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Brewing a global mix... - Views on News from Equitymaster
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  • Jan 8, 2000

    Brewing a global mix...

    The economic liberalization process in India has created a new breed of companies. These are the global aspirants. Included in this group are companies that have initiated moves or have set up bases in international markets, by acquisition, alliances or green field ventures. Tata Tea, however has opted for a more aggressive approach. The company is acquiring UK based Tetley, the world's second largest tea brand.

    Tata Tea is the largest integrated producer of tea in the world. The company's assets include 24,500 hectares of tea estates, a 100 percent export oriented instant tea factory and a host of tea brands including Tata Tea, Kanan Devan, Chakra and Agni. Tata Tea comes in second after the venerable Hindustan Lever Limited (HLL) (a 51 percent subsidiary of Unilever Plc.) in the packet tea segment. The company also has majority stakes in Consolidated Coffee Limited (CCL) and Asian Coffee Limited (ACL). While CCL is the largest coffee company in Asia, ACL is engaged in the manufacture of instant coffee.

    Tata Tea, initially an only plantation company, had made a foray into the branded packet tea segment in 1983. It has since garnered a market share of 23 percent. The management has aggressively ploughed back funds into the process of launching and building new brands. In volume terms, the branded packet segment accounts for 84 percent (financial year 1999) of the company's tea sales. The graduation from being a commodity to a product driven company has enabled Tata Tea to increase its value added output. This has resulted in better margins even as the high level of integration has given it a strong control over its cost structure.

      2QFY2000 2QFY1999 Change
    Net Sales 2,313 2,154 7%
    Other Income 132 117 13%
    Expenditure 1,718 1,396 23%
    Interest 33 39 -17%
    Depreciation 48 48 1%
    Profit before Tax 646 787 -18%
    Tax 184 234 -21%
    Profit after Tax 462 553 -17%
    Net profit margin 20.0% 25.7%  

    The acquisition of Tetley is the final step in converting Tata Tea into a product driven company. The acquisition, which is likely to cost of over US$ 400 million, is to be routed through a special purpose vehicle (SPV). Tata Tea will infuse upto US$ 150 m into the SPV for the purpose of funding the acquisition.

    Tata Tea has much to gain from this acquisition. First and foremost would be the brand 'Tetley'. The brand has a global appeal as against the limited domestic appeal of the 'Tata' brand. The complementary nature of the brands would enable Tata Tea to dominate the global tea market. The other gains would be in terms of access to Tetley's superior technology and global sourcing skills - two factors that would be critical as global competition heats up. These factors will enable the company in reducing costs and improving efficiency, thus improving overall competitiveness.

    The acquisition of Tetley has not been devoid of controversy. Sara Lee and Nestle dropped out early in the race due to the high price being demanded by the promoters of Tetley. In light of this, Tata Tea had relatively little competition in acquiring the company. This has raised concerns regarding the possibility that the company may have over paid for Tetley.

    Tata Tea's decision to acquire Tetley through a SPV, into which it will infuse funds, is unlikely to settle well with the shareholders of the company. This is mainly due to the fact that though there will be an immediate equity dilution (after the planned GDR issue), Tata Tea will not earn revenues on account of this investment in the near future (as an immediate merger is not planned). This will lead to a dilution in earnings and also a reduction in the return on capital and the return on equity. Moreover, the benefits of a merger (like cost reduction) will be further postponed. The shareholders will thus have to bear the burden of the investment without any quid pro quo (in terms of enhanced revenues and profits).

    On the business front, Tata Tea has the unenviable task of competing with HLL in the domestic market. HLL is the leading consumer products company in India and has recently been conferred the title of being the number one consumer products company in the world by a leading international magazine. HLL is increasingly becoming aggressive in its food and related businesses to generate growth. This could lead to the intensification of competition, and consequently, a thinning out of margins.

    Tata Tea's move to acquire a leading global brand will definitely give a thrust to its global ambitions. However, the rising competition in the domestic and international markets could still spoil the party.



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