TSRYY Treasury Wine Estates Ltd (PK)

By Rebecca Thurlow in Sydney and Saabira Chaudhuri in London 

Treasury Wine Estates Ltd. sought to break out of the shadow of past failures by buying up most of Diageo PLC's North American and British wine operations.

The US$552 million deal, announced Wednesday, will see the Australian vintner focus more aggressively on the top end of the U.S. market--rather than the cheaper wines that have delivered so much pain for the company in recent years.

Treasury Wine is one of the world's biggest winemakers, and the owner of premium and mass-market brands including Penfolds, Wynns, Wolf Blass and Beringer. Its quest for scale comes at a time of similar moves in the beverage industry, following Anheuser-Busch InBev NV's takeover proposal for SABMiller PLC, which if successful would combine the world's two largest brewers.

For London-based Diageo, the world's largest spirits maker, the deal is the latest move to sharpen its focus on its core spirits business.

Chief Executive Ivan Menezes has repeatedly underscored that Diageo is changing, after a tough couple of years that have frustrated investors as the maker of Smirnoff and Captain Morgan lost market share in the U.S., its biggest market. Mr. Menezes has moved to drop prices in the U.S., shed certain noncore assets, and sharpen Diageo's focus on higher growth regions like Africa and India. Net sales in the wine business, which makes up 4% of Diageo's sales, declined 1% in fiscal 2015, while the company's operating profit fell 0.8%.

"Wine is no longer core to Diageo and this sale gives us greater focus," said Mr. Menezes on Wednesday.

Treasury plans to tap shareholders for 486 million Australian dollars (US$350 million) to fund the deal with Diageo, just as earnings are rebounding from large write-downs linked to slowing commercial sales in the U.S. that forced the company to pour gallons of wine down the drain in 2013.

Treasury Wine's chief executive, Michael Clarke, said the acquisition would transform the firm's U.S. business into a "larger player of scale" in the faster-growing luxury and so-called masstige segments of the U.S. market. Masstige wines are branded as premium-quality labels priced somewhere between the cost of mass-market and luxury ones.

The acquisition will double Treasury Wine's sales revenue from luxury and masstige wines in the Americas. Diageo owns a collection of high-end wine brands produced out of the Napa Valley, California, including the Beaulieu Vineyards and Sterling Vineyards.

As part of the deal, Treasury Wine will also get control of Diageo's U.K. commercial brand Blossom Hill, one of the biggest-selling wine labels in Britain by volume. Mr. Clarke said the acquisition of that would give "critical mass" to Treasury's global commercial wine portfolio, helping to reduce costs.

The deal has been in the making for nearly a year now, with Mr. Clarke starting discussions with Mr. Menezes, back in November.

Under Mr. Menezes Diageo has, so far this financial year, struck deals that will give it around US$1.54 billion, including last week's exchange of emerging-market brewing assets with Heineken NV, and Diageo's move in July to restructure its South African and Namibian joint venture with Heineken and Namibia Breweries Ltd.

Diageo in the past year has also sold the Gleneagles Hotel and golf resort and swapped its Bushmills whiskey brand for tequila brand Jose Cuervo.

"Diageo's strategy is to drive stronger, sustained performance through focus on our core portfolio," said Mr. Menezes on Wednesday.

The spirits maker will be left with a small handful of wine assets, namely London-based fine wine merchant Justerini & Brooks, the wine brands of its India and Turkey business, a wine business in Argentina and a handful of assets in the U.S. It will use the sale's proceeds to pay down debt, which stood at over GBP16 billion in June.

For its part Melbourne-based Treasury Wine has faced difficulties in the U.S. ever since being spun off in 2011 from Foster's, which was later bought by SABMiller. The spinoff came as U.S. consumers were developing a growing interest in premium wines--leading them to shun cheaper labels like Treasury's mass-market Beringer range. At the same time, a high Australian dollar made it difficult to battle growing competition from other wine-producing nations such as Argentina, Chile and South Africa.

In 2013, a particularly bad year for the company, Treasury Wine vastly overestimated U.S. demand for Beringer, and ended up having to destroy thousands of gallons that had passed the sell-by date. The faux pas led to a large write-down linked to the vintner's U.S. operations that hastened the departure of its former chief executive, David Dearie, later that year.

It also sent the company's shares into a tailspin, attracting two failed takeover bids from private-equity firms last year.

Mr. Clarke was brought in to steady the ship. His strategy has included prioritizing marketing spending on a selection of the vintner's luxury and masstige wines, while cutting supply-chain costs in the commercial wines business. It is a strategy that seems to be working, and which helped the company swing to a profit last financial year.

Treasury said Wednesday that its sales and earnings performance continued to gain momentum in the latest quarter, and that it expected underlying profit to rise to A$270 million-A$290 million this financial year, from A$225 million last year.

Mr. Clarke said demand for Treasury's luxury and masstige wines in the U.S. was growing so fast that the vintner was managing to sell everything it makes. It hopes also to use some of the Diageo grapes to meet rapidly rising demand in other regions, especially Asia.

"This is about getting access to additional luxury grapes," he said.

The deal also includes the assumption of capitalized leases of US$48 million, taking the total deal value to US$600 million, Treasury Wine said. The acquisition is subject to certain regulatory approvals, including antitrust acceptance in the U.S., and is expected to complete in approximately three months.

Write to Rebecca Thurlow at rebecca.thurlow@wsj.com and Saabira Chaudhuri at saabira.chaudhuri@wsj.com

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October 14, 2015 06:39 ET (10:39 GMT)

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