Tequila Sector Acquisition of Herradura Group by Brown-Forman for US6m

Brown-Forman appears to have paid a super premium for its recent acquisition of the tequila brands of Herradura and El Jimador. The most likely rationale for such a hefty price tag is the cost of having to get into a must be in growth category.

Throughout the years we have seen similar such strategies being employed by large drinks groups who were desperate to get hold of a significant brand in a key category, for example Seagrams acquisition of Martell Cognac was priced at over 30 times earnings and Allied Domecq's acquisition of Beefeater from Whitbread in the early 90's was at a similar premium. Both never lived up to their promise and effectively diluted shareholder value.

So how about Herradura and El Jimanor. El Jimador with approximately 1.3 million cases has not grown sales over the last 5 years, and the same goes for Herradura with approximately 300,000 cases of sales and remaining static over the last 5 years. Both brands hardly penetrate the key US market selling around 200,000 cases between them.

When you compare this to the market leaders Cuervo and Sauza with 5.2 million and 3.0 million cases respectively between them with dominant positions in all key international markets and approximately half of their volumes coming from the highly valuable US market, Herradura and El Jimador look relatively inconsequential.

The motivation for Brown-Forman has to be the believe that they can really make a move with these brands in the US market, this is the only way they are going to generate a financial return. Additionally they realise not having a credible tequila brand in the portfolio severely disadvantages them against the likes of Beam Global, Diageo and Pernod Ricard who dominate the US spirits market.

Brown-Forman will have to spend heavily and deal with the backlash of competitive forces in their home market from more powerful adversaries in Diageo and Beam Global. This is going to be tough and may be a stretch too far.

Another consideration from a Tequila perspective across the whole category is dealing with the excess Agave over supply problem. This requires ensuring long term essential tequila supply is maintained in a market where growers are not making a return that enables them to generate a living. A very serious issue for the Tequila business and the Mexican economy as a whole. Brown-Forman is now involved with this issue as are the rest of the players in the market.

If you look at the deal Fortune and Beam Global did to take out some of Allied Domecq's brands which included Sauza, Courvoisier, Makers Mark, Canadian Club, Laphroaig, Teachers, Harveys, Cockburns, Fundador, and a number of significant regional brands in Spain and Germany for US 5 billion. The Brown-Forman deal really does look expensive, but most likely they feel they had little choice as there are very few really high quality assets available in the sector and money at present is relatively cheap.

So what next on the acquisition trail. Everybody sees Vin and Spirit of Absolut fame but also including Cruzan rum and Plymouth gin in the portfolio as a really obvious one for the future if the business is de-nationalized. Another one has to be Remy Cointreau for my money and I think they will go first.