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Diageo Makes Offer for Controlling Stake in United Spirits

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Diageo’s renewed offer to gain a controlling interest in United Spirits confirms its commitment to emerging markets, following a spate of acquisitions over the last 5 years securing access to local brands and all important routes to market. Initial results have been mixed, with sales in the six months to December 2013 softening below expectations, this however is part and parcel of operating in changeable immature markets, over the long term given demographics and economic development this has to be the right strategy.

Diageo became the largest shareholder in United Sprits in 2012 acquiring a 28.8% stake, exerting considerable influence and gaining a controlling interest has long been anticipated. The attraction for Diageo is clear, by volume India is globally the second largest spirits market behind China and is forecast to experience a 3.5% CAGR between 2013 and 2018, accounting for over 15% of global volume growth. In Diageo’s key whisky category the argument is even more compelling, India is the world’s largest market by volume, almost four times larger than the US in second place. Granted, the vast majority of these sales comprise of low cost local whisky, but there is clear demand for higher value scotch and this will be realised as economic growth continues.  In 2013, only 5% of Indian households had an annual disposable income of over US$10,000, but this still equated to 74million, by 2025 this is predicted to increase to 195million.

United Spirits, with a 35% share of the Indian spirits market in 2013 is an attractive proposition, however this share has been diminishing and the acquisition is not without challenges.  Mounting competition is one issue to address, as too is the difficulty of integrating such different operating structures. India cannot be viewed as one country, but rather a collection of unique market environments, with different consumers, taxes and infrastructure, simply copying over a western model will not work.

Beyond this, in less mature alcoholic drinks markets greater volatility should be expected and planned for. Prior to the global financial crisis an accusation could be leveled at Diageo that it was too dependent on mature western markets, where profitability on premium brands was strong, but long term growth was weak. Diageo answered this with a number of acquisitions, Ypióca in Brazil, Shui Jing Fang in China, and Mey Içki in Turkey all of which have strong potential. This was not though reflected in the last 6 months of 2013, with sales from emerging markets posting a disappointing 1.3% growth, triggering a 5% decline in Diageo’s share price – a rather short-termist reaction. Factors influencing this were the Chinese government’s crackdown on gifting as well as more restrictive selling practices and excise increases being introduced in Turkey. These specific examples could not have been foreseen, but are indicative of the greater volatility that can be expected.

Indeed, unforeseen circumstances are not the reserve of emerging markets. The consequences of over exposure in Western Europe, notably Spain and Greece were not predicted 10 years ago. Global markets are increasingly linked, but economic events can take time to spread and impact at different rates. This combined with local peculiarities makes having a balanced geographic presence all the more important, Diageo has gone a long way to addressing this and successfully gaining control of United Spirits would further secure its position.

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