Why Diageo wants a tequila sunrise down Mexico way

Under a 2002 agreement, Diageo is the brand distributor for Cuervo in the US, while the Beckmanns retain the equity. In Mexico, Cuervo?s other key market, the Beckmanns are both owner and distributor.

Both in private and in public, Walsh argues that, given the costs it has incurred across the US, Cuervo does not pay its way across its North American distribution system.

To fully reflect that, he wants to control the brand, to benefit from the increase in equity value it feels the Beckmanns are benefiting from.

The financials alone reflect the reason why Walsh is so keen. According to Melissa Earlam at UBS, Jose Cuervo is the world?s market leader in tequila with 19pc volume share ? twice that of Sauza, the number two, which is owned by Beam Global.

More interestingly, while the brand has grown strongly in its home Mexican market, up 6.8pc over the past four years, it has shrunk by 2.3pc in the US, which Earlam says is down to not participating in price discounting ?as aggressively as some of its peers?.

Given 62pc of its volume is sold in the US, clearly Walsh sees an opportunity here to increase its presence ? and its potential ? in the US and further afield.

Although Cuervo can trace its roots back to 1795, when Jose Maria Guadalupe Cuervo produced the first tequila in the world, Diageo?s relationship with the company is much more recent.

In 1987, Grand Met, the precursor to Diageo, bought Heublein from RJR Nabisco for $1.2bn. The Heublein drinks portfolio included a 45pc stake in Jose Cuervo, but, as the result of some adept negotiating by the Beckmanns, that was transferred back to the family in return for Diageo taking ownership of some interest in some of its brands in Mexico.

That negotiation took place in the early years of Walsh?s tenure ? he became chief executive on January 1, 2000 and this month will celebrate his 30th year at the company he joined as an accounts manager ? and is, no doubt, one he now regrets.

One insider intimated that although Walsh has been privately airing his views over Cuervo for some time, the fact that the distribution deal ends next June gives a real focus to the Beckmanns. ?It compels us both to try to bring this to some form of a conclusion,? said the insider.

The talks are, however, complicated by the fact that it is very much a family negotiation, not a corporate one. Although the Beckmanns ? Beckmann senior and his children control the shares ? are far more tightly knit than say the generationally diverse clan which controls the Hermes luxury goods group, it is still an emotional issue rather than simply a financial transaction.

?Our read is, the family don?t want to sell out. It?s owned by one man ? not the case that he?s 90, he?s 60-something, and it doesn?t strike us he?s ready to sell out,? said Ian Shackleton, drinks analyst at Nomura. ?So will Walsh get a deal? We?re a bit sceptical.?

It is for that reason that Walsh is unlikely to seize control fully ? at least straight away. What is more likely, it is thought, is that Diageo will retain the US distribution agreement and take a small minority stake in Cuervo, with an agreement to discuss a higher stake again in, say, three or five years. It is thought the stake will be paid for in Diageo shares ? given that Cuervo is highly cash generative.

Not quite the route to control Walsh has talked about, but closer to the main prize, and importantly, preventing the Beckmanns from realistically speaking to other distributors when the agreement next falls due.

It remains unclear whether the Beckmanns have spoken to either of the other possible US distributors ? Bacardi and Pernod-Ricard ? but not to have done so at this stage would be a little surprising. Walsh is not without ideas for a Plan B should the Beckmanns turn out to be playing a cunning game of bluff.

Beam Global is often suggested by some as a potential acquisition target should the Beckmanns not play ball.

Spun out of Fortune Brands last year, its current market capitalisation is $9.1bn, and so, although much larger than Cuervo, in many ways an acquisition might be easier ? given its shares are quoted and shareholders approachable.

Beam?s ownership of Sauza, would be the jewel in the crown for Diageo, but its bourbon assets ? including Jim Beam and Maker?s Mark ? would also be attractive.

But, for now, it is thought Beam remains very much a secondary target behind Cuervo.

If Walsh and his team are to succeed on that front, it will require not only deft negotiation but also a willingness to work with the Beckmann family, rather than against it.

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