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Diageo: What Could The AB InBev – SABMiller Deal Mean?

September 24, 2015
Food & Drink

Diageo, the world leader in spirits has been seeing tougher times of late. Some may call this sheer bad luck, where the company, in spite of having a world class product portfolio, has been subjected to losses in light of a slowdown in markets across Asia and Latin America, changing tastes and preferences in markets such as the U.S., tough economic conditions across Europe, and currency headwinds. Recently, the news of a takeover offer between the world leader in beer, Anheuser-Busch InBev and second in line, SABMiller emerged. Could Diageo ’s woes worsen if this takeover actually occurs?

First and foremost, let’s understand the nature of rivalry between these relevant firms. While Diageo is the leader in spirits, AB InBev and SABMiller dominate the global beer market. However, it may not be entirely accurate of write off Diageo as a competitor for AB InBev and SABMiller. After all, ever so often, we hear of how shifts in consumer preferences from beer to spirits or vice versa have been hurting certain company’s performance. Now, clearly if AB InBev and SABMiller decide to join forces, it is very straightforward to expect large-scale efficiency gains, given the massive size of these names. In this case, the post merger entity could very well transfer a part of these cost savings to consumers. A study titled “Competitive Analysis with Differentiated Products” suggests that the own-price elasticity estimate for various beer brands ranges between -3.8 and -6.2. In this case, if price declines resulting from cost savings are instituted, many spirits consumers could shift to beer, particularly in emerging markets where price is a major consumption consideration.

The next factor stems from the fact that Diageo does not only compete with the likes of SABMiller and AB InBev as a spirits maker but also has it’s own line up of beers. The company is the proud owner of the world’s no.1 stout beer brand, Guinness, apart from other beer brands such as Kilkenny, Meta Beer, and Dublin Extra Lager. Guinness is a particular favorite of African citizens, with stout beer having an approximate 45% market share in the region. More recently however, the sale of Guinness, particularly in big African markets such as Nigeria, have been troubled due to a weaker consumer environment forcing customers to down-trade to less premium options. Against this, Guinness experienced a 5% volume decline in the last fiscal year. Now, Diageo’s main competitor in the market is SABMiller, who with their cross shareholding in the Castel group have managed to set foot in over 35 African countries. With their roots in South Africa, SABMiller has managed to carve its way to being the market leader in Africa. With AB InBev having no meaningful presence in Africa, SABMiller’s solid hold over this lucrative market makes it the top selling point for the acquisition. If the joint entity can ensure better price competitiveness in the region by passing on cost savings, to make good quality beers available at more competitive prices, Diageo’s Guinness may have much more to deal with in the region.

Now, what has Diageo been banking on to drive their beer brands in the lucrative African market? Top on the list is innovations. For instance, the last fiscal year witnessed the national roll-out of Orijin, a kind of fruity drink that has 6% alcohol content. Orijin has seen growing popularity particularly in key African markets such as Nigeria, with the brand aiding a 9% beer net sales increase. Bloomberg describes the brand to be a “faster-growing addition in Nigeria to its flagship Guinness stout.” However, competitors are not sitting still, with many innovating in this space to get a slice in Orijin’s growth. The next is pricing. Clearly, Diageo acknowledges the losses that they have encountered in top markets such as Nigeria due to their premium pricing position and will be expected to show more subtlety in pricing going forward. However, in the situation that the AB InBev takeover does come through, Diageo may have to ramp up their rate of innovation in the region along with offering more competitive prices to avoid losing market share. The combined impact of this could very well weigh on their finances.

A final consideration is of how likely the take over is expected to be. It is obvious that an acquisition of this magnitude that involves the two top players in the global beer market is bound to have numerous anti-trust issues to overcome. Given that the addition of SABMiller to AB InBev’s umbrella is going to literally complete the latter by bringing in untapped markets across Africa and South America, along with bringing the combined market share in key markets such as the U.S. to over 70%, might make it almost impossible for other players in the beer space to compete. Furthermore, the move is bound to bring in major economies of scale along with production, distribution, and marketing efficiencies, which might institute various barriers to entry and expansion for other existing and prospective players in the global beer market. In this case, even if the deal is passed, it might involve significant divestitures, which may not make the post-merger entity as much of a threat as they seem to be currently.

In conclusion, although an AB InBev – SABMiller combination could threaten Diageo and force them to scale up innovations and offer competitive prices, potential anti-trust issues might just mitigate the kind of threat that this duo could pose. Even then, Diageo has the potential to stand up to this force since they do, after all, specialize in spirits rather than beer, which has been seeing more favorable consumption trends in a number of top markets such as the U.S. Lastly, the prospects of this takeover coming through could be highly questionable since this is not the first time that talks of such a takeover have surfaced.

Trefis has a $115 price estimate for Diageo, which is above the current market price.

Source: Forbes

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