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The City: Diageo declines Montana option

Published:  18 January, 2007

You will hear the cheer from Paris in London.'
So said Pernod Ricard's joint MD Richard Burrows only a month ago on the possibility of Diageo not taking up an option to buy most of Montana, New Zealand's biggest wine producer, from the French group. At the time, Diageo was duly diligent, and Pernod Ricard expected the world's biggest drinks group to pay about 320m, excluding the Corban's, Stoneleigh and Church Road brands.

Now Paul Walsh, Diageo's chief executive, has turned down the option to buy Montana, which he extracted from the French group as part of the price for Diageo staying on the sidelines in Pernod's $7.4bn break-up of Allied Domecq. The reason given

is that the acquisition would not meet Diageo's investment criteria', implying that Montana did not provide sufficient prospects for increased export-led growth together with margin improvement'.

The French group could hardly contain its delight at Diageo's decision. Not only did it win Diageo with its first offer; also, retaining Montana puts it firmly in the No 3 spot in the world branded-wines league behind Constellation and Gallo. It will have to service an extra 300m of debt, but that had already been factored into the equation, and Pernod Ricard says it can still fund extra acquisitions should they occur. Most observers

believe that could mean a further foray into Champagne to bolster Mumm and Perrier Jout.

Walsh says Diageo recognises that wine is a growing category' and that it will add selectively especially within the premium segment'. So a big buy is not on the cards. But he is hardly a loser from the latest decision. First, there was no cost to the Montana option, and he did extract Bushmills for 200m from Pernod Ricard for staying on the Allied sidelines. The Irish malt is exactly the sort of niche, premium product Walsh wants in his armoury. Second, the stock market hardly reacted to the decision, the drift down in Diageo's shares reflecting more the muted tone of the AGM trading statement than disappointment that Walsh had turned down Montana. If it needed further convincing, it knows he is determined not to dilute shareholder returns, even as a short-term tactic.

Which leaves the question of where he is going to spend Diageo's burgeoning free cash flow. Many believe Taittinger could be a target, but that would mean further strains on the relationship with Mot Hennessy, where Diageo owns 34%. Walsh recently said his focus was on developing the further potential of the American spirits market.

Watch that space.