Is Diageo’s acquisition of Aviation Gin a sign that M&A activity within the drinks industry is back on track?

With the onset of Covid-19, mergers and acquisitions (M&A) inevitably took a back seat as companies focused on operational activities, such as keeping supply chains open and refocusing on those channels that were still available to them. Reducing costs and managing liquidity, particularly within the spectre of bad debts, also became a focus. Consequently, drinks M&A activity in the first half of the year slowed significantly.

In the UK, investment firm Grant Thornton indicates that 27 transactions were announced in Q2 2020. This is a sharp fall compared to the first quarter of the year, where 44 deals were reported, and when compared to the same quarter last year (52 deals) – a 39% and 48% reduction, respectively. Grant Thornton’s head of food and beverage, Trefor Griffith, commented: “It is no understatement that the second quarter of 2020 saw the most rapid change in consumer behaviour since the end of World War II. The surprise is not that deal volume was down on the previous quarter, but that the fall wasn’t sharper. The surviving transactions were either long term strategic deals or those that aligned with pandemic-resistant trends…these deals give some comfort that M&A activity will continue, despite some parts of the sector facing an uncertain immediate future.”

Some deals, nevertheless, did go ahead. Campari completed a purchase of a 49% shareholding in Italian e-commerce operator Tannico and was also in talks to acquire Champagne Lallier. Sazerac was also active, acquiring the Early Times and Canadian Mist brands from Brown-Forman (for an undisclosed price) in June 2020, and in the same month, also bought Paul Masson brandy from Constellation Brands for $255m. The following month, Constellation Brands announced the purchase of Empathy Wines, together with its direct-to-consumer (DTC) platform. Many of the deals that went ahead had already long been in the pipeline, such as Asahi Group’s purchase of AB InBev Australia.

The leading multinationals have all used the latest reporting round to emphasise the strength of their financial positions. Overall, the leading drinks multinationals have again proven their resilience, and sales have held up better than expected thanks to the strength of the take-home market and the rapidly emerging ecommerce channel. Most have reduced expenditure, conserved cash and raised additional liquidity.

When announcing Diageo’s fiscal full-year results in July, CFO Kathryn Mikells said: “If you look at the total financial picture for Diageo, we do have real financial strength. We’re an A-rated company. We’ve taken actions to further bolster what was already a strong liquidity position. We have £5.3bn of standby credit facilities. We ended the year with £3.3bn in cash. We’re in a quite good position to continue to make balanced decisions.”

Those “balanced decisions” seem to include acquisitions. On 17th August 2020, Diageo announced the acquisition of Aviation American Gin through the acquisition of Aviation Gin LLC and Davos Brands LLC. Through this acquisition, Diageo is also acquiring the other brands in the Davos Brands’ portfolio consisting of Astral Tequila, Sombra Mezcal and TYKU Sake.

Whether the Diageo deal is a signal that the multinationals are now fully back in the M&A game, or if it’s just an outlier remains to be seen. The multinationals certainly have the firepower, but many will likely still be primarily focused on the day-to-day complexities of operating in an uncertain environment. This is even more so with mid-sized groups who also have the impediment of reduced access to finance and their internal M&A resources are typically more stretched.

While the big and mid-sized players have successfully weathered the pandemic, large elements of the industry remain financially uncertain and the issue of liquidity has become only more pressing. There is a big contrast between the well-capitalised and diversified multinationals and less liquid smaller players, including many within the craft sector and numerous start-ups that have entered in recent years. A large pool of distressed companies opens potential M&A opportunities, particularly bolt-on deals.

The determination for the seller comes down to the short-term liquidity requirements, coupled with the assessment of future market challenges. Alantra managing partner Ashley Rountree, who heads up the asset firm’s beverage sector says: “Unless you really have to sell you would prefer to put it off. Almost everyone that I know is deferring it to next year. If you can tough it out you would prefer to do that, and if you can’t, then you aren’t going to be such an attractive target anyway. There are exceptions. I think there are going to be some distressed sales of distilleries rather than brands.”

He adds: “This should currently be a target-rich environment with many companies facing liquidity issues, but I haven’t seen that yet. The brands that are of greatest interest to owners are those that are surviving the new reality. Buyers are not as interested in companies that are in trouble. They are more interested in brands where the entrepreneur is still on board, moving ahead and still in high growth. Maybe instead of growing by 40% this year, they are growing by 20%. Those are the companies that are still interesting the major multinationals rather than finding distressed assets.” That was certainly the case with Aviation gin.

There will inevitably be some bankruptcies. That could lead to bottom fishing by venture capital (VCs) companies who would buy them from the banks. The VCs may be at a disadvantage because they lack the platforms that the multinationals have to build synergies. There may be an opportunity for VCs to bundle some of these distressed assets and provided necessary scale and investment.

Valuations are also tough in such an environment, as they rely on forecasts. Do you view the current pandemic as a short-term dislocation to trading or something that it likely to depress the market for years to come, and how do you model that? Rountree said: “I haven’t seen any direct impact on valuations yet. This perception of Covid-19 creates a lot of uncertainty, but it is not an economic problem. It is a medical problem. We just need to figure out when it is safe to go back into the water with deal-making, so to speak, and we haven’t seen any impact on the multiples being applied. But we also haven’t seen that many transactions in the Covid-19 era. It is an open question still.”

Said another investment banker: “If you are trying to sell something, you need to present a business plan. The big players are starting to get more comfortable giving guidance, which suggests that visibility is starting to improve a bit, which is what you need. How do you value something if you have no business plan, or within that business plan a 30% range in outcome?”

There are mechanisms that can facilitate deals when valuations are tough, such as earn-outs (a cash amount for the business up front and then specific payments in the future if the business reaches certain goals). That was the mechanism that Diageo applied in its deal for Aviation. The total purchase price was $610m, which includes an initial payment of $335m and a further potential consideration of up to $275m based on the performance of Aviation American Gin over a ten- year period. This reflects the brand’s current growth trajectory and expected upside potential.

There is also a practical difficulty of arranging face-to-face meetings during a pandemic. Said another banker: “M&A requires a lot of relationship building and in-person visits, from both the buyer and seller. That has been impossible. We had two deals underway, but we had to put them on hold because we couldn’t have the buyers come in. That has been a major break from the ordinary way of doing business. Most of these deals are not that time sensitive, so people are waiting.”

The question is, when will M&A activity likely resume to previous levels? Rountree said: “I would expect the buyers in the industry to get more active again in September and undertake transactions in Q4.”

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