Diageo chief executive Paul Walsh has said he wants control, or a route to control, of a brand owned by the secretive Beckmann family and a deal for a small stake is anticipated and could be concluded by the early summer, they added.
The maker of Smirnoff vodka and Captain Morgan rum already distributes Cuervo in most big export markets outside Mexico and has been in talks with the Beckmanns about the brand's future when a long-term distribution contract ends in June 2013.
The most likely scenario is that Diageo takes a minority stake and then looks to increase its influence over time and gain control of this valuable brand, said one banking source with knowledge of the situation on Thursday.
Diageo is keen to strike a deal by this summer well ahead of the end of the distribution deal, and Walsh has been clear that a renewal of the current distribution contract is simply not an option as the group does not make enough profit from the brand.
His minimum requirement is an equity stake in the business, but he would be willing to buy the whole company at the right price so it can start to plan its future marketing investment to grow the tequila brand.
Cuervo is the global market leader in tequila with a 19 percent share, twice the size of No.2 brand Sauza and by far the leader in the main tequila markets of Mexico and the United States, which account for 81 percent of Cuervo's global volumes.
Over the next 18 months we believe that Jose Cuervo is top of Diageo's shopping list, as are local emerging market deals, similar strategically to Mey Icki in Turkey, said Melissa Earlam, an analyst at brokers UBS.
She values Cuervo at $3.1 billion, putting it on a multiple of 16 times core profit or EBITDA, above a 13.7 times median for recent spirit deals, reflecting the scarcity of good assets and the appetite for them in the industry.
Talks between Diageo and the Beckmanns are said to be going well with some predicting a deal may be concluded in May to mark a second emerging market deal in a year after Diageo bought Turkey's Mey Icki last August for 1.3 billion pounds.
Analysts say if Diageo is unsuccessful with Cuervo then it might be tempted into a breakup bid for U.S. group Beam Inc
They stress that Diageo has a good recent track record of investing in spirits brands in emerging markets with small stakes initially and then slowly increasing its influence over time, as happened with Zacapa rum in Guatemala, China's Sichuan Shuijingfang <6007799.SS> and Hanoi Liquor in Vietnam.
These deals have helped Diageo increase its sales from emerging markets to around 38 percent of its total by the end of 2011 as it looks to match Walsh's target to get half its sales from these fast-growing markets by 2015.
It has shown discipline with potential deals when it walked away from a link-up in 2009 with India's biggest liquor maker United Spirits
Cuervo has suffered due to uncertainty, with the end of the distribution deal looming, and it saw the biggest sales decline among Diageo's key 11 strategic brands with revenues tumbling 12 percent in the its half-year to end-December 2011.
Analysts suspect Diageo had been cautious in committing marketing spend behind a brand that it could potentially lose next year, and say Cuervo is certainly not realising its growth potential at the moment.
We believe that the Ceurvo brand has neither maximised on its full potential in the U.S., nor has the international potential of the category outside the U.S. and Mexico been capitalised on. We believe the ownership of the brand by Diageo could likely unleash this and accelerate top line performance, said UBS's Earlam.
(Editing by Mark Potter)