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United Spirits: Still riding the high horse - Outside View by Luke Verghese

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United Spirits: Still riding the high horse
Feb 21, 2013

This company is a lot more than just about spirits-the investment portfolio is of much greater significance

A management makeover

Leafing through the latest annual report of United Spirits one wonders how the enlightened management of Diageo ever managed to arrive at an enterprise value of this target company. (Diageo is acquiring a 53.4% stake in the company which will include an open offer. This involves a cash outlay of over US$ 2 bn). It would appear that they were in a slightly tipsy state of mind while in the evaluation process. That they actually did arrive at a value is another matter altogether - but the fact that Mallya finally agreed to the deal could in a sense infer that the valuation may well have been tilted in his favour. This company is a complex and intricate web of confusion that would put even the most enterprising spider to shame. That the promoter group was able to run riot over its affairs with only a 27.78% holding in the voting capital of Rs 1.3 bn is in itself a litmus test of the moribund state of shareholder activism in this country. Mind you some 54.86% of the outstanding stock is today held by bodies corporate -including banks, FIs, FIIs, mutual funds, insurance companies and such like. This morbid status quo ante is in spite of the fact that numerous such shareholder representative bodies having reared their head in the last few years.

The investment portfolio

Consider some of the raw data on hand. The company boasts of an investment portfolio of current investments and non- current investments with a book value of Rs 189 m and Rs 16.1 bn respectively at year end and totalling Rs 16.29 bn. The total dividend income that it realised during the financial year was Rs 33.8 m from a subsidiary and Rs 10.7 m from others totalling Rs 44.6 m. This must surely rank as a Return on Investment of supreme vintage! Under the category of non-current investments, it has investments in six non-subsidiaries and 21 subsidiaries, and separately in preference shares. The vast bulk of its investments are concentred in the equity capital of four companies - Shaw Wallace Breweries, Palmer Investment Group, Royal Challenger Sports which are all subsidiaries, and in Pioneer Distilleries which is characterised as a trade investment. These four companies account for over 81% of all non current investments. The book value of its investment in Palmer Investment Group alone is valued at Rs 6.9 bn, followed by Shaw Wallace Breweries at Rs 3.2 bn.

Loans and advances

Separately, the company has advanced Rs 3.8 bn as short term advances to either related parties or to tie-up units. Then there are the loans and advances to related parties amounting to Rs 46.5 bn. Through a footnote we are solemnly told that this 'advances' portfolio includes interest free loans amounting to Rs 44.6 bn. Another foot note avers that within this loan portfolio, it has granted interest free foreign currency loans aggregating to Rs 39.8 bn to USL Holdings for acquisition of long term strategic investments (mark the wording). It would appear that these long term strategic investments have a truly very long term horizon it would seem! Then there is an additional burden of Rs 2.4 bn on this count arising from the depreciation of the rupee against the foreign currency, and which is accounted for elsewhere. The company also advises most nonchalantly that this loan is not going to be paid back but will be converted into equity capital, whenever. The unstated reason for this is that the investments made by USL Holdings are not yielding a dime's worth, and were also not meant to yield any return in the first place. But I will delve more on this development later on in the show. That is the take on the long term advances portfolio.

Then there is the take on the 'short term loans and advances' portfolio. It has advanced short term loans to related parties amounting to Rs 739 m. This is a new development as there is only a NIL entry in the previous year end. Separately there are the advances that it made to 'Tie-up units' consisting of advances considered good and advances considered doubtful amounting to Rs 3.13 bn. What exactly the words 'tie up units' refers to is not known but presumably it means companies from which it sources raw materials, goods and services or some such. The company has purchased goods worth Rs 2.5 bn from four group companies White and Mackay, Tern Distilleries, Pioneer Distilleries, and a marginal sum from 'Others'. These units do not appear to fit into the definition of tie-up units. The total purchases of traded goods however amounted to Rs 8.5 bn against Rs 7.6 bn previously. So there is no knowing what pecuniary benefits if any the parent received for playing the role of Santa Claus to such units. The total interest income that the company received during the year amounted to Rs 559 m and, almost half of this interest that it received and amounting to Rs 295 m has come from four siblings. However, in what manner this interest actually accrued from its siblings is not known. The rest of the interest receipt must have come from such liquid assets as bank deposits and other interest yielding assets like its debenture holding portfolio. But in any event the returns are more than pitiful any which way one looks at it.

