Fool's Eye View

[ July 17, 2000 ]

Drinks before dough at Diageo

By Maynard Paton (TMFMayn)

Carburton Street, London -- Diageo (LSE: DGE) have finally confirmed that they are to dispose of their Pillsbury subsidiary, famed for its dough-based food offerings, to the US food manufacturer General Mills (NYSE: GIS). In what was described as a "strategic re-alignment", the basic financial terms of the transaction involves General Mills swapping 141m newly issued shares and taking on $5.1b of debt for Diageo's diverse food concern. The deal values Pillsbury at a total of $10.5b and after completion, Diageo will end up with a 33% shareholding of the enlarged General Mills and Pillsbury combine.

Diageo's stated rationale for the agreement is two-fold. Firstly, it allows the group to "integrate" and focus their attentions purely on the remaining alcoholic drinks division, Diageo owning such famous brands as Guinness, Johnny Walker and Baileys. And secondly, the company can, through its prospective shareholding, participate in "the enhanced growth, cost synergies and shareholder value benefits which accrue to the new General Mills".

Having looked at Diageo in this feature, and commented upon their consumer products rival Unilever (LSE: ULVR) many times also, I'm neither surprised nor impressed at the latest "drinks before dough" corporate re-jig.

No more dough

My lack of enthusiasm simply stems from Diageo's lame reasoning of "focus". After disposing of the Doughboy and the Jolly Green Giant, Diageo claim that the "the new organisation will bring UDV and Guinness together with an integrated strategy in beverage alcohol" and "its goal will be to achieve a winning share of high value adult drinking occasions".

Hold on! Wasn't Diageo formed in late 1997, by the merger of Grand Metropolitan and Guinness, to similar cries of "operating synergies"? If that's the case, why on earth does it take the disposal of Pillsbury two-and-a-half years later to inspire this "integrated strategy" between all the various branded drinks? Surely this should have been done right at the birth of Diageo, and so the benefits from the "integrated spirits, wines and beers platform" that remain ought to be minimal.

No surprise though

In fact, it's no real surprise that today's corporate comings and goings have taken place at all. The food and drinks manufacturing trade is renowned for its corporate activity, with all the sector players constantly buying and selling their counterparts to try and improve their otherwise pedestrian sales growth opportunities. Overall sales and volume growth are typically in the sub 5% bracket for those taking an organic route to growth within the industry.

Although Diageo will hopefully benefit from their holding in the enlarged General Mills entity, I can't help but think that by selling off its food division, it has further limited its core prospects. A company focused purely on premium priced alcoholic drinks must have far less global growth opportunities than the former broader-based operation.

When I announced the Qualiport's disposal of its holding in sector cousin Unilever, I declared: "I do feel that the industry, from an investment angle, isn't particularly appealing. It's a combination of low sales growth combined with acquisitions, disposals and the annoying reoccurrence of "exceptional integration" charges." Today's news from Diageo just enforces my bearish view.

In summary, I can do no better than refer Fools again to my Qualiport review of Diageo. I concluded then that buying Diageo "would be akin to buying a second-class Unilever -- in essence a similarly large and pedestrian company, but having far more exposure to economically-sensitive products with limited appeal."

And given that the Qualiport eventually sold Unilever, the investment potential of a drinks-focused Diageo can at best be only described as very restrained.

Where Next?

• Visit the Diageo discussion board | website