Mallya Seals Diageo Deal but Kingfisher Future Uncertain

Diageo has agreed to buy a majority stake in United Spirits Ltd, controlled by Vijay Mallya, for $2.1 billion, or Rs 11,000 crore, fuelling a push by the world’s biggest spirits group into fast-growing markets. However, the fate of his Kingfisher Airlines was not clear as Mallya chose to delink the United Spirits sale with the United Spirits deal. He adopted a guarded approach on the issue of using the money received from Diageo to bail out the Kingfisher Airlines, which has been grounded since September 30.

“Each individual company is a public entity. Kingfisher Airlines’ issues will be resolved by Kingfisher Airlines and UB Holdings. It would be unfortunate if you try to link this transaction with the airline. Lets not cross contaminate everything and interrelate everything,” Mallya said in a conference call after announcing the deal to sell United Spirits stake. Diageo, which first tried to buy United Spirits in 2008, said on Friday it would end up with 53.4 percent of India’s largest spirits company in a two-part deal. The Johnnie Walker and Guinness owner has been focusing on emerging markets where a growing middle class is developing a taste for more expensive drinks. Diageo has also been in talks to buy leading tequila maker Jose Cuervo.

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“This (India) will become Diageo’s number two market after the United States and if you look at the projections on what’s happening with the emerging middle class…it has the potential in the long term to become our largest market,” said Diageo Chief Operating Officer Ivan Menezes.

The stake sale will help Mallya with the much needed cash to pay off USL’s debt and free up funds to revive  Kingfisher. Diageo said it would fund the acquisition with cash and debt and expected no damage to its single-A credit rating – or its ability to make further acquisitions. It added that the deal, which values United Spirits at 20 times EBITDA, would increase earning per share from the second year. “Clearly this is a business that can grow very fast and where profitability can double easily within four or five years, so…I don’t think this is an expensive deal at all,” said Ian Shackleton, analyst at Nomura International.

However, according to Reuters Breakingviews columnist Quentin Webb, Diageo is paying a heavy price for Indian Spirits.”Diageo has sought a piece of United Spirits for a long time. An earlier round of talks fizzled in 2009. But Mallya, who keeps a stake and remains as chairman, is now in a tighter spot. His loss-making and debt-laden Kingfisher Airlines  urgently needs fresh capital. So the puzzle is why Diageo has not secured better terms,” he said. If the deal gets regulatory and shareholder approval, it will be the biggest inbound Indian M&A deal since British oil firm Cairn Energy sold a majority stake in its Indian business to Vedanta Resources  last year.

The main regulation issue is around United Spirits’ Whyte and Mackay whisky, which Diageo – the world’s biggest scotch company – would likely have to sell. Diageo Chief Executive Paul Walsh said the takeover did not hinge on Whyte and Mackay.

Kingfisher Problems

Mallya, who styles himself as ‘King of the Good Times,’ played down any link between the United Spirits sale and problems at his Kingfisher airline, which has been grounded by debts, safety concerns and unpaid staff. “We are working towards a comprehensive rehabilitation plan including recapitalisation of the airline. It would be unfortunate if you would try to link this transaction with the airline,” he told reporters. “I have now done what I think is best for my spirits business and, of course, we will also address the needs of Kingfisher Airlines, but these will be done separately for the good of the company and its stakeholders,” he said. “I am not selling my family jewels. I am embellishing them.”

Mallya even said he was not aware of any deadline set by the bankers for recapitalising Kingfisher. The comment comes three days after SBI said the carrier would have to get capital “by the month-end”. Kingfisher was up 4.6 percent while United Breweries Holdings was 3.2 percent higher and United Breweries, which makes Kingfisher beer, was up 0.4 percent. United Spirits shares, which have nearly tripled this year on takeover hopes, were up 1.3 percent at Rs 1,360.5.

“Some of the Mallya group companies have been in turbulence for some time. This is his final opportunity to revive the fortune of the group,” said Jagannadham Thunuguntla, head of research at SMC Investments and Advisors Ltd in New Delhi.

The Centre for Asia Pacific Aviation has said a fully funded turnaround for Kingfisher would cost at least $1 billion. Mallya will stay on as chairman of United Spirits while Diageo will name the top executive team. UBHL will keep 14.9 percent of the company. Diageo will acquire 27.4 percent of United Spirits from its founders and a packet of new shares for 1,440 rupees – a premium of around 7 percent to Thursday’s close. Diageo will then launch a mandatory offer for another 26 percent on the open market. If it fails to buy outright control, UBHL would vote with Diageo on decisions for

four years. UBHL has an option to sell its remaining shares to Diageo from the end of the first full year of control for seven years. Diageo – which also owns Tanqueray gin, Baileys liquer and Smirnoff vodka – makes about 40 percent of sales in emerging markets and had aimed for 50 percent by 2015. CEO Walsh told a conference call that he would now reset that goal. Diageo said it had also agreed to a request from Mallya to form a joint venture to run a sorghum beer business in South Africa which it said would help it build its presence in another market with a growing drinking class.

The deal is part of a new wave of consumer goods M&A in Asia-Pacific after Heineken’s $6.4 billion buyout of the maker of Tiger beer and SABMiller’s $12 billion acquisition of Foster’s in December Diageo was advised by JM Financial, Bank of America Merrill Lynch and UBS. UBHL and United Spirits were advised by Citigroup and Ambit Corporate Finance.