Vijay Mallya emphasized repeatedly, in a call with the media, that the transaction between United Spirits Ltd (USL) and Diageo Plc should not be linked to the troubles facing the group’s airline business or the group’s debt overhang. The timing makes it hard to dismiss that perception, but that is not as relevant to minority shareholders as is the question: did he sell the group’s stake in USL cheap, or on unfavourable terms, either of which indicates a distress sale?
Diageo is paying Rs.1,440 a share to acquire a majority stake in USL, which is a 6% premium to Friday’s closing price. The low premium leaves very little on the table for investors hoping for quick profits. But the share has risen by 35% since 25 September, when a possible deal was first confirmed, and it has more than doubled since June.
In the first half of 2012-13, USL’s consolidated sales rose by 20% year-on-year, and its Ebitda (earnings before interest, tax, depreciation and amortization) rose by 20.1%. That is a good performance, but still does not explain the sharp rise in its stock. That can be attributed chiefly to expectations of the Diageo deal going through. The offer values it at 57 times its annualized earnings per share for 2012-13, based on its first half numbers.
That is expensive, and to some extent, already factors in Diageo’s value as a co-promoter, and the interest reduction that is likely to follow. Barring regulatory hurdles, Diageo will pump in Rs.2,092 crore into USL (10% of its post-issue equity capital), which will considerably lower its consolidated debt of Rs.8,186 crore, and bring its net debt to equity ratio down to 0.4:1 from 1.6:1.
In short, USL’s shareholders are being offered a fair price, and even those who bought shares as late as June are sitting on super-normal profits. So, should they sell in the open offer? A partial exit seems prudent. A lot depends on what Diageo does after it comes on board, the phasing of debt reduction, impact of operational or financial restructuring if any, and its integration plans. Expecting the share to skyrocket further from here is unreasonable.
Diageo has got what it wanted, which is a top-notch foothold in a fast growing emerging market for alcoholic beverages. While it is paying a stiff price, in return it has effective control over the board of USL, as it can appoint the CEO, CFO and other whole-time directors.
The UB Group retains Mallya as chairman, and can recommend one independent director, but these rights are subject to minimum shareholding requirements. Diageo will own at least 27.4% of the expanded share capital of USL, and if the open offer succeeds, it will rise to 53.4%.
If Diageo had acquired a shareholding under 25%, then this may not have been perceived as a sell-out. So has the UB Group lost in the process? Not really. They continue to own a significant, even if not a majority, stake in USL. Also, Diageo will value UB’s skill in navigating India’s complex alcohol market that is riddled with policy impediments at the state and central level.
More importantly, Diageo would not want Mallya as a competitor. If their shareholding agreement is terminated, the non-compete will end in two years. That is too short a time frame for a person perceived as a shrewd and aggressive entrepreneur, with a proven track record in the alcohol business. If he re-enters the spirits business on his own, he will have no dearth of backers, given his success in the industry. That may explain why Mallya continues as chairman of USL, and will do so as long as his stake in USL is at least 1%, and even if it goes below that level, he will continue as chairman emeritus in a non-board role.
In effect, it is unlikely Diageo will want UB to exit USL, barring unforeseen events. That should be good for the group, and for the value of the stake in USL held by United Breweries Holdings Ltd.
But where is Kingfisher Airlines Ltd in the picture? There is no direct connection. But the listed holding company, UB Holdings, will get Rs.2,404 crore from Diageo. The cash in the bank gives it some breathing space. The stake sale may, therefore, give the group more bargaining power, and also give lenders the confidence to back a debt restructuring proposal for the airline, as the promoters now have cash to back their word.
Whether this money is enough or more disinvestments will be needed remains to be seen. But this is an important step in finding the funds needed to lower the group’s debt overhang, and getting Kingfisher back on the tarmac.