Is the time right for Treasury Wine Estates to swoop for Diageo's wine business? - Comment

It’s hard to believe now, but when Diageo acquired Seagram’s wine operations in late-2000, it was seen as a real opportunity; exciting even. Spirits, after all, were sluggish at the time, whereas wine was in impressive growth in the US and Europe. This, it was felt at the time, could be a niched, but prestigious, addition to the business.

Those of us who raised an eyebrow at the coming together of a giant, spirits-based, multi-national and a vintage-sensitive, low-margin, labour-intensive industry like wine were largely ignored or labelled Cassandras. And, for a while, the optimists seemed to have it right. As recently as 2005, wine was still sufficiently interesting to Diageo for it to be buying Chalone for $260m, while in 2008 they shelled out $105m for Zinfandel specialists Rosenblum Cellars. Indeed, after the Chalone purchase, Ray Chadwick, president of Diageo Chateau & Estate Wines, described it as ‘an extremely good strategic fit with our current business.’

The key word in that sentence would be ‘current’. Wine and Diageo have spent a lot of time over the last seven years sitting in silence, asking themselves what each saw in the other in the first place, and wondering whether they’d be better off apart. The honeymoon is over and we cynics have - eventually - been proved right.

To be fair, the blame for this marital breakdown can be at least partly attributed to difficult trading conditions as much as a lack of inherent chemistry. Under pressure from shareholders, Diageo cannot afford indulgences, and is dispensing with vanity projects to concentrate on its core business. It’s hard to argue with the decision to sell off the Gleneagles Hotel & Golf Course earlier this year but, ever since the decision to stop selling en primeur Bordeaux in 2009 and then selling the (ex-Seagram) Barton and Guestier brand to Castel Freres in 2010, the markets have questioned the company’s long-term commitment to wine and have been waiting for signs of a permanent split.

Certainly, there would be a logic to it. Diageo is, after all, a $46bn company, and wine is a mere 4% of that business. While there is a clear synergy between, say, distributing Moet & Chandon or Dom Perignon and a premium spirits portfolio, the latter sits less well with a range of wine estates, or two low-margin wine brands.

Indeed, part of the problem is the sheer lack of focus of the wine side of the business. You could argue that Blossom Hill, Piat d’Or and Beaulieu Vineyards might belong in the same portfolio, but where does that leave a top end Napa Cabernet like Sterling Vineyards? Or a Bordeaux negociant like Vignobles Internationaux? Throw UK fine wine merchant Justerini & Brookes into the mix, and you have a business that could charitably be described as wide-ranging.

Others have been there before. Brewer Foster's Group, having bought Southcorp for AUD3bn (US$2.24bn at today's exchange rate) in 2005 struggled to make the wine side of the business work, and demerged it just six years later. It’s possible that Diageo might yet follow that route, though, ironically, Treasury Wine Estates – Fosters’ one-time wine arm – is the current front runner for the Diageo wine business.

Treasury’s turnaround is impressive. This time last year, the group rejected two bids from private-equity firms, saying they ‘undervalued’ the company – a ballsy assertion, given that TWE had just posted a AUD100m loss for the financial year. Yet, its confidence seems to have been justified. It did, as promised, return to growth this year (AUD77m worth) and appears to have a workable road-map in place. 

Key to the latter is an increased focus on its 15 ‘priority brands’, which, since the company currently has around 80 wine labels on its books, probably means there’s still a fair bit of rationalisation to be carried out.

This, you might think, would seem to mitigate against any purchase of the Diageo wine arm. And certainly, given that TWE has only just returned to profitability - and clearly hasn’t yet tidied up its portfolio to its own satisfaction - it’s fair to say that any putative Diageo deal has probably come a year or two earlier than the board might have liked.

But, at the same time, the fit is not a bad one. Treasury is moving from an agriculturally-driven company to a marketing-driven one. Its strategy, as stated in its 2015 Annual Report, is for ‘fewer, stronger brands with international reach’ and there’s no question that the likes of Blossom Hill and Piat d’Or fit that brief. Moreover, as a wine specialist, TWE would be able to bring knowledge and commitment to the brands that seemed to be lacking under Diageo.

The US is a priority market for Treasury (48% of all its volume is in the Americas) and, since it already has seven wineries in the country, adding a few more would hardly be a leap into the unknown. In Sterling and Rosenblum, it would have wineries in the ‘masstige’ (mass/prestige) area that it professes to target, plus the added benefit of the tourism mecca that is Beaulieu Vineyards.

And, since its Asian business grew 50% in the last financial year, having the Vignobles Internationaux negociant business, giving it access to a raft of Bordeaux chateaux, might not hurt either. I can’t see TWE having any interest in Justerini & Brooks, though, but otherwise the fit is pretty good.

Moreover, I’d say that, in negotiations TWE holds the upper hand. Diageo has been known to be out of love with wine for a while, and potential suitors have been conspicuous by their absence. Not many have the weight to contemplate a big-money deal, and those that do are in ‘consolidation’ rather than ‘expansion’ mode at the moment.

As mentioned earlier, my gut feel here is that this deal has come a year or two too soon for TWE. But, they’re a newly-confident company with a plan that seems to be working. If the numbers don’t stack up exactly how they want, I think they’ll be happy to walk away.

Diageo, though, to quote Ernest Dowson’s famous poem, is desolate and sick of an old passion. I think it scents an opportunity to sell up and move on; to free up some capital and pour it back into the key parts of its business. It needs to sell more than Treasury needs to buy, and I’d expect that to mean a good deal for the shareholders of both companies.

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