United Spirits, the next shaky ground for Mallya

Brewing billionaire Vijay Mallya's woes seem to be compounding. His flagship spirits arm, United Spirits Ltd (USL), is starting to mirror Kingfisher Airlines.

An over-leveraged acquisition of Scottish liquor company Whyte & Mackay (W&M) for $1.2 billion, and change in the strategy and overhang of the acquired company are taking a toll on the balance sheet of this market leader.

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While volumes are good, with USL controlling 55 per cent of the spirits market in India, the cost at which this growth has come does not bear up well under close scrutiny.

The United Breweries (UB) Group company is under a leverage of 1.7 times on a debt of Rs 7,713 crore (Rs 77.13 billion), and close to Rs 2,000 crore (Rs 20 billion) was piled on during the first nine months of 2011-12. Interest outflow as a result of this spiked by 34 per cent annually.

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The UB Group management has repeatedly stressed it has historically leveraged debt to the hilt and has delivered time and again.

"When we borrowed heavily for the acquisition of Shaw Wallace for Rs 1,200 crore (Rs 12 billion) more than seven years ago, the same concerns were raised. But we successfully integrated that company and our bankers have faith in us and have supported us with further debt," A K Ravi Nedungadi, UB Group president, had told Business Standard in several interviews. 

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On increasing leverage, USL joint president and chief financial officer P A Murali said there were Rs 1,700 crore worth monetisable assets on the balance sheet. "It's a tight rope walk until we decide to monetise, but we are not in a desperate situation to unlock the assets," Murali told Business Standard.

According to him, there are four assets which can be monetised when push comes to shove.

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"One is, of course, the treasury stock, worth around Rs 800 crore. Then, we hold 8.5 million shares of United Breweries Ltd, worth another Rs 350 crore. The third is of unlocking value in W&M, where we need not hold 100 per cent. We can always offload stake, hold majority and management control. And finally, we also own the Royal Challengers Bangalore cricket team in the Indian Premier League, which also can be banked upon," he said.

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Based on the valuations of Pune and Kochi teams, which were upwards of $300 million, Murali believes Royal Challengers, which has been in the league for nearly five years, would be worth much more.

"We had got the franchise for $110 million, which we have to pay over 10 years. We have almost completed five years' payment and the valuation will be better as we proceed further," he noted.

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Murali said even as these assets were there to be monetised, the various measures of backward integration in which they were investing close to Rs 900 crore over the next three years, would start to bear fruit in the next 18 months and investors would find more value in the company.

"We may look at a strategic partner at that time," he said. The $1.2-billion acquisition of W&M has been proving to be an unwieldy one and USL is taking its fourth major step to reduce the gearing, or debt-equity ratio, which does not show any sign of loosening. In the past two years, USL has raised as much as Rs 2,800 crore through treasury stock sale, qualified institutional placement and re-financing of foreign currency loan to pare down interest costs.

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It's embarking on a foreign currency convertible bond issue of Rs 1,200 crore (Rs 12 billion) to repay a part of the debt and take another shot at reducing interest outflow.

Analysts have said roping in a strategic player is another option, but with stock falling to a Rs 550 level, from an earlier high of Rs 1,300, this will be tough.

But all these steps may not be enough to bring down the debt-equity ratio. Nikhil Vora, managing director of IDFC Securities, said in his latest report on USL that there was an urgent need to bring in more equity.

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"We sense a structural derate in the business. Our apprehension stems from USL's mass positioning rather than value. Incrementally, increasing leverage and given the state of affairs of the UB Group, we believe there is an urgent need for capitalisation within USL," Vora said.

Against this backdrop, we believe monetisation by way of sale of treasury stocks and shares of UB (aggregate value of Rs 900 crore) could be potentially undertaken in the near term. However, issues being faced by the UB Group will continue to remain an overhang," he adds.

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Long-haul strategy

When USL acquired W&M in a much celebrated deal in 2007, another global spirits major, Diageo, was a major client of W&M for its scotch supplies.

A few months after the deal, the contract came to an end and Diageo stopped picking up supplies, thus denting major revenues. Anticipating this, Mallya resorted to a strategy of totally stopping bulk sales and started focusing on building brands.

"The strategy is a good one, but it's of a long haul. While W&M indeed has iconic brands, building total revenues from brands is going to be an uphill task and till then, the operating margins from W&M is expected to be under severe stress," another industry analyst told Business Standard.

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While the earnings before interest, taxes, depreciation and amortisation margin at W&M was down at 21.82 per cent, net debt rose by 23 per cent to 𧵂 million (around Rs 1,060 crore).

Abneesh Roy of Edelweiss Securities wrote while he believed in USL's brand equity and stronghold in the alcohol industry, he was cutting USL's earnings estimates by 17 per cent each for 2011-12 and 2012-13 due to lower volumes, rising interest costs and raw material prices.

"Increasing working capital, W&M overhang, consumer sentiment, higher regulatory actions and stress on group companies remain cause of concerns," Roy said.