Drink up

Foster's Group Ltd. is down in the cellar taking inventory.

After spending nearly A$7 billion ($5.7 billion) in 12 years building a wine business from scratch into the world's No. 2, the Melbourne, Australia-based behemoth may find that many of its holdings have turned to vinegar.

Foster's, which is Australia's largest beer and wine company and the world's second-largest wine producer after Fairport, N.Y.-based Constellation Brands Inc., recently embarked on a strategic internal review of its wine business. It is considering all options, including a full or partial sale of its portfolio, now estimated to be worth about A$3.8 billion.

"We have not been immune from industry-wide pressures including an economic slowdown in key markets and higher prices," acting CEO Ian Johnston said in August. His comments came as Foster's reported its first loss in 16 years after it wrote down the value of its wine operations by A$602.9 million. Johnston added that the company is responding to trends with sales initiatives "across key categories and markets." Foster's hopes to complete its stock taking, and find a new CEO, by year's end.

While selling the wine activities at a loss would be hard to swallow, Foster's may have no choice as the owner of Napa Valley's Beringer Vineyards and Australia's Wolf Blass and Lindeman labels pays the price for a four-year spending spree led by former CEO Trevor O'Hoy.

The portfolio reshuffle comes amid an increasingly crowded global industry characterized by a growing supply of brands (some 3,500 available to U.S. consumers alone, by some counts), especially in higher-priced market segments, and an onslaught of financial investors and other new oeno-entrepreneurs. All this adds up to a groundswell of international M&A activity in the $95 billion sector. "The wine market is much more segmented than any other alcoholic drinks industry, with the top 10 wine companies controlling less than 5% of production," explains José Luis Hermoso, senior researcher at the International Wine and Spirit Record in London. "The search for size, synergies and cost cuts, as well as diversity and ability to offer a wide choice, means that consolidation will continue."

In the U.S., there is also consolidation among distributors. "To remain a competitive, top-tier supplier, we must be able to provide our customers with consumer preferred brands from a variety of growing regions [for wine], or key brands in hot categories [spirits]," notes Paul Hetterich, executive vice president and the head of M&A at Constellation since June 2003.

Like its smaller peer Foster's, Constellation is active on the dealmaking front. After the $885 million purchase of Fortune Brands Inc.'s U.S. wine business in December 2007, Constellation has made several divestments. In June, it sold Geyser Peak and other U.S. brands to Ascentia Wine Estates for $234 million in cash. In August, Constellation announced plans to sell some Australian vineyards and production facilities to reposition its Australian wine business. With Constellation refusing to rush into any sale, that could potentially pose problems for Foster's in vying for investors' attention should it end up selling some domestic assets.

Foster's has clearly not been as adept as Constellation at juggling multiple brands and adding wine to its powerful beer business. Where did it go wrong?

In a recent report, analysts at Citigroup Global Markets Inc. fault the firm for making several tactical errors in the U.S., which is Foster's largest market. Notably, it imposed a 20% price increase on Beringer White Zinfandel and Beringer Californian Collection that caused sales volumes to fall. It also reduced its merchandising and promotional activity for Australian wines.

In the end, Foster's may not sell its entire global wine business. The most likely scenario appears to be retaining a handful of top brands and selling the rest, probably to multiple suitors.

"Whoever buys the whole [Foster's] business will need to clean up the massive, messed-up portfolio -- an option few are eager to undertake," says one expert. Don't hold your breath for a Constellation-Foster's tie-up or the wine equivalent of InBev SA-Anheuser-Busch Cos.'s mega-brewing deal.