The acquisition of a Ugandan tea firm by planter McLeod Russel India Ltd coincided with a prediction of falling tea prices. The Food and Agricultural Organization said it expected weather patterns to be normal in 2010 in the main tea producing regions of Asia and Africa. It also expressed concerns about the effect of a growth in the cultivated area, which may result in higher output in coming years.

In 2009, the FAO composite tea price had reached a high of $3.18 per kg, 34% higher than the 2008 average. India’s end-November auction prices were 18% higher than in the same period a year ago. In 2008, tea prices ended 28% higher than at the start of the year, now marking two years of sharp increases in tea prices.

If prices could fall in 2010, acquiring a business may seem counter-intuitive. But good years are also when firms get enough cash, which can be used for an acquisition. McLeod’s net cash generated from operations in fiscal 2009 on a consolidated basis nearly tripled to Rs204 crore. The current year, too, will be good, with sales up by 23% to Rs465 crore in the first half and net profit up by 73% to Rs223 crore. McLeod has been on the acquisition trail for some time; it had announced an acquisition of tea plantations in Rwanda, but that deal has got stuck due to political issues. Now, it has announced the acquisition of Rwenzori Tea Investments Ltd, Uganda, through its UK subsidiary. McLeod will pay $25 million (Rs117 crore) as equity consideration and repay inter-corporate debt of $5 million, leading to an enterprise value of $30 million. In return, it gets six tea plantations with an annual output of about 15 million kg of black tea. The business being acquired had revenues of $24 million and a net profit of $5 million in 2008, according to news reports. McLeod expects revenues to grow by 25% in 2009 and profits to grow by 40%. Higher tea prices would be the chief contributor to growth.

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Based on McLeod’s fiscal 2009 numbers, the acquisition would add about 14% to its consolidated revenues and 27% to its net profits. The acquisition is thus significant. Indian firms seeking to buy African tea firms are interested not only in expanding revenues but improving margins. Lower costs in these regions and better yields make them more profitable. Rwenzori’s net profit margin in 2008 at 21% was nearly twice that of McLeod. The acquisition values Rwenzori’s business at a price to sales ratio of 1.

The valuations seem reasonable, pricing in the likelihood of a fall in prices in the next year or two. McLeod plans to boost production in Rwenzori by 33% in five years, further adding to sales and profitability. Apart from tea prices peaking, political uncertainty is the other risk in this transaction.

Graphics by Naveen Kumar Saini / Mint

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