Ever since it struck a $2 billion deal (which became costlier later) to buy a majority stake in United Spirits Ltd in November 2012, Diageo Plc. has been hit by a series of roadblocks and embarrassments in its efforts to clean up the way India’s largest liquor company had gone about its business.
On Saturday, Diageo-controlled United Spirits took its most significant and risky step in breaking away from its past by asking chairman Vijay Mallya to resign from the board after an internal inquiry alleged the liquor baron may have been involved in financial irregularities at the company. Mallya refused to resign and criticized the internal probe, which was led by the Diageo-appointed chief executive officer of United Spirits, Anand Kripalu. Diageo is now reviewing its shareholder pact, which required the company to support Mallya as chairman as long as he controlled at least 1% of United Spirits.
The probe alleged that United Spirits may have understated the amount it was owed by Mallya’s UB Group entities, among other violations. In earlier years, United Spirits was the cash cow of UB Group and analysts and investors suspected the tycoon was using the liquor company to prop up his loss-making Kingfisher Airlines.
The suddenness with which United Spirits moved against Mallya took analysts and investors by surprise.
But the Bengaluru-based company has made clear moves to distance itself from Mallya and his UB Group over the past two years or so, including removing several senior United Spirits veterans, moving UB executives off United Spirits’ payrolls and giving in to auditor BSR and Co.’s demands for more transparency on certain disputed transactions, according to current and former United Spirits executives. These people spoke on condition of anonymity as they aren’t allowed to speak to reporters about this issue.
In an email, a United Spirits spokesperson said the company “has been assessing its control environment and expects the results will be positive".
“Deloitte is performing testing on behalf of management and working with KPMG (BSR) to ensure that issues are quickly identified and addressed by the management. More than 450 control tests are being undertaken to provide good quality assurance over the control environment," the spokesperson said.
Mallya didn’t respond to emails seeking comment.
Obsession with controls
After buying a 25% stake in United Spirits in July 2013, a small team of Diageo employees led by Jason Lucas, a finance and strategy expert, took over the job of integrating United Spirits with Diageo.
Altogether, roughly 40 Diageo employees including Steven Grubb, global compliance head, and Devraj Doss, the chief financial officer at Diageo India, moved to United Spirits.
Their mandate was clear: to put in place strict procedures and documentation requirements to track each penny spent by United Spirits.
Running a liquor business across India is particularly cumbersome. Each state has its own regulations, which can change with a change in government, and approvals are required for the smallest of decisions. In such a scenario, bribing government officials or wholesalers was considered routine and many liquor companies didn’t enforce documentation related to manufacturing as well as marketing spending strictly.
Having operated in India for two decades, Diageo was aware of this and it wanted to ensure compliance with regulations at all costs.
Lucas and Grubb, both of whom wielded CEO-style powers at United Spirits until Kripalu’s appointment, immediately asked the company’s executives to stop giving discounts to wholesalers and moved UB Group executives off the payrolls of United Spirits, among several other compliance-related measures.
“Diageo and Mallya have acted like friends at the time of the merger, but Diageo was very clear from the start about changing things at USL. When Jason Lucas and Grubb, particularly, cracked down on compliance, USL executives got jittery. Grubb’s team was going through each and every vendor contract, accounting for bulk discounts to dealers and banning gifts," a former United Spirits executive said, requesting anonymity.
By September 2013, Diageo had moved as many as 100 UB Group and Kingfisher Airlines executives off the payrolls of United Spirits.
In the same month, Diageo, which had secured the right to appoint the CEO and CFO at United Spirits, said Cadbury India’s managing director Kripalu would be the next CEO at United Spirits.
Apart from learning about the liquor business, one of Kripalu’s immediate priorities was to help finalize a new code of conduct that would replace United Spirits’ eight-year-old code. The company rolled out its new code in February last year.
This covered all aspects of its business including accounting, marketing, dealing with government officials, anti-bribery policies and entertainment expenditure. After the new code was put in place, United Spirits lost at least five of its senior employees, two people familiar with the matter said.
“Most of the senior people who left were asked to go. They had violated the code of conduct put in place by United Spirits and Kripalu was very strict about this," one of the executives cited above said.
Although these moves weren’t directly aimed against the UB Group, the goal was to bring in an entirely new way of running the business and force out United Spirits veterans who wouldn’t toe the line.
After taking control at United Spirits, Diageo appointed BSR and Co. as the new auditor for United Spirits, replacing Grant Thornton.
BSR played a key role in the events that led to the board of United Spirits asking for Mallya’s removal.
During the finalization of United Spirits’ accounts for the year ended March 2014, BSR discovered various transactions that didn’t pass accounting muster. These included the loans given by United Spirits to UB Group entities and lower debt claimed by some United Spirits debtors than what was owed to the company.
The auditor refused to sign off on United Spirits’ accounts until the company gave more details on these issues, according to the two people cited above. Initially, United Spirits pushed back at BSR and insisted its accounting was correct. But BSR held its ground and the company was forced to look into these issues and get back with more details.
In August, the audit committee of United Spirits, too, refused to clear the company’s accounts.
Finally, after the company failed to get its fourth-quarter results cleared three times, on 4 September, United Spirits finally published its results for the year ended March 2014 and said it was investigating whether the company and its executives had violated rules by lending money to UB Group companies.
BSR issued a qualified opinion on the accounts and said it reserved judgement on the issues being addressed by the inquiry until it is over.
United Spirits hired auditing firm PwC in October for the investigation, along with other independent advisors as well as legal experts from Diageo.
By this time, Mallya’s stake in United Spirits had slumped to 5% as UB Group lenders sold United Spirits shares to recover part of their loans.
In October, Diageo said UB Group was no longer entitled to recommend an independent director to United Spirits following a reduction in its shareholding in United Spirits, citing its shareholders agreement with Mallya.
Six months later, United Spirits made its penultimate move against Mallya. On 23 April, UB Group veteran P.A. Murali said he would resign from his position as United Spirits’ chief financial officer.
“Murali was trying to act as a leveller between Mallya and Diageo. But he could only do so much. Acting on the top management’s decision, Kripalu called for an emergency meeting and asked Murali to quit," according to a UB Group executive familiar with the matter.
Murali didn’t respond to telephone calls and text messages from Mint.
Two days later, the report of the internal investigation alleged that Mallya may have been involved in financial irregularities and that United Spirits may have understated the money owed to it by the UB Group. By this time, United Spirits had also stopped marketing spending on the Mallya-controlled Indian Premier League cricket team Royal Challengers Bangalore.
“…without making any determination as to fault or culpability, the directors noted that they had lost confidence in Mallya continuing in his role as a director and as chairman and therefore, the board called upon Mallya to resign forthwith as a director and as the chairman of the board and step down from his positions in the company’s subsidiaries," United Spirits said on Saturday.
The company’s board said if Mallya declines to resign, it would go to United Spirits shareholders to seek his removal. The board also asked Diageo to review its shareholder agreement with Mallya’s UB Group. According to this pact, Diageo agreed to support Mallya as non-executive director and chairman of United Spirits as long as UB Group or Mallya holds at least 1% in United Spirits. UB Group currently owns roughly 5% of United Spirits.
Mallya has appointed well-known lawyers Amit Desai, M.L. Bhakta and Harish Salve to represent him, The Times of India reported on Monday.