Diageo, the world’s biggest spirits group, may have confirmed that it is in discussions with Vijay Mallya’s United Spirits to acquire a stake in the business, though observers aren’t pinning their hopes on a deal going through.

The two companies had been in extensive negotiations regarding a stake sale two years ago – talks that eventually collapsed, despite Diageo’s eagerness to expand its presence in the Indian market, where United Spirits, the market leader has around a 59 per cent market share.

There are a number of hurdles that will have to be overcome, for the deal to be successful – notably the issue of valuation which Diageo cited as the principal reason (among several) for the previous attempt failing.

“Diageo’s track record on acquisitions suggests they are cautious acquirers with a strong emphasis on shareholder value. They won’t overpay and will happily walk away if the deal is deemed not attractive enough,” says Martin Deboo, an analyst at Investec in London, pointing to the company’s decision back in 2008 to walk away from a deal to acquire Sweden’s Absolut Vodka.

Size of the stake

Then there’s the size of the stake that Diageo will be able to acquire and whether it will be able to gain management control over the group – or at least have the prospect of an incremental build-up.

“They would only buy a business if they saw a route to long term control of the business,” says Trevor Sterling, an analyst at Sanford Bernstein.

The company has, for example, incrementally increased its stake in Chinese white spirit maker Shui Jing Fang.

There will be competition issues to look at to – notably the future of Whyte & Mackay, the Scottish whiskey business that United Spirits acquired back in 2007, which Diageo may be forced to sell should a deal go ahead.

“It’s a delicate balancing act for Diageo,” says Sterling.

At the same time, given the state of his business empire, the pressure on Mallya to reach a successful deal will be higher – as it will be on Diageo.

“The company has said they want to get 50 per cent of their sales from emerging markets by 2015 so to an extent they are a hostage to that guidance,” says Phil Carrol, an analyst at Shore Capital.

The company currently does around 40 per cent of its sales in emerging markets, and has been building up its business organically and through acquisitions, including in Vietnam, China and Brazil, and has been in talks to acquire Mexican tequila brand Jose Cuervo.

(This article was published on September 26, 2012)
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