When former chief executive Paul Walsh left Diageo (LSE: DGE) (NYSE: DEO.US) last summer, he must have thought that his final deal — the acquisition of a 25% stake in India’s largest liquor-maker, United Spirits Limited, had succeeded.
Unfortunately, Mr Walsh’s careful plans for Indian domination have started to come unravelled, and I’m concerned that Ivan Menezes, Mr Walsh’s successor as CEO, is starting to get a little too desperate to complete the deal.
Make me an offer
Diageo has launched a new tender offer to United Spirits shareholders, offering them Rs3,030 per share — a price that equates to a whopping 38 times EBITDA (earnings before interest, tax, depreciation and amortisation).
This valuation is more than double the Rs1,440 per share Diageo paid last year, under a previous tender offer — so what’s changed?
Control is slipping away
The problem for Mr Menezes is that Diageo’s control of United Spirits is gradually slipping away. Diageo purchased its original 25% stake in United Spirits from United Breweries, which retained a 13% stake in United Spirits, and agreed to vote at Diageo’s discretion, giving the British firm effective control of United Spirits.
However, 7% of Diageo’s holding is being contested by creditors to United Spirits chairman Vijay Mallya’s bankrupt airline, Kingfisher Airlines, and the voting deal with United Breweries ends in 2018.
A question of growth
United Spirits’ share price has risen by nearly 400% since Diageo’s first disclosed its interest in the firm in 2012. As a result, Diageo’s latest offer needed to be generous to have any chance of succeeding. The question is whether United Spirits’ growth prospects justify its inflated valuation.
India’s fast-growing middle class should drive growth in the liquor market, but United Spirits sales volumes (in cases sold) only grew by 7% in 2012 and by just 3% in 2013, against wider industry growth of 3.5%. That doesn’t seem like runaway growth to me.
If United Spirits shareholders take up Diageo’s latest offer, it will cost the British firm £1.1bn to acquire a further 26% stake in United Spirits. I suspect that most of this money would come from new borrowing, increasing Diageo’s large net debt of £8.8bn still further.
In my view, Diageo shareholders should question the value of this deal — and whether it might have been handled more skilfully.
Is Diageo still a buy?
Although I think Diageo’s valuation is too high for new investors, I do rate Diageo as a long-term hold for existing shareholders.Â