Now, take a look at the company's loan portfolio. It amounted to Rs 42.8 bn at year end, against Rs 36.1 bn previously. The loan consists of both long term and short term borrowings. The finance cost debited to P&L account amounted to Rs 5.8 bn against Rs 4.4 bn previously. By simple extrapolation one can figure out that the cause for these borrowings in the first place was the seeming extravagance of the parent in dishing out confetti to its siblings and tie-up units. This is the reality of the matter. Not to be forgotten is the lack of any return from its investment portfolio.

The Contingent Liabilities

If matters are not perplexing enough consider the following. United Spirits at year end had given guarantees on behalf of other bodies corporate amounting to guess what - Rs 43.5 bn against an infinitely smaller Rs 4.5 bn previously. To whom have these guarantees been furnished, on what account, and on behalf of which group companies please? Neither is it known how the guarantee amount could have risen by such an astronomical sum in the space of one year, and why it was allowed to grow unchecked in the first place. Have matters gone horribly wrong somewhere done the line? More importantly, is the company in a position to honour guarantees of such a magnitude? Separately, it has given counter guarantees to its bankers for a sum of Rs 456 m. Does the company have the financial acumen to undertake such guarantees? Does standing up for these guarantees entail payment of any guarantee fees? Were all these figures factored in by Diageo when they agreed to make this company a subsidiary of the group? If so it must have led to extremely complex valuation parameters.

The many siblings

If one finds this data alarming enough consider the following stats. It boasts of 21 direct subsidiaries, investments in the share capital of three listed companies, investments in the share capital of three unlisted companies, investments in the preference capital of two companies, investments in the equity capital of eight listed companies which are categorised as other investments, and also investments in debentures, mutual funds, government securities, the USL Beneficiary trust, and in the equity capital of yet other unlisted companies. Most of these investments are of the pinprick variety but nonetheless investments. But in another schedule under the heading 'Related party disclosures' the company has given the names of 78 subsidiaries. The vast bulk of these companies are 100% owned. One wonders whether Mr Mallya even knows the existence of all these companies. Not that it matters. This list obviously includes the list of understudies of siblings etc. The firangi underlings are based out of Nepal, The British Virgin Islands, Jersey Islands, Panama, UK, Scotland, France, China and, Venezuela. It is very apparent that Mallya is also an anglophile or some such. Some 53 of the 78 siblings are based out of the UK. Separately, there is the investment in one associate company, and another investment in United Breweries (Holdings) Ltd which is classified as a subsidiary in which its investment is more than 20%. I will give more details on these siblings along the way.

It is of course to the intense credit of United Spirits that inspite of all these shenanigans the company's operations are on the ball, and it is also the market leader in its primary line of activity - the spirits business. Due to its status as the local market leader by a mile, it is also a by default a global market leader. It exports very little but the sheer volumes that it makes do with in the local market give it the global status. The earnings in foreign currency in fiscal 2011-12 amount to Rs 34 m. By contrast its expenditure in foreign currency amounted to Rs 3.1 bn. And boy oh boy it also boasts of 28 plant locations spread over 17 states/ union territories across the country. Separately, it has a plant in Nepal; operated 10 leased facilities in India from 3rd parties, and contracted with 50 tie-up manufacturing facilities that distil molasses or grain to produce extra neutral alcohol. It is a humungous operation, no less.

The largest spirits marketer

The directors' report adds that in 2010 it became the largest distilled spirits marketer in the world by volume with worldwide sales of over 114 million cases. The figures for the calendar year 2011 are still unavailable. The company however believes that having added on over eight million cases in fiscal 2012, it remains at the numero uno position. Its worldwide sales in fiscal 2012 were at over 122 million cases - but the catch is that, and as stated earlier, some 119 million cases were sold in a single geography - India.

The chairman of the board Dr Vijay Mallya extols with pride at some of the company's extraordinary achievements. United Spirits is one of the only two companies in the world with a dozen brands among the top 100 spirits brands worldwide he chortles. Our company is now universally acknowledged as one of the fastest growing scotch players in the world is another memorable blurb. But the quote that takes the cake and the bakery is as follows. United Spirits shall focus on profitability and return on capital employed in the coming years and leverage its size and reach to achieve improved financial parameters in preference to volume growth brands. If only he had followed up in the practise of these prophetic sounding words, matters would not have come to such a sorry pass today. In retrospect he was only laying down the foundations for the functioning of the company under the Diageo umbrella-only he didn't envision that he was foretelling the change in management.

