USL stake: Diageo open to creeping acquisition

Last Updated: Thu, Dec 13, 2012 04:55 hrs

The sharp rise in the stock price of United Spirits spells trouble for Diageo, the British liquor major. Last month, the company had announced it was acquiring a 27 per cent stake in Vijay Mallya's United Spirits at Rs 1,440 a share. The company had envisaged getting control of another 26 per cent through an open offer.

Now, with the open offer seemingly unlikely to yield anything, Diageo has conveyed to analysts that it would consider the creeping acquisition route. The analysts have queried what this would mean for their desire on management control.

Agnes Bota, director, investor relations, at Diageo, has been interacting with analysts on the issue. In an interaction with CLSA, she said: "If the offer is not successful, we are not worried, as the agreement with the former management gives us the same control that we would have with a majority shareholding as well. According to the agreement, (Mallya's) UB Goup would vote alongside Diageo for a period of four years."

Analysts also note UB is obliged to vote alongside Diageo for a period of four years; beyond this, if Diageo wants control, it will have to increase its holding. CLSA's analysts say: "We are also unsure of Diageo's comfort on the investment at a significant premium to the original price of Rs 1,440/share." Though UB Holdings is bound to vote in favour of all resolutions proposed by Diageo's for a period of four years, this does not amount to management control. This probably explains why Mallya has been calling it a partnership all along and not a sellout.

According to the agreement Diageo has with USL, it would acquire a 12.8 per cent interest in the existing share capital of USL from UB Holdings and other members of Mallya's group. Another 6.5 per cent would be bought from the USL Benefit Trust, two subsidiaries of USL and SWEW Benefit Trust, both companies had conveyed in an analyst presentation. Apart from this, approval of USL's shareholders would also be sought for a preferential allotment of new shares amounting to 10 per cent to Diageo.

Following these transactions, Diageo would make an open offer for an additional 26 per cent, as mandated by Indian rules. Interestingly, the agreement has a clause which says that even after these transactions, if Diageo's stake is not above 51 per cent, then UB Holdings will be required to vote in favour of all resolutions proposed by Diageo for a period of four years.

Following the conference call that analysts have had with Diageo, it's apparent that Diageo has an option. The first route is to go for creeping acquisitions. A Religare note says Diageo is unlikely to raise the offer price but could look at creeping acquisition. Diageo has conveyed to analysts that it believes 20 times the ratio of enterprise value to operating earnings is a reasonable multiple for acquiring UNSP's business, looking at other emerging markets and growth opportunities. Even if Diageo were to make a creeping acquisition of five per cent (as allowed under the rule) each year, it would not be able to take its stake to over 51 per cent.

The other route before Diageo, analysts say, is a preferential allotment. However, this would require the permission of shareholders, as it would entail a further dilution. No wonder, Mallya is calling this a partnership, as he will continue to hold 14 per cent in USL.

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