Domecq, best known for its sherries produced in Jerez, is the eighth- largest spirits company in the world. It operates mainly in Spain and Mexico, producing sherries, brandies, whiskies, anis and wines.
The deal will be funded by a pounds 650m rights issue by Allied. The terms are two for 13 at a deeply discounted 490p per share.
Shares in Allied, which also forecast an underlying 5.6 per cent rise to pounds 655m in pre-tax profits for the year to 5 March, fell 44p to 561p.
Tony Hales, chief executive, said Allied's wine and spirits business had increased profits but the Carlsberg-Tetley brewing joint venture had been affected by 'intense competitive pressures'.
Allied already has an indirect 27 per cent stake and a 5 per cent direct holding in Domecq. It will end up with 73 per cent of the Domecq group, with the remaining 27 per cent controlled by Ramon Mora- Figueroa, chief executive of Domecq, and his family.
Michael Jackaman, chairman of Allied, said: 'Domecq will materially advance our status as a world leader in our core spirits business.'
He added: 'Allied-Lyons' international reach will be greatly extended. Domecq gives us substantial profits from its successful Spanish and Mexican businesses. The agreement is a logical development in our strategy.'
Domecq made taxable profits of 16.4bn pesetas ( pounds 80m) last year, up from pounds 78.5m in 1992.
A pounds 75m restructuring provision and a pounds 75m fair value account adjustment have been made by Allied. Some pounds 650m of the purchase price is goodwill.
Allied, which will change its name to Allied Domecq, will become the third-largest spirits company worldwide in terms of cases sold. Domecq sells 22 million annually and Allied 23 million, jointly equating to 405 million 75cl bottles.
The company will rank behind the market leader, IDV, owned by Grand Metropolitan, and United Distillers, part of Guinness. Seagram of Canada is relegated to fourth position.
However, in terms of the leading 100 spirits brands, Allied will leapfrog Bacardi, Seagram and United Distillers into second place behind IDV.
Allied owns seven of the top 100 spirits brands while Domecq has six. Allied's brands include Ballantine's and Teacher's whiskies, and Beefeater gin. Domecq has Presidente and Carlos brandies, La Ina sherry, and Anis Domecq.
The two companies have been associated with each other for 26 years through Hiram Walker Europa, which is the key to unlocking the complex deal.
Ownership of HWE, originally set up as a joint venture in 1968 to establish a domestic whiskey producing company in Spain, is split 50/50 between Allied and Carrizuelo, the company run by Mr Mora-Figueroa and his family.
HWE owns 54 per cent of Pedro Domecq. The remaining shares are held by two institutions and 500 members of the Domecq family, who are now selling.
Pedro Domecq owns 83 per cent of Pedro Domecq Mexico, which in turn has 41 per cent of Tequila Sauza. The Spanish company also owns 54 per cent of Destilerias y Crianza.
Spain-Alecq, a new company, will buy HWE. Allied will have 73 per cent of Alecq.
Of the pounds 739m purchase price, some pounds 283m is for control of Domecq, pounds 74m for Destilerias y Crianza, and pounds 102m for Domecq Mexico, Tequila Sauza and Domecq Importers.
The remaining pounds 280m will be locked in a put option held by the Mora-Figueroa family, which has the right to sell it to Allied in the next six years. The cost of any dividends paid to the family will be deducted from the pounds 280m put.
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