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United Spirits Ltd (USL) is close to losing Whyte and Mackay (W&M), with the Office of Fair Trade in the UK saying it is considering London-based Diageo’s offer to sell most of the W&M business. The regulator felt following the merger of Diageo and USL, other players in the bottled-blended Scotch whisky sector might not be able to sufficiently compete in this segment.
“The OFT considered to what extent other manufacturers of blended whisky were capable of competing with the merged business. The evidence showed other manufacturers did not have, and could not quickly reach, sufficient capacity to offset the loss of competition likely to result from the merger,” OFT said in a statement.
OFT has found there is substantial competition in the retail sector between Bell’s whisky (a Diageo label) and W&M’s own label and branded blended whisky, and the combined capacity of Diageo and USL may lead to substantial reduction of competition in the supply of blended whisky to retailers.
“Our investigation considered a wide range of evidence and we concluded the likely loss of competition could give rise to higher prices for retailers, and ultimately, consumers,” said Chris Walters, OFT chief economist and the decision maker in this case. “We are now considering Diageo’s offer to sell the bulk of the Whyte & Mackay business, with the exception of two malt distilleries, to address our concerns.”
While Diageo has offered to sell the bulk of its W&M business, it has sought to retain the inventory and assets associated with the malt distilleries that supply USL and international markets---the Dalmore and Tamnavulin distilleries. The other distilleries owned by W&M’---Invergordon, Jura and Fettercairn distilleries---and all of W&M’s central operations have been offered to be put up for sale.
W&M is a USL asset, acquired in 2007 by liquor baron USL chief Vijay Mallya for $1.2 billion. The company accounts for annual revenues of about POUND 200 million and sales of three million cases of legendary brands such as Dalmore, Isle of Jura and Vladivar vodka. The acquisition had led to Rs 8,500 crore of debt in the USL balance sheet. But it helped Mallya to enter the Scotch and Whisky Association, with which he had been at loggerheads for about a decade. It is not clear if the sale of this asset would cost Mallya his membership in the association. Senior industry analysts in London told Business Standard while his exit was a clear possibility, there was a chance for Mallya to retain his membership if he struck a deal for this with Diageo, a member of the association.
In response to the OFT statement on Monday, USL said its board would consider the matter and decide on whatever action had to be taken. Diageo has said it will assist OFT with its on-going work.
Diageo, the world's largest maker of spirits, and USL are suppliers of spirits across the world. In the UK, Whyte & Mackay is primarily active in the supply of whisky, but also owns and distributes other spirits, including vodka.
“A number of retailers expressed concerns to OFT about possible price rises for bottled blended whisky sold in the UK, as a result of the merger,” OFT said, noting Diageo and USL were two of the leading suppliers of blended bottled whisky to retailers in the UK, especially to supermarkets and other large retailers.
“While the undertakings in lieu are being considered, OFT’s duty to refer the merger to the Competition Commission is suspended,” OFT’s Walters said.
Valuation concerns
OFT’s decision may lead to a loss of bargaining power for Diageo-USL when it tries to offload W&M assets, estimated at about $1.5 billion. But with market conditions difficult, there is speculation the asset may fetch only about $700 million. The time frame OFT specifies for the sale of W&M assets will be crucial
Some analysts say the sale, even if carried out at the purchase price, will help USL clear its large debt burden. “We see it as a positive stock driver---if we assume W&M assets are disposed of at a value close to its purchase price (conservative assessment), USL would be nearly debt-free,” Morgan Stanley said.
“We forecast USL PBT (profit before tax) at Rs 150 crore in FY15. In the event of a W&M sale, the resultant lower finance costs alone would contribute about 40 per cent to our earnings estimate. In such an event, near-term earnings visibility may be stronger than markets believe,” said a Morgan Stanley analyst.
A lucrative market
The Scotch market offers the most attractive potential for the alcoholic beverages sector, with demand beginning to soar in Asia, Latin America and Africa. When USL announced its results for the September quarter this year, it had said its volumes in the Scotch segment had soared 60 per cent.
Diageo known for its portfolio comprising Johnnie Walker, J&B, Buchanan’s Scotch whiskies, has said it plans an investment of about POUND 1 billion in Scotch whisky production through the next five years. USL’s Scotch portfolio includes W&M, Black Dog, Dalmore and Jura.
W&M has recorded one of the fastest growths within the category, with a rise of 11.5 per cent in volumes last year, according to data from International Wines and Spirits Research. With sales of 623.5 million cases in 2012, W&M saw most of its growth outside the UK. W&M ranks 29 th on the list of the most consumed Scotch brands globally, with brands Johnnie Walker, Ballantine’s and Chivas Regal topping the list.
THE ACHILLES HEEL
How Whyte & Mackay weakens United Spirits
* W&M’s acquisition has impacted consolidated profits of United Spirits
* United Spirits has reported consolidated losses in three of the past five years, despite healthy standalone profits
* This could be attributed to high interest cost for servicing debt of $1.2 bn taken for acquisition of Whyte & Mackay in 2007
* United Spirits refinanced/restructured its debt four times over 2008-2012 but it was still unwieldy
* Whyte & MAckay asset sale could boost earnings up to 20%, according to analysts
* Non-core assets such as Whyte & Mackay and investments in United Breweries (UB) could fetch Rs 5,300 crore or higher, based on market/inventory value, according to analysts
* Analysts indicate sale of Whyte & Mackay (at its inventory price) and UB stake could boost 27-40% to FY15 & FY16 estimates
* Sale of Whyte & Mackay would result in improved working capital (since it has ageing scotch inventory) and return ratios and lower leverage
* Whyte & Mackay is a non-core investment for Diageo. It would not fit in Diageo’s framework — production centre or blending scotch
