Friday, April 15, 2005

Pernod-Ricard Looking for New Drinking Partner (Isn’t Everyone?)

Pernod Ricard, maker of the eponymous French pastis, has its sights on British owned Allied Domecq. After several weeks of rumor surrounding a possible deal, Patrick Ricard, cofounder of Pernod Ricard, has confirmed that he is engaged in negotiations aimed at acquiring Allied Domecq, the second largest spirits producer in the world. Pernod Ricard currently ranks third. If successful, the deal, which is estimated to be worth around £7.2 bn ($13.5 bn), could threaten UK-based Diageo’s position at the top of the world spirits market.

Pernod Ricard is not going it alone. The company has teamed up with American rival, Fortune Brands, in order to pool enough cash and to avoid anti-trust concerns. Upon completion of the deal, Fortune and Pernod Ricard would divvy up the brands between them based on strategic interests and sell off those that neither wants. Pernod Ricard’s goal is to fill in gaps in its drink offerings and gain access to the American market. Fortune wants to expand its drinks business and enter the European market. The takeover bid for Allied comes on the heels of the successful 2001 acquisition and integration of Seagrams by Pernod Ricard and then partner Diageo. The two companies split the brands, one-third and two thirds, respectively. In the swinging world of drinks producers, however, partners change frequently and satisfaction seems a fleeting pleasure. As a result, Pernod Ricard is on the prowl again.

Analysts are cautiously optimistic that the deal will go through, though it’s expected that a couple late entrants might yet make a bid. Matthew Jordan, an analyst at Dresdner Kleinwort Wasserstein, sees a likely challenge from either Bacardi or Brown-Forman. Jordan says, “Unless [Bacardi and Brown-Forman] have already looked at Allied and rejected a bid, we think it quite likely that they will assess Allied as an acquisition opportunity within the next few weeks. This has the potential to create a bidding war." Louis Vuitton Moet Hennessy might also make a run for it. Analysts point out that Allied Domecq is one of the few large targets left and many companies out there are looking to gobble up new products and gain market share in the fragmented drinks market. According to figures in the French paper, Le Monde, the four leading companies in the industry share less than 20% of the market. Furthermore, access to lucrative distribution channels makes the takeover that much more attractive. As stockbrokers Panmure Gordon point out, any takeover would present “significant distribution synergies.”

While most analysts see a successful deal within weeks, there is some pessimism out there. Observers have noted that any deal would likely bring close scrutiny from regulatory agencies at the local market level. Jeremy Batstone of Charles Stanley Stockbrokers cautions that “There will be a lot of regulatory interest in any offer. We are still in the foothills of what could be quite a long slog.” This is particularly true in certain geographies, such as Spain, where Pernod Ricard and Allied have largely cornered the market.

Interestingly, there are few critics of Pernod Ricard’s overall strategy, assuming the deal passes regulatory muster. The analysts’ consensus goes something like this. Through the acquisition, the French company gains access to U.S. markets where hard liquor consumption is on the rise. And as a bigger company, Pernod Ricard will have greater control of and cheaper access to distribution channels, allowing it to keep competition out and establish itself in more retail locations. Furthermore, the takeover enables Pernod, who had previously focused on the high-end market, to branch out into the middle market with the newly acquired brands. Costs should also go down as Pernod realizes greater synergies following the takeover.

Can it be? Is it really such a great deal? Or is everyone in an absinthe induced stupor, counting their commissions and ignoring possible pitfalls?

Tough to know. Pernod Ricard’s debt burden will increase substantially, not only what they borrow but also what they acquire – Allied is carrying nearly £2.1 bn, but the company proved more than capable of managing expansion and paying down that debt in its acquisition of Seagrams back in 2001.

Dilution of the Pernod Ricard brand as the company expands into the middle income market is a possibility but the fact is that no one really knows or cares who owns the booze they choose to drink so that’s not likely to be a factor. Which leads one to question the extent of synergies created by the takeover. In this case the synergies lie primarily in the distribution networks and corporate overhead and don’t really assist in marketing or production since each brand must maintain its own identity (as opposed to the strategies in the confectionary business…). That might be enough however.

Anti-trust regulation could still spell trouble but a close look at the data suggests that the market concentration pre-acquisition is low with an HHI of 158. Post-acquisition HHI of 179 is still way below the threshold of 1800. Even on the local level, monopoly issues will most likely be avoided by splitting up brands between Pernod and Fortune and spinning off others to third parties if necessary.

Another concern is whether Pernod Ricard is growing too big too fast. Could be but they’re sticking to their core competency so the danger is mitigated. Furthermore, if Pernod’s goal is to compete with Diageo, they have no choice.

Perhaps the biggest challenge is the fact that Americans have a bit of an anti-French thing going these days. But so long as Pernod Ricard keeps a low profile and spares Americans the difficulty of pronouncing their company name, the new world prospects look good for the former absinthe bootleggers from Marseille.

Victor Casier, Sebastien Leroy and O’Neal Spicer

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