Diageo shares jump amid rumours of takeover

Shares in Diageo jumped by 8% in early trading in London this morning to stand at an 18-month high of £19.00.

Jorge Paulo Lemann

The surge follows a sharp rise on Wall Street late on Friday after the London market had closed. The reason for the sudden popularity of Diageo was publication of a lone report in Brazil that the country’s richest man, billionaire Jorge Paulo Lemann, might be thinking about putting together a takeover bid for the world’s largest premium alcoholic drinks company.

The report, published by a prominent columnist in Brazil, has not been confirmed and neither Diageo nor Lemann has commented on it.

It said that Lemann might team with the buyout specialist 3G Capital, where he is chief investor and strategist, and the world’s most prominent investor, Warren Buffett, in evaluating whether to attempt to takeover Diageo, which the market values at £45 billion. To be considered, any bidder would need to offer considerably more.

Lemann and Buffett combined to takeover HJ Heinz two years ago. More significantly, Lemann’s equity company controlled 65% of Brazil’s beer market before merging in 2004 with Belgium’s Interbrew to form InBev. That group bought America’s Anheuser-Busch in 2008 to become the world’s biggest brewer.

This is not the first time that speculation has surfaced about a possible bid for Diageo – or at least its beer division. Just over a year ago it was rumoured that Anheuser-Busch InBev and its fierce rival SABMiller wanted Diageo’s iconic Guinness brand plus the group’s African brewing interests to bolster their positions and at the same time thwart each other’s ambitions to expand via acquisition. Anheuser has just over 20% of the global beer market while SABMiller, the second largest brewer, has 9.5%.

Diageo’s beer division, which comprises Guinness plus key interests in Africa, generates about 17% of the group’s net sales, equivalent to about 10m case equivalent of spirits.

In Africa it is seen as giving key routes to market to Diageo’s spirits brands as well as being a valuable asset in its own right. Given that Africa is widely predicted to be the next chapter in the emerging markets growth story, Diageo is thought unlikely to consider selling it at anything less than a massive premium.

However, Diageo’s shares have been slipping for about 18 months, so an opportunistic bid might gain support. Taking over the group in its entirety could be more cost effective pro rata than taking a tilt at the beer arm on its own.

Observers speculate that if Lemann and Buffett were to decide that the target is attractive, the plan would be to fold the beer interests into Anheuser-Busch InBev and leave the spirits empire as a stand-alone company. It would remain the world’s biggest spirits group.

Buffett’s Berkshire Hathaway investment group is famed for taking large stakes in companies with iconic brands in mature markets. For instance, apart from Heinz, it has large holdings in American Express, Coco-Cola and Mars. It is a trademark of Buffet’s investment style to seek out companies that generate large amounts of cash. Diageo fits that profile as each year it generates free cash flow in excess of £1 billion.

In addition, with the trend to premiumisation in spirits predicted to continue, albeit more slowly than previously, and the emerging markets growth story continuing, a revitalised Diageo spirits group could prove an even more attractive cash cow.

Diageo’s chief executive, Ivan Menezes, is trimming annual costs by £200m but perhaps Lemann and Buffett will spot more scope. If they do, a single unconfirmed report of their interest might turn into something more concrete.