Diageo puts brake on consolidation of accounts with USL

Offers no reason for move, says will start consolidation next fiscal

Diageo Plc will delay the consolidation of the accounts of United Spirits Ltd into its own books by six months from the initial plan to begin in January, 2014. Without elaborating on the reason for the delay, CEO Ivan Menezes has said Diageo will begin consolidating the account of United Spirits starting its next fiscal year, that begins in July 2014.

The decision of the Karnataka High Court in December had unsettled Diageo when it struck down part of the deal in which the company had picked up a 25.02 per cent controlling stake in United Spirits. While the global behemoth call the decision “wrong in law and based on erroneous facts,” it filed an appeal in the Supreme Court and reiterated that the setback would not alter its long-term plans for the company. However, the company has been increasingly trying to increase its stake in United Spirits at every given opportunity, even through open market transactions at a 70 per cent premium to the initial price at which it acquired a controlling stake in the Indian firm. Diageo currently holds 28.78 per cent of United Spirits but has not begun consolidating the accounts of the Indian spirits company into its own.   

In the short period from October-December 2013, Diageo has had access to United Spirits’ distribution that pans across 98 per cent of the country and has begun reaping immediate rewards. Diageo’s India operations registered 35 per cent growth in net sales for the July-December period in India, compared to the average 1.3 per cent growth in net sales across emerging markets. Net sales of its Johnnie Walker Scotch grew 87 per cent in India, contributing to almost half of India’s revenue growth.

Albeit late, the company will go ahead its decision to consolidate the results of United Spirits into its own from July, 2014 and not January, as announced earlier when it acquired a 25.02 per cent stake in the Indian firm from liquor baron Vijay Mallya. United Spirits raked in an annual revenue of about Rs 10,752 crore and an operating profit of about Rs 1,377 crore at the end of  fiscal ‘13. Its net profit for the period, however, slipped into the red on large finance costs, currency exchange losses and other exceptional items.

“Diageo has repeatedly insisted that it was in United Spirits for the long term. Given this case, the company will not change its long-term plans for United Spirits. After all, no other acquisition in the country would give them a similar route to market across India,” says an industry expert.

While Diageo does not have the requisite majority stake in the Indian firm to begin consolidating  accounts into its books, it will use its control over the Board of United Spirits for the purpose. The IFRS accounting standard, followed by Diageo, allows the integration of account as long as one company has a control over the board of the second. When Mallya had signed away control of United Spirits to Diageo, he had also agreed to vote directed by Diageo for a four-year period.

“Diageo has its interest protected from all sides. So whether they have less than 20 per cent or more, Diageo’s decisions for United Spirits are unlikely to be challenged at least for four years,” says an analyst. “Within that period, they have enough time to raise their stake in the company to the level they desire.”

Diageo, which focusses on compliance as its top most priority at United Spirits is also working on a code of conduct to be followed and implemented at United Spirits in February, in line with its global operating practices. The company had brought its global ethics and compliance director from London to the Bangalore office of United Spirits in a new role over the last year to personally oversee that United Spirits complies with its global operating standards.

Diageo had first planned to acquire a majority stake in then Mallya-controlled United Spirits, but that soon fell through due to a poor response to an open offer and Mallya’s enormous neck deep debt levels that had required a large amount of United Spirits’ shares to be pledged as collateral. It currently has a 28.78 per cent stake in United Spirits, but that level will drop to 21.82 per cent if the Supreme Court upholds the lower court verdict. While Diageo’s appeal comes up in the Supreme Court for hearing on Wednesday, the company is moving ahead undeterred, confident of securing full control of the company in the long term.