Diageo, whose brands include Smirnoff vodka and Johnny Walker whisky, said it had reached an agreement with the family Nolet of the Netherlands to form a new joint venture for Ketel One. The family would continue to own the brand rights and distillery, while Diageo becomes sole global dristributor.
The Nolet family also has the right to put its 50% stake to Diageo in year the fourth or fifth years after competion at a further cost of $900m. The deal is expected to close by March 31, subject to approval by regulators.
By making the deal, Diageo effectively ruled itself out of Absolut vodka maker Vin & Sprit, which the Swedish government is in the process of privatising. Pernod Ricard, Fortune Brands and privately owned Bacardi as front runners for that asset.
The agreement "definitively quells concerns over the company’s lack of scale in the fast-growing and profitable super-premium vodka segment in the US and of potentially overpaying for the Absolut vodka brand," said Credit Suisse analyst Swetha Ramachandran.
Diageo said expects the transaction is earnings neutral in year one and value accretive from year five. The group gave no details on Ketel One's profitability but said the brand sold a total of 1.9m nine-litre cases in 2007.
As each case sells for about $950 each, that suggests turnover of $330m and operating earnings of $95m, putting the transaction on about 5.5 times sales and 19 times profit.
While expensive by usual takeover measures, the price tag looked relatively reasonable compared with Bacardi's 2004 deal to buy Grey Goose vodka, which was at 26 times earnings.
"Diageo needed a strong brand in the vodka category and is getting it through Ketel One," said analysts at Goldman Sachs. "The high valuation from this acquisition sets up a precedent for the next round of M&A in the spirits sector, which we expect to be triggered by the privatisation of the V&S Group. Unfortunately for those bidding for the V&S Group the precedent does not come at the best time."
Like Absolut, Ketel One is reliant on the US market. More than 90% of sales come from the States, where it is the seventh-biggest vodka brand on a 4% market share. Sector watchers disagreed about how much growth was left in the market.
"Given recent 5-10% US volume growth, most of this upside will stem from Diageo’s ex-US distribution network, where Ketel One has virtually no current presence," Citigroup's team argued.
But Credit Suisse reckoned there was room for expansion in America. It argued that Ketel One is stocked in bars but has little hold of the retail market, where 90% of US spirits growth in 2007 came from. Using Diageo's distribution platform, the joint venture can drive growth by moving into supermarkets.
Absolut, which sells 10m cases, would be valued at about €6bn using the same metrics as the Ketel One transaction. The comparison is not perfect, however, as Absolut is a more important strategic asset for the drinks sector. The Swedish company is also likely to be less profitable than its Dutch rival, and is currently locked into distribution agreements that will be troublesome for any buyer to unpick.
Goldman Sachs repeated "buy" advice on Diageo, along with French peer Rémy Cointreau. "What we expect from the spirits industry in 2008 is increased consolidation and we believe that Rémy Cointreau (as a strategic asset) is at the centre of it," the broker told clients.
The team at Credit Suisse also expected more deals.
"Family-controlled spirits and beer businesses have historically been reluctant to relinquish control of profitable, highly cash-generative brands but with cost pressures increasing and distributor economics worsening, increasingly joint-venture structures with large spirits and brewing companies are becoming palatable to them and in some cases, necessary," Ramachandran told clients.
"We believe that over time, companies like Remy and Campari could look to strike similar deals in the spirits sector and Royal Unibrew and EBI (Efes Breweries International) in beer."
Shares in Diageo were up 0.6% to £10.23.
