Consolidation, the fight for premium brands and distribution economies characterize an old economy sector in turmoil. The alcoholic beverages sector mostly excludes brewing but includes wines and spirits. There are relatively few listed companies worldwide in the sector, which gives some indication of how much consolidation there’s been. Even before the recent Seagram deal, the top ten spirits companies controlled roughly 58 percent of the branded market worldwide, according to Moody’s Investors Service.
However, this is by no means the whole story. As Moody’s says: ‘These companies represent only around an estimated 15 percent of the total global market when local and unbranded spirits are also taken into account, indicating a degree of fragmentation in the wider market.’Most local brands are owned by private, family-run companies, where the process of mergers and acquisitions has failed to make a widespread impact over generations, offering scope for future consolidation.
When researching the sector, an appreciation of the overall nature of alcoholic beverages is useful. And at the risk of igniting the wrath of drinkers with strong brand loyalties, Peter Doyle, professor of marketing at Warwick Business School in the UK, says, ‘The drinks industry is a classic example of differentiating essentially identical products.’ He explains that through blind product testing it has been repeatedly proven that across a whole range of drinks – from vodka, through lager beers to colas – consumers are unable to distinguish one brand from another. Therefore marketing, salesmanship and hype, for want of a better word, are key to making a brand the consumer beverage of choice.
‘With drinking,’ continues Professor Doyle, ‘social status is important. People buy brands that give them confidence they are making the right choices. Nobody wants to serve a drink that a guest is going to think is cheap or nasty. As people feel technically unqualified to choose between drinks of the same type, the way you avoid social risk is by buying well-known brands.’
All at Seagram
Herein lies the key to the contest between the sector’s major players for rights to the premium drinks brands. Strong brands sell at significantly higher prices than weaker ones, so can they assist in creating value for shareholders?
When Vivendi decided to auction the drinks arm of its newly-acquired Seagram’s, it sparked a flurry of excitement among competitors in the drinks sector. Late last year, Diageo agreed with France’s Pernod-Ricard to acquire and split up Seagram’s portfolio of drinks brands, and they’ve since been muddling through the regulatory and legal hurdles (see sidebar, End of a dynasty).
The Seagram deal was a particularly important one for the sector. That’s because Diageo and Pernod-Ricard were able to acquire premium brands at great cost, though this gives both companies scope for boosting their profit margins. Also, in Diageo’s case, a widespread distribution network allows the company to reap more economies of scale by delivering many more brands at only a marginally-increased distribution cost.
If the theory behind such transactions is straightforward, the practice of selling the story to shareholders involves convincing them them that there will be future cash flow benefits resulting from intangible premium brand values. But there’s no guarantee of that: after all, there is always the problem that brand values – just like stock prices – can go down as well as up.
‘Analysts need reassuring that brand values are being well supported by marketing,’ explains Catherine James, group IR director at Diageo. ‘Marketing expenditure is a huge proportion of what we spend – 18 percent of our total revenues. It’s the biggest single driver of value for the shareholders. People have to be reassured that we know what we are doing with that money and that we are using it in such a way that we maintain brand equity. Marketing is there to maintain your brand equity just as capital expenditure is there to maintain your buildings and your production resources.’
But could there be a risk that consumers become brand suspicious, brand weary or lose faith in the imaging of drinks products? ‘At the end of the day,’ says Peter Durman, James’s opposite number at Allied Domecq, ‘it’s all about managing your brands in each of the markets you operate in.’
But even as stock markets around the world continue to look shaky, times are not so bad right now for beverage company investors. Viewed by the market as old economy, sector stock prices have held up well over the last year relative to the major indices and to their own share prices over the longer term.
Growth scope
Safe haven stocks, then, but will there be growth in the future for shareholders to look forward to? Opinions on growth in the spirits market diverge.
Diageo’s CEO foresees 4 percent annual growth in the $430 bn worldwide market. And the upmarket French fashion goods house LVMH, which has specialized its wines and spirits operations to focus on cognac and champagne brands, anticipates a good level of growth as well. Moody’s, however, is of a different view. ‘Having completed restructuring programs, many of the major spirit companies are now focusing heavily on the challenge of achieving organic growth in a global market, a difficult task because overall consumption is expected to remain flat or even decline marginally.’
The international rating agency adds, by way of summary, ‘Overall, the industry is likely to remain under pressure from a combination of mature markets, health concerns, social trends, legislative pressures and also sub-inflation price increases.’
Though some analysts may believe the scope for growth to be limited, the sector is regarded as well-insulated against global economic downturns, mainly because unlike foreign holidays and new cars, the sector produces relatively low-cost luxuries that are unlikely to be dispensed with during an economic downturn.
Along with shareholder value and growth prospects, another key metric for analysts is debt levels. As the Seagram deal demonstrates, the cost of consolidation can be high, with competition for brands likely to become more intense. Both Standard & Poor’s and Moody’s have criticized the debt levels of Diageo and Allied Domecq, questioning whether further downward rating revisions would be needed in the future.
Calling time
Perhaps not surprisingly for companies skilled at marketing and advertising, the IR activities of companies like Diageo and Allied Domecq are well-regarded by analysts. Both of these provide a high level of financial disclosure with a good quantity and quality of financial and operational information. Perhaps more surprising is the divergence of views among analysts as to future share price performance. A recent poll among analysts shown on Allied Domecq’s web site showed a wide spread of buys, sells and holds, which may say more about the analysts, their agendas and their masters than about the company itself.
