A marriage that was just waiting to happen

Whatever the competition authorities and the consumer might make of the proposed merger of Guinness and GrandMet, it is hard to fault the deal in financial or commercial terms. In spirits, which is what this marriage is really about, the two companies' geographical and product spreads mean this was a combination just waiting to happen.

It marks a first step in the consolidation the industry has needed for years to solve the deep-seated problems of price increases below inflation in its mature Western markets, de-stocking and heavy price discounting after the late 1980s party collapsed into the hangover of the early 1990s recession.

GMG Brands, as the new monolith is to be called, will be Britain's eighth biggest company and the world's seventh largest food and drink group, with a market value in excess of pounds 20bn. Valued at just less than McDonald's, it will dwarf other global players like Heinz and Kellogg. It will have 18 of the world's top 100 spirits brands, combined sales of almost pounds 13bn, profit before interest and tax of pounds 2.2bn and free cash flow of over pounds 900m.

Such is the strength of the new group's balance sheet that one of its first moves will be to hand pounds 2.4bn of surplus capital straight back to shareholders via a 60p payout, which for tax reasons will be in the form of a new class of share, convertible into cash.

Even after that act of largesse, its earnings will cover interest payments on its debts more than five times.

Although a genuine merger between the two companies, the deal is to be structured as an all-share takeover of GrandMet by Guinness, which will change its name to GMG Brands before swapping one of its own shares for each GrandMet share. As a result of their company's slightly greater size, GrandMet shareholders will end up owning 53 per cent of the enlarged group.

The deal represents a combination of some of the best known food and drinks brands in the world. More than half its profits will come from its spirits arm, a combination of Guinness's United Distillers (UD) and GrandMet's International Distillers and Vintners (IDV).

Its enlarged spirits portfolio will combine Johnnie Walker whisky and Gordon's gin from UD with IDV's J&B scotch, Gilbey's gin and Bailey's liqueur.

Sales of its spirits brands, which also include Jose Cuervo tequila, Hennessy cognac and Malibu, will leave its main competitors, Allied Domecq and Seagrams, standing.

The combined UDV will sell more than 100 million cases of spirit, compared with Allied's 47 million and the Seagram's 41 million.

GMG's other interests include GrandMet's Pillsbury food manufacturing business, Haagen Dazs ice-cream, and Guinness's 34 per cent investment in the Moet-Hennessy champagne to cognac group. It takes in the original Irish stout brewing operation and Burger King.

The commercial appeal of the proposed deal hinges on the ability of the new spirits business to push a greatly enlarged portfolio of brands through an existing distribution network around the world. GrandMet has next to no exposure to the developing markets of the Far East and Latin America, so adding its products to Guinness's existing offering will increase sales in those regions rapidly at little extra cost.

Guinness currently makes around 44 per cent of its spirits profits in developing markets, while GrandMet's exposure is less than 10 per cent. The combined group will make about a quarter of profits from those fast- growth regions.

In the mature markets of North America, where GrandMet is strong, and Europe, combining the two operations will increase GMG's buying power in a still highly fragmented market and help it force through price rises after years of flat demand and low inflation keeping a lid on the cost of spirits.

Less clear cut are the benefits of holding on to the non-spirits operations, even if John McGrath, chief executive-designate, is understood to believe that by the end of the decade Burger King will be the fastest growing part of the group and provider, thanks to its franchise system, of a sizeable fillip to the group's return on capital.

The real attractions of the proposed deal are financial. Structured as a marriage of equals, the merger avoids the enormous squandering of value that a hostile bidder's shareholders would have to face by eliminating the need to pay a premium for control. With cost savings of just pounds 175m pencilled in over three years, it is little wonder that Guinness balked at paying a premium of maybe pounds 4bn over GrandMet's market value of pounds 11bn.

With a return on capital of only 8 per cent compared to Guinness's 12 per cent, GrandMet gets arguably the better end of the deal from that perspective.

Putting the two groups together should mean an aggregate return in excess of the weighted cost of their capital of around 10.5 per cent, a benchmark the industry has struggled to match through the long years of recession.