* 3G weighing bid for Diageo, according to Brazilian media — An article on Veja
(6 June) suggests that 3G Capital is in the early stages of looking into a bid for
Diageo. It is difficult to say whether the report is credible, but Diageo seems the sort
of target 3G would consider, in our opinion. In any case, we doubt anything would
happen soon, and indeed it may not happen at all. But at the very least we believe
the potential for a take-out should (1) increase pressure on management to
accelerate change and consider actions that would unlock shareholder value and
(2) underpin the stock’s valuation.
* Diageo seems the sort of target 3G would consider — 3G looks for strong
brands, cost cutting opportunities and, more broadly, potential to unlock shareholder
value. Diageo offers several global billion-$ brands, a strong route-to-market across
the world, opportunities to unlock value, in our view, and it comes from 2 years of
weak operational performance. On cost cutting, while Diageo appears reasonably
efficient already, we have no doubt that 3G, with its ZBB approach, would be able to
extract further savings, but probably not on the scale of other deals it has done.
* ABI-SAB less likely? — IF 3G were to acquire Diageo, we think it is likely that they
would sell the beer assets to ABI. In this scenario, we believe ABI-SAB would be
much less likely, for sure in the short term, but this is all hypothetical of course.
* The threat of a take-out increases pressure on Diageo management — In this
note we go through some of the actions mgt could and maybe should consider to
restore confidence and/or unlock shareholder value: (1) sell non-core assets, (2) set
performance targets, (3) accelerate cultural change, (4) more cost savings, (5)
consider what to do with MH stake, (6) raise balance sheet gearing to buy back
shares, (7) communicate a plan for beer, (8) review some senior mgt positions.
* We reiterate Buy – In addition to the above, we believe Diageo is undervalued
(14% PE discount to EU staples), it’s an excellent business for the long term and we
expect an operational improvement in F16. We have had to cut our EPS by ~3.5%
however, mostly on FX (pg 10). As a result, we have lowered our target to 2,200p.