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November 9, 2012 4:14 pm
A marriage of convenience or the start of a long-term relationship? Diageo shareholders will be hoping for the latter as their company buys up to 53 per cent of United Spirits of India for £1.3bn. The deal will give Diageo control of the market leader in India, where alcohol sales are growing 15 per cent a year and the middle classes are developing a taste for upmarket brands. It also has attractions for Vijay Mallya, who is selling part of his United Spirits stake to Diageo. His Kingfisher Airlines business is in deep trouble, so the cash injection will come in handy even if it will not, on its own, solve the airline’s problems.
But there are grounds for concern. Diageo is paying 20 times historic earnings before interest, tax depreciation and amortisation, which is eye-popping even by the standards of emerging markets drinks deals. Campari recently paid 15 times ebitda for a Jamaican rum company. And Diageo is buying a low-margin business. United Spirits’ forecast operating margin of 13 per cent compares with 30 per cent at Diageo. But at least there is scope to improve profitability. Still, it will take six years for the deal to beat its 12 per cent cost of capital. And Diageo’s model (buy an emerging market drinks business then push its global brands through the acquired distribution channels) will be harder to implement than usual because India has a 150 per cent import tariff on spirits. Even if that comes down, Diageo will have to negotiate the labyrinth that is India’s alcohol regime.
Less tangibly, Diageo will have to get used to doing business with Mr Mallya. The relationship is good at the moment, but the structure – Diageo in control of United Spirits but Mr Mallya in the chair – has scope for conflict. At least there is an encouraging precedent. Heineken owns 38 per cent of Mr Mallya’s United Breweries, and that relationship has, so far, been smooth.
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