Diageo's (DGE) acquisition of Mey Icki, the leading spirits manufacturer in Turkey, for £1.3 billion is a sound strategic move that should allow the firm to dominate the Turkish market and expand its premium brands, in our opinion. At less than 10 times 2010 EBITDA, the price is attractive, in our view, but the deal does not budge our fair value estimate of the equity or our issuer credit rating.
Mey Icki holds a 70% share of the Turkish spirits market, and it is dominant in vodka and raki, the local spirit primarily consumed in restaurants. Turkey is an attractive growth market. The International Monetary Fund forecasts GDP to increase 5% in 2011, driven by growing foreign direct investment and disposable incomes. Around 60% of the population is under the age of 35, and 800,000 new legal-age drinkers enter the market every year, according to Diageo, which provides spirits manufacturers with a long runway for growth. The raki market has grown at a five-year historical compound annual rate of almost 8%. Although there should be some near-term procurement benefits, and margins in Turkey tend to be higher than Diageo's overall margins, we think this acquisition is more a strategy for growth than for profitability. The deal gives Diageo a dominant position in Turkey, and we expect the firm to leverage its newly acquired distribution platform to expand its share of premium international spirits, a growing category.
At less than 10 times 2010 EBITDA, Diageo appears to have paid a very sensible price for Mey Icki. The acquisition multiple is less than half the 21 times EBITDA paid for Absolut by Pernod Ricard in 2008. It may make investors think twice about the multiple that could be realised for Fortune Brands' spirits business, which is expected to come into play when the firm breaks up later this year. The subdued valuation may be partly due to the lack of competition in merger and acquisition deals from Pernod, which is currently focused on reducing debt rather than growing through acquisition. We assume that the deal closes in July 2011, the beginning of Diageo's 2012 fiscal year, and that revenue in the Europe section grows slightly faster than we had originally anticipated (by around 10 basis points annually), and the higher margins in Turkey add around 20 basis points to the operating margin. Even so, the deal is too small to move the needle on our fair value estimate. We continue to think the shares are fairly valued and recommend waiting for a near-term pullback before investing.
Diageo said the deal will be financed by cash on hand and short-term debt, but we assume that by the end of fiscal 2012, the firm will have issued new long-term debt. The incremental £1.3 billion does not change our estimate that net debt/EBITDA will be just over 2.5 times in 2012, and our credit rating is unchanged.
We expect to learn more about the Mey Icki acquisition at the Consumer Analyst Group of New York conference this week. Diageo presents on Thursday.
Philip Gorham, CFA is an equity analyst with Morningstar.