But by far the biggest question in the industry is where the battle for the brands will go next. One answer might be further into local brands, especially in high population emerging markets. Another answer might be that provided by Warwick Business School’s Peter Doyle, who says that wines as a sector may be ripe for branding and packaging in the way that Scotch whiskies have been.
Doyle points out that wine is a hugely fragmented sector, with many producers in many territories. What’s more, it’s a product that varies from year to year and bottle to bottle, making all but the most expert of consumers unsure about whether they are getting good value. Add a confidence-building brand and widespread distribution capability and maybe the next opportunity for growth in the sector is there to be seized.
Already, leading companies in the sector have been snapping up popular wine brands. Pernod-Ricard now owns the popular Australian wine Jacob’s Creek, while brewer Lion Nathan narrowly edged out Allied Domecq in a battle for ownership of Montana Group, New Zealand’s largest winemaker. Purists may find globalization of wine brands insidious, even distasteful, but many of those who drink wine may welcome having their choices made easier for them.
Even if further acquisitions of wine brands by the big companies in the sector do not take place, it seems likely that further distribution agreements and link-ups will be forged.
If the reams of research produced by industry commentators and analysts are to be believed, intense corporate activity is likely to continue in the wines and spirits sector long after the Seagram deal is done and dusted. Whether these aggressive acquisitions allow the major drinks groups to maintain and enhance shareholder value remains to be seen.
End of a dynasty
By far the most significant event in the sector over recent months has been the sale of Seagram’s spirits and wine business.
The deal, announced last December and still awaiting regulatory approval, involves Diageo and Pernod-Ricard jointly paying $8.15 bn to Seagram’s new parent, Vivendi, for a package of top brands which they intend to share between them.
Sixty-one percent of the funding is being paid in cash by Diageo, in return for which it will gain market-leading positions in American blended whisky with the 7 Crown label, and in Canadian whisky through VO and Crown Royal.
Pernod-Ricard is stumping up $3.15 bn, gaining Chivas Regal, Glen Grant, Royal Salute and Glenlivet whiskies as well as Martell Cognac and Seagram’s Extra Dry gin. It also adds several leading national brands in Latin America, Asia and Europe to its stable and will own Seagram’s whisky distilling and bottling facilities in Scotland. The deal is expected to receive the go-ahead from antitrust authorities in the EU, the US and Canada at time of press. In recent research, Credit Suisse First Boston said, ‘The Seagram deal has… driven a step change in the spirits sector and has created an outright leader in the industry in the shape of Diageo.’
Pernod-Ricard
The Seagram deal should rocket Pernod-Ricard from fifth in the world wines and spirits sector into contention for second largest beside Allied Domecq.
It owns 80-odd brands such as Havana Club Rum, Wild Turkey Bourbon, Jameson Whisky, Pastis 51, Ricard and Pernod, Glen Campbell Scotch Whisky and Jacob’s Creek Wine.
It intended to use funds raised from the sale of its Orangina soft drink operation to Coca-Cola to pay for the Seagram transaction, but this was blocked by the antitrust authorities, forcing the company to resort to bank debt.
Following the Seagram deal, Pernod-Ricard will have operations in 45 countries, but with thinner distribution arrangements than Diageo, so managing the diverse operations will be a challenge that investors will watch carefully.
Diageo
Formed in 1997 from the merger of Grand Metropolitan and Guinness, Diageo owns drinks brands including Smirnoff, Johnnie Walker, J&B, Gordon’s gin, Malibu, Baileys, Guinness and Tanqueray gin.
With sales of $16.6 bn a year and a market cap approaching $34 bn, the company is a FTSE 100 stock. Apart from the Seagram deal, it acquired Bundaberg Rum in early December and has announced its intention to combine its Pillsbury food business with that of General Mills, as well as float part of its Burger King business.
Diageo CEO Paul Walsh estimates that sales in the global branded beverage alcohol market total $420 bn annually and are growing at 4 percent, with his company’s market share below 10 percent.
Top institutional holders in spirits companies
| ($mn) | |
| Barclays Global Investors | 2,140.38 |
| National City Corporation | 1,644.11 |
| Fidelity Management & Research | 1,486.83 |
| Banc of America Capital Management | 1,455.16 |
| Brandes Investment Partners | 1,438.06 |
| Putnam Investment Management | 1,113.59 |
| Caisse des Dépôts & Consignations | 1,041.31 |
| State Street Global Advisors | 946.12 |
| Vanguard Group | 788.52 |
| Firstar Bank | 778.86 |
Source: Thomson Financial/Carson
Allied Domecq
Second in sales to Diageo, Allied Domecq’s portfolio includes brands such as Ballantine’s, Beefeater, Kahlua, Sauza and non-alcohol operations including Dunkin’ Donuts, Baskin-Robbins and Togo’s.
Although second to Diageo, Allied Domecq is considerably smaller and therefore does not benefit from large-scale economies. Analysts have suggested that it may have difficulty in adding new, reasonably priced brands to its portfolio due to competition from others in the sector. Others have raised the question of whether Allied Domecq has a long-term independent future. Over recent months its share price has held up well, despite turbulent stock market conditions.
