Investors are growing increasingly concerned that Diageo (NYSE: DEO) doesn't have a coherent acquisition strategy. While it is trying to cash in on the premiumization trend in alcoholic beverages, the distiller looks like it's taking a scattershot approach and it's not getting good value for shareholders from its decisions.
It's not just the purchase of Casamigos, the tequila with Hollywood star power behind it, that worries them. It also includes the 2015 deal with Casa Cuervo to swap Bushmills Irish whiskey for Don Julio tequila and $408 million in cash. It wouldn't have been so bad had Diageo not just decided to launch a new Irish whiskey label, Roe & Co.
In a letter to its investors, Diageo's eighth-largest investor, Lindsell Train, criticized the moves as inconsistent and said that while they "don't necessarily ring alarm bells, but are definitely of the kinds that need having an eye kept on."
The price of fame
Diageo was an early convert to both the value found in premiumization and using celebrity to move liquor. A decade ago, it collaborated with rap impresario Sean Combs on the premium Ciroc vodka, whose sales peaked at 2.6 million cases in 2015, but have declined since, with sales tumbling 15% in the U.S. last year. They partnered again in 2014 to purchase the super-premium tequila brand DeLeon, and Diageo also teamed up that year with soccer's David Beckham for a new single-grain whiskey, Haig Club.
So the decision by the distiller to buy actor George Clooney's Casamigos premium tequila really wasn't a surprise. What raised eyebrows was the amount of money it paid for it: $700 million, with an additional $300 million in earnouts. Diageo has seemingly climbed aboard the premiumisation bandwagon with both feet and is willing to pay top dollar for small-batch brands so long as they come with a dash of paparazzi flash. But that makes turning a deal into a successful acquisition all the more difficult.
The limits of paying premium prices
Recently, Constellation Brands (NYSE: STZ) wrote down the carrying value of its Ballast Point Brewing craft beer acquisition, for which it paid $1 billion two years ago. The $86 million impairment charge is negligible to the purchase price, but it's indicative that Constellation overpaid and Diageo may soon feel the same.
Analysts were immediately critical of the Casamigos purchase price, noting that even if it is the fastest-growing superpremium tequila in the U.S. as Diageo touted, the distiller still paid 20 times annual revenue, a fairly exorbitant amount when other deals typically go for just four to six times sales. It is possible Casamigos could turn into the next Patron tequila, a blockbuster superpremium tequila in its own right, but Morningstar analysts say it's just as likely "it might be value destructive."
Even Lindsell Train thought the acquisition could be "interesting," but when you factor in Diageo's willingness to shed Bushmill's for another premium tequila, only to come back two years later and try to build up something that doesn't have the 400-year history of the one you gave away, it becomes concerning.
A tequila sunrise
It's true, tequila is a growth market. Euromonitor International estimates that consumption grew 6% globally last ar, while rising 8.4% in the U.S. America also happens to be the largest market for tequila, representing half of total cases sold worldwide. Consumption is expected to grow 15% by 2021.
Diageo's biggest problem has been the maturity of its spirits portfolio, which isn't aging well, and though that might explain why it's willing to bet big on upstarts like Casamigos and Roe & Co., their diminutive size means whatever impact they're going to have is going to be negligible. And in the case of Casamigos, it's going to be pitting premium-tequila in direct competition to Don Julio, which is targeted at the same market at the same price point. Diageo could end up cannibalizing sales.
There's good reason investors are worried that rather than be accretive to earnings after three years as Diageo contends, the acquisition will be dilutive. And trying to create something out of nothing in Irish whiskey when you had the grandpappy of them all in your portfolio but traded away, investors may get even more restive if they don't see the promised results.