LONDON Diageo, the world's biggest spirits maker, has pulled out of long-running talks to buy a stake in top-selling tequila brand Jose Cuervo in a surprise move that could slow its race into fast-growing emerging markets.
The collapse of negotiations could also fuel speculation the British group will seek a deal with U.S. group Beam, home of the world's No.2 tequila brand Sauza.
A weekend newspaper report said Diageo had held talks with Japanese brewer Suntory over a joint bid for Beam worth over $10 billion, though it added nothing had been decided. Diageo declined to comment.
Faced with sluggish growth in recession-hit European economies, Diageo is looking to tap burgeoning middle classes in Asia, Africa and Latin America, where it aims to make around half of its turnover by 2015.
A deal with Jose Cuervo, valued at about $3 billion, would have given Diageo access to the emerging Mexican spirits market and a stronger product range there to go with its Johnnie Walker whisky and Smirnoff vodka brands.
Diageo, Cuervo's main distributor outside Mexico, had been expected to take a stake in the business with the possibility of gaining majority control at a later date.
But a short statement on Tuesday revealed discussions had broken down without agreement. The two companies had been wrangling over price since last year. From June 2013 the distribution deal ends, leaving Diageo without a major tequila brand and Cuervo without a major distributor.
Diageo shares were down 1.2 percent to 1,863.5 pence by 1000 GMT, underperforming a broadly flat UK benchmark index.
However, RBC analysts noted that Cuervo only accounts for about 3 percent of Diageo revenues and 2 percent of profits, and the failure of the deal might free up funds for other deals.
Davy analysts said the collapse of the Cuervo talks could explain speculation about Diageo's interest in Beam.
"Whether Diageo was just using the threat of buying Beam as a bargaining tool with Cuervo is hard to say. But now the market will probably ascribe a higher probability that Diageo will take a look closer at Beam's portfolio," they said.
Cuervo is owned by the Beckmann family, heirs to the Cuervo family who founded the company in the Mexican town of Tequila in 1795. The business is the clear leader in tequila's two biggest markets, the United States and Mexico, ahead of Sauza.
However, Cuervo's U.S. share has been gradually declining. It was one of Diageo's lowest margin brands and was not realising its potential in the United States, Diageo's Walsh said when talks started in 2011.
"We believe that the future of the (Jose Cuervo) brand would be best delivered by aligning ownership of the brand with its route to market and I have no doubt that Diageo has the best route to market for this brand," said Diageo CEO Paul Walsh.
"However it has not been possible to agree a transaction which delivers value for Diageo's shareholders and therefore, by mutual agreement, we have terminated our discussions."
Diageo could now focus on growing its own 'super-premium' tequila brand Don Julio.
Premium tequila brands, which are high margin and high growth, are made entirely from the blue agave plant that grows in the Mexican state of Jalisco, while cheaper brands are mixed with spirit derived from sugar cane and other sources.
Last month, Diageo paid $2.1 billion for a majority stake in India's largest spirits company United Spirits, and it has also secured smaller deals for producers of baiju, cachaca and raki in China, Brazil and Turkey.
The group, whose brands also include Guinness, Tanqueray gin, and Baileys liqueur, was advised on the Jose Cuervo talks by Goldman Sachs and HSBC.
(Editing by Kate Holton and Mark Potter)