Diageo has much to work on, not the least the disparate and at odds siblings. One wonders whether they have even got a hang of the eccentricities involved in their functioning. The other issue is the availability of extra neutral alcohol given the importance now given to fuel blended with alcohol (ethanol), and the other being the brutal fact that some 70% of the company's products are being sold to parastatal (government controlled) buying agencies who the company moans are loath to giving price increases to cover even cost increases. But the latter problems are known factors as Diageo already has operations in India.

More on the siblings

The consolidated statements which includes the financials of the parent and that of the 78 siblings shows gross revenues of Rs 182.3 bn and a pre-tax of Rs 3.4 bn. Now, juxtapose these figures with the data rolled out by the standalone entity. It shows gross revenues of Rs 160.4 bn, and a pre-tax of Rs 5.1 bn. In plain English it means that the grand ensemble of siblings collectively amount to nothing. This is not saying anything new however.

The parent on its part has furnished the brief financials of 34 siblings, and what a pretty sight they make for. At the top of the heap from the viewpoint of the parent is the dollar denominated Palmer Investment Group its 100% subsidiary. It has a paid up capital of US$ 15 m translating into Rs 763 m. It however cost the parent Rs 6.9 bn as the shares were issued at a premium to the face value. The average issue price was Rs 461 per share. And pray what does this worthy do? It does very little going by the financials on display. It has total assets of Rs 904 m, in which the investments have a book value of Rs 826 m. It had a NIL turnover and a pre-tax profit of Rs 14 m. None of its investments yield a dimes worth. This is what one would call magic mantra but let that be.

Next in line from the viewpoint of the parent is Shaw Wallace Breweries, another 100% subsidiary. Its equity stake in the company cost it Rs 3.2 bn. The share capital of this company is Rs 1.64 bn and it boasts total assets of Rs 7.1 bn. But what do you know It realised no revenues and but still managed a pre-tax profit of Rs 400 m. This is simply fantastic nonsense. No income to show but generating profits nevertheless. Further, some 12 of the siblings have a zero capital base or close to it, generate zilch turnover or close to it, but manage to mine pre-tax profits or losses as the case may be. Then there is this offspring, UK offspring United Spirits (UK) Ltd, which actually has a negative share capital base of Rs 18 m, and reserves of Rs 57.77 bn, and boasts total assets of Rs 57.77 bn! Wow, Wow! This is really getting to be top of the pops stuff. Needless to add it has no revenues or profits or losses to show for it. The investments are all duds it would appear - but obviously there is much more to it. Or, what of the financials of the dollar denominated USL Holdings Ltd, and the pounds sterling denominated United Spirits (Great Britain) Ltd? Both again are 100% lackeys of the parent - but more importantly, why the need for such holding companies? Each one of them is a class act in themselves. The former has a share capital of Rs 25.4 m, reserves of Rs 529 m, total assets of Rs 44.8 bn, and no revenues. The latter has no share capital, negative reserves, total assets of Rs 53.3 bn, investments of Rs 41.3 bn, no revenues, but still raked up a pre-tax loss of Rs 467 m. This can be referred to as the most efficient use of capital. Even the Central Govt will find it difficult to best these figures.

Thank heavens the company has not furnished the financials of all its siblings. The only foreign based company of significance is its 100% owned Whyte and Mackay Group Ltd. This sibling is not a direct descendent of the parent. With a capital base of Rs 3.75 bn and reserves of Rs 5 bn, it has total assets of Rs 26.6 bn. It notched up revenues of Rs 17.8 bn and posted a pre-tax profit of Rs 1.2 bn. But it avoided paying any tithes to the parent. The other firangi investment of some value is Bouvet Ladubay S.A.S, the French wine maker. On a share capital base of Rs 733 m, it has total assets of Rs 2 bn. It turned up revenues of Rs 1.3 bn and made a marginal pre-tax profit of Rs 73 m. But at least it is profitable.

This then is the collective sorry state of the underlings. But the fact is that it was all planned down to the last T. What will become of all these siblings, and the investments held by them? It is not known how this apple pie will be carved up. But we will know for sure soon enough.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


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