Diageo Overpays for World Whisky Domination

Owning the biggest distiller in the biggest market comes at a high price.

Apr 16, 2014 at 6:00PM
Screen Shot

Source: United Spirits.

Parsimony may have cost Diageo (NYSE:DEO) the chance to control the largest distiller in the world's largest whisky market two years ago, and now it's forced to pay through the nose for its mistake.

India is the world's largest whisky market, consuming around 1.5 billion liters of whisky annually, or about half of the world's consumption. United Spirits is the biggest spirits company in the country, owning a 40% share by volume. On a per capita basis, however, India ranks far down the list behind No. 1 France (the U.S. places third).

Emerging markets have become the target of distillers that see their economic expansion creating more middle-class consumers with more disposable income available to spend on adult beverages. Diageo just made a $1.9 billion bid to gain majority control over United Spirits, in which it already owns a near 29% stake. Had it not been so frugal, however, when it ran a tender offer last year, Diageo could have taken control over it for a much lower price. The company's new offer is now twice the price it was willing to pay back then, but is so high that it will take at least seven years for the acquisition to make a positive contribution to earnings.

The World S Biggest Whiskey Drinkers Whiskey Consumption Per Capita

In 2012, Diageo attempted to acquire a 53% position in United Spirits for $2 billion, and got around 25% from interests owned by Vijay Mallya, the billionaire tycoon who controlled the spirits company through his UB Group conglomerate. However, when he attempted to tender the additional portion of the company, its offer of 1,440 rupees was below where United Spirits' stock was trading on Indian bourses and, because Diageo refused to raise the price, the tender received little interest from shareholders. Diageo has since obtained an additional 4% of the stock.  

The latest bid is 18% above what United Spirits' stock was trading for when the bid was announced and, if successful, will give Diageo control of almost 55% of the distiller. Yet, because of the amount of time it will take for the acquisition to make a positive contribution to the distiller's results, the risks associated with it run high. Although India is projected to account for roughly 70% of the whiskey consumed worldwide through 2017, Reuters reports that some two-thirds of Indians don't drink alcohol at all for religious or cultural reasons. 

Moreover, Diageo has pursued a number of acquisitions or staked majority claims in various emerging markets including Mey Icki in Turkey, Ypioca in Brazil, the Serengeti and Meta Abo breweries in Africa, Shuijingfang in China, and Halico in Vietnam, but not all are turning out as planned. China, for example, cracked down on extravagant gift-giving, and Diageo's sales there tumbled 66% during the six-month period ended this past December.

While India appears to hold a lot of potential, Diageo investors may want to brace themselves with a stiff drink for the possibility it turns in underwhelming results tomorrow because it is overpaying for United Spirits today due to it being so stingy yesterday.

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