One company's misery is another company's opportunity. Indian billionaire Dr. Vijay Mallya, who owns 28% of United Spirits Ltd., is in need of cash for his ailing Kingfisher Airlines, and so has entered into negotiations with Diageo (NYSE:DEO) to sell part or all of his stake in India's largest distiller. The Indian market is growing significantly and, thus, any move by Diageo to increase its influence in the country should be welcome news for shareholders.
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Drinks International publishes an annual listing of liquor brands selling at least one million nine-liter cases in a given year. Of the top 30-selling whiskies in 2011, 14 are Indian with eight from United Distillers, which holds 40% market share in the country. United Spirits is so big into whiskey that five of the 20 largest brands by case sales anywhere in the world are its own whiskey products. The five brands, led by McDowell's No. 1, accounted for the volume equivalent of 634.5 million liters of whiskey in 2011. United Spirits is one of the only two companies in the world with a dozen brands among the top 100 spirit brands worldwide, the other being Pernod-Ricard (OTC:PDRDY). Most importantly, 83% of its $1.48 billion in revenue was generated in India. This compares with approximately $69 million for Beam Inc. (NYSE:BEAM) and $100 million for Diageo, which got out of the Indian whiskey market 10 years ago, but now appear ready to move back in.
Diageo is attempting to take away global market share from the world's second-largest spirits business, which has three Indian whiskey brands - Royal Stag, Imperial Blue and Blender's Pride - that are all top 100-sellers. Its Indian business generates one-seventh the revenue of Pernod-Ricard so reaching a deal, something it was unable to complete in 2009, is critical to its growth in the Asia/Pacific region. Clearly the circumstances under which Dr. Mallya has come to the negotiating table differ greatly from the previous round of talks and should help the proceedings along. Having said that, Diageo needs Mallya almost as much as he needs them so it's fair to say he can drive a good bargain in the process. If Diageo were to acquire 25% of United Spirits, it would be required under Indian law to make a follow-up offer for another 26% and control. Some suggest 25% would go for $800 million.
If the past three years are any indication, that's the low-end of any deal. According to Bloomberg, the average premium paid for the 227 deals involving a liquor company over the past three years was 23%. United Spirits shares are up more than 100% in 2012, currently valuing the company at $2.8 billion. Given Dr. Mallya likely has other financing options available, Diageo is probably looking at a valuation higher than the 23% premium because his stock hands it the Indian market on a platter. Therefore, a 25% stake could go as high as $1 billion. Further complicating matters is the report that Dr. Mallya is only interested in selling 15%, which means Diageo would have to find 10% from another shareholder in order to initiate an offer to take control. That's easier said than done given there are other liquor companies which might want in on the action. Stay tuned, because it's going to get interesting. Whatever happens, the good doctor will figure out how to remain chairman while selling a good chunk of his stake in the company. Kingfisher's future depends on it.
The Bottom Line
According to the International Wine and Spirit Research, India's spirits market in terms of volume is expected to grow 5.6% annually over the next five years, which is better than China and other emerging markets. Factor in that India's spirits business produces 120 million cases of whiskey annually and you're talking about a transaction that Diageo must complete. It doesn't have to, mind you, but it should if it wants to keep Pernod Ricard from nipping at its heels.
At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.