Stephen Byers, the Secretary of State for Trade and Industry, said the proposed deal raised competition concerns for the British brewing and pubs sector. It will report its findings by 27 October.
The referral appears to pave the way for rival bidder Punch Taverns to secure victory. However, there was speculation yesterday that Punch is likely to reduce its pounds 2.9bn cash bid by up to pounds 200m.
Punch can now argue that its deal is effectively the only one on the table. Its proposal also has the benefit of lower risk for Allied shareholders as it is not conditional on regulatory approval and can potentially be completed much more quickly.
One analyst said: "I would have thought this was a pretty hard knock for Whitbread to come back from. If Punch does not reduce its offer it would be pretty hard for the Allied board not to recommend it."
The analyst said that if Punch did decide to reduce its offer it would cause "tremendous ill will" in the City. It would also increase the pressure on the Allied board whose handling of the sale process has been heavily criticised.
The DTI decision caught Whitbread and Allied Domecq off guard as both companies had previously expressed confidence that their agreed deal would not run into regulatory problems. Shares in both companies closed sharply lower as the City began to bet on a knock out blow from Punch. Punch was seeking meetings with the Allied board late yesterday to determine Allied's position.
Hugh Osmond, chairman of Punch Taverns, was initially euphoric when news of referral broke: "They [Whitbread] are finished," he said. However, the Whitbread camp was yesterday claiming that Punch's offer could also run into competition problems. Punch yesterday struck an agreed pounds 69m deal yesterday to buy Inn Business, which controls an estate of 688 tenanted pubs.
However, analysts said all previous competition issues in the pub sector had centred on matters of vertical integration rather than simple pub numbers. They said that if Punch does run into competition problems after a deal has been recommended, it could sell some of its pub estate. So too could Bass, which has agreed with Punch to buy over 600 of the Allied pubs for pounds 1bn.
Analysts remained critical of the way the Allied board has handled the sale. One said: "They almost don't deserve to get the result they have. They could end up getting a bloody good price almost through no result of their own efforts."
City frustration over the performance of the Allied board is likely to be increased further by the share option windfalls the Allied directors will be eligible for on completion of the pub sale. Details published yesterday show that Tony Hales, the former chief executive, remains eligible for around pounds 400,000. His successor Philip Bowman, who only joined the company last December, will receive pounds 180,000.