Diageo takes control of United Spirits

Patience (helped by wads of dollars) eventually paid off. Five years after entering initial takeover discussions, Diageo can finally claim ownership of United Spirits (USL), India’s major drinks company, media reported on 23 June 2014.

Following the successful close of its USD 1.1 billion tender offer on 19 June 2014, Diageo will own 54.7 percent of USL for which it will have paid a total of GBP 1.86 billion (USD 3.2 billion).

Thanks to the GBP 430 million (USD 726.5 million) received from the sale of the Scotch whisky business Whyte & Mackay to Philippine’s Emperador drinks group in May this year – a disposal enforced by the UK’s competition authorities – this outlay will be partially reduced by lowering USL’s debts.

Media say the response to Diageo’s latest stock market offer is in stark contrast to the reception of its bid a year ago, which was aimed at picking up a 53.4 percent stake in USL. Last year’s offer was pitched well below USL’s market value, which is why Diageo only won 0.4 percent of the shares.

The latest bid gives Diageo complete control of USL – once dominated by the Indian entrepreneur Vijay Mallya – via a majority shareholding.

The price Diageo has paid for control of USL is almost 39 times the Indian group’s annual earnings (EBITDA), it was reported. This is phenomenally high. For comparison, Japan’s Suntory paid a multiple of about 20 times earnings for U.S. drinks group Beam earlier this year.

Indian media say that USL operates on a thin profit margin of 4 percent and Diageo will be more than happy if it is able to hold it at that level in the near future before looking at raising it. The market expects that Diageo will muscle it up to double digits – a tall task in the current circumstances. The market had similar expectations from Dutch brewer Heineken when it acquired a 37.4 percent stake in Mr Mallya’s beer company, United Breweries, in 2008. Four years later, United Breweries was still struggling with gross profit margins of a little over 4 percent.

Although far from cheap, USL is to help Diageo build up a bigger stake in emerging markets. Diageo expects the USL deal to have a positive effect on earnings per share by 2020.

USL is by far the dominant player in India’s drinks market with a share of about 30 percent, selling a massive 123.7 million cases (9 litres each) a year, with 21 brands each accounting for more than 1 million cases. Five of them sell more than 10 million, it was reported. For comparison, Diageo sells 130 million cases with the Johnnie Walker whisky brand representing about 20 million cases.

Diageo began talks with Mr Mallya about USL in late 2008, but at that stage the Indian entrepreneur put what Diageo’s then CEO Paul Walsh said was an “exaggerated value” on USL. The global financial crisis added woes to Mr Mallya’s empire. He had overpaid for Whyte & Mackay in 2007 and his Kingfisher airline ran into mountains of debt leaving the airline grounded.

Reportedly, Diageo’s newly-appointed management at USL is cleaning up the Indian company’s books, including loans to Kingfisher and drinks wholesalers in the subcontinent.

Deutsche Bank reckons that this could involve Diageo writing off up to GBP 200 million (USD 345 million) from USL’s balance sheet via potential write-downs of inventories, the Indian Premier League cricket franchise in Bangalore and a longer-than-expected period for working capital improvement.