unnoticed. believes attention must be given to the possibility of more consolidation in the New World.

Since Diageo announced beer and wine would permanently replace its burger and pies interests, anticipation has risen as to when the global showdown between itself and Allied Domecq for Seagram's spirits and wine division will really begin.

Both Paul Walsh (Diageo's CEO) and Philip Bowman (Allied's CEO (pictured left)), however, have indicated in recent months a keen desire to expand the wine portfolios within their companies. In fact, Bowman mentioned at the company's interim results in May that Allied would be looking at expanding its wine portfolio in the next 12 months (albeit before the Seagram demerger was formally announced).

The official line from each company remains almost religiously spirits focused. The talk of "core brands" continues to take on more significance in driving company strategies forward. However, no-one should be surprised if either Allied, Diageo or both announce a major wine deal in the next six months.

Rumours began circulating the Australian wine industry late last week that executives from a top UK spirits company were heading down under in search of a wine acquisition - both Allied and UDV/Guinness were named.

To many sources this came as a shock, especially in UDV's case. Not only have Diageo's wine concerns been viewed as outside its all important nine priority brand list, but industry pundits in Australia believe that the company will eventually sell all its vinous concerns, which includes BV, Blossom Hill and Le Piat d'Or.

But as one Australian wine source said: "There is certainly substance in this [acquisition] story." Foster's Brewing Group, owner of Mildara Blass, with a market capitalisation of about $A8 billion (£3.2 billion), Southcorp ($A3 billion) and BRL Hardy ($A1 billion) are seen as the only Australian companies likely to be of interest. As one Australian analyst put it: "Whatever they might be looking at, it will be big."

Of the Australian vintners, Southcorp seems the most likely. Sources close to the company claimed UDV executives are preparing to discuss a possible "alliance" with the number two producer, behind BRL Hardy.

But in the UK, others believe it is Allied which is on the verge of a wine deal, buoyed by Bowman's strong Australian connections.

Southcorp is seen as a prime target partly because of a recent share price slump following a profit downgrade caused by slow trading in the lead-in to Australia's new tax system on July 1, and a smaller vintage than expected.

Its global leadership in premium wine production, strong positions in the UK and US markets and an increasing emphasis on brands is considered likely to make it attractive to brands-driven companies such as Allied and Diageo.

"It is quite possible that both companies would be interested if the opportunity arose because of their strong California wine interests," said Alex Oldroyd, analyst with Morgan Stanley. She still believes Bowman has more pressing engagements in the City, convincing financial backers to help fund the Seagram deal, but does not rule out a future alliance.

"Buying Southcorp does not have to mean a direct takeover. Allied could negotiate a stock transaction. Bowman may be talking to them about selling on Seagram's wine business. But what must be remembered is both Diageo and Allied are looking for highly profitable businesses which bring a return on capital - and at the moment that is Seagram," she said.

Southcorp's shareprice closed at $A4.83 last Friday, a 12 cents loss for the week and only 61 cents above its 52-week low, though still $A1.73 below its 52-week high.

Grahame Kraehe, Southcorp's CEO, told this week that the time was now right for Southcorp to advance towards being a major global wine industry company and that it was actively considering acquisitions, joint ventures and alliances and a combination of all three.

One Australian wine source says: "A company that is ripe for taking over is one that has just issued a profit warning. Southcorp's shareprice has just plummeted so they are a cheaper acquisition."
"Fundamentally it is not a bad company at all. Southcorp has strong grower negotiations, tremendous history and branding. It has an international portfolio with high calibre winemakers. The fact that for some reason its shareprice is going through the floor is not testament to the quality of the business - it is therefore perfect for someone wanting to get involved in the Australian wine business to consider taking over," he added.

BRL Hardy, Australia's number one wine company, is another likely contender. But the source says: "BRL could be taken over but I am not sure it would be. Hardy's share price is too expensive by comparison to what else is out there. You can buy a Ferrari or a Lamborghini. They are both performance cars, however one is a lot cheaper than the other."

The argument may already be academic, however, as there is a strong chance, as reported last month, that Hardy is the prime target for the Californian premium wine giant Robert Mondavi (click here for story).

New Zealand's second largest wine company Corbans is also a possibility. Indeed, a spokesman for Salomon Smith Barney, adviser to Corbans immediate owner, the DB Group, told that the company was tendering from a "field of major international wine companies and financial institutions" about an acquisition. He would not comment, however, on any names.

Buying Mildara Blass is another issue. Foster's Brewing is very unlikely to want to sell its successful wine arm, which is now Australia's fourth largest wine producer. So if a company wanted it, the prospective purchaser would have to buy Foster's outright.

It seems unlikely either Allied or Diageo would want to get involved in the low margin/high volume lager world. But IDV is known to have looked closely at Foster's some years ago when the dominant Australian brewer was struggling. Foster's has since acquired Mildara Blass and an extensive portfolio of high margin premium wines.

The premium wine sector offers an interesting prospect to the large spirits companies. Although margins, at the standard end, are still a far cry from the world of Smirnoff and Tanqueray, they are still good in the over £5 market and get better the closer to the premium end you get.

"Historically, wine doesn't earn drinks companies much money but recently the premium wine market, with brands such as Jacob's Creek, Penfolds and Wolf Blass, has taken off and you are looking at attractive propositions producing growth," said Ian Shackleton, analyst with Donaldson, Lufkin and Jenrette (DLJ).

He agrees that Bowman's background and connections puts Allied in a strong position for an Aussie acquisition but is sceptical of any deal while the Seagram auction is running. "The Seagram deal would transform Allied. This would give it the volume to rival UDV and strategically offers more scope to spread its markets. The problem with New World wine ventures is their predominance in English-speaking markets which isolates continental Europe and Latin America," he said.

Allied's wine business is concentrated in the US, where it is the second largest marketer of super-premium table wines, with over 1m cases. Its main brands are Clos du Bois, Atlas Peak, William Hill, Callaway and Harveys.

To put the value of premium wines into perspective, recent AC Neilsen figures show that the UK market alone is creating multi-million pound brands. Of the Australian wines, Jacob's Creek is number two valued at £71.4m; Hardy's Stamp of Australia and Nottage Hill hold third place valued at £62.6m; Southcorp's Lindemans and Penfolds are take fifth and eighth place, valued at £34m and £25.4m respectively. UDV's old favourite Le Piat d'Or is ranked the UK's seventh most popular brand worth £23m.

Shareholder value is the well-used excuse for pursing mergers and since the Diageo merger, investors have been concerned with both companies' shareprice. In Diageo's case, apart from a brief period of post-merger euphoria, the shareprice has never really taken off. Allied's shareprice has been equally unstable, even dropping out the FTSE 100 earlier this year and only recently rebounding.

This may be partly explained by the companies' reliance on spirits, which is a declining market. In the UK alone spirits consumption has fallen 25.8% between 1980 and 1998 and in the US the figure is 39.4%.

Wine by comparison has leapt by over 100% in the UK and fallen only 7% in the US. As more consumers turn to wine products, is it such a surprise that companies eager to become the world's premier alcohol producer would be looking in that direction?

Elliot Lane and Chris Brook-Carter

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