unites spirits announcement - qa transcript
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Diageo plc Diageo announces agreements in respect
of United Spirits shareholding
Paul Walsh
CEO
Well, good morning or good afternoon everybody, and thank you for joining us.
Apologies for my croaky voice, but I've got a bit of a cold. But before we take your
questions today on the announcement, Ivan and I are going to quickly cover the key
points of the deal we announced today.
The acquisition of our shareholding in the number one spirits company in India is a
significant milestone in Diageo's strategy to build our presence in the world's fastest-
growing markets. It enhances our position as the world's number one premium drinks
company as India now becomes our second-biggest market by sales revenue.
United Spirits is a very successful business. It's well positioned with its range of
brands across categories and price points to capitalise on the very strong growth
trends that we see in India. And Diageo can now bring its skills and capabilities to
that market.
As Vijay said this morning, this is a winning partnership. It brings Diageo's strengths
in marketing and innovation together with USL's scale, leading local spirits brands,
strong routes to market, and an exceptional supply base. This is an important asset. If
we were to acquire a majority shareholding through the MTO, we would be making
an investment of about GBP1.3b.
As you can see, it delivers against our economic profit target for acquisition in these
fast-growing markets. EPS accretion in year two reflects the investments that we will
make to ensure that USL has the best possible platform for growth.
Before I hand over to Ivan to talk about the acquisition structure and the expected
timeline to completion, I want to also talk about the changes to the Executive
Committee we also announced this morning.
The focus of Diageo's business has changed in the last few years. We've made seven
acquisitions in the emerging markets, and today we've announced two more. We've
made the decision that focus on these investments will ensure their success. And
Andrew Morgan has the experience to bring that focus to these new additions to the
Diageo family.
I'll now hand over to Ivan.
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Ivan Menezes
COO
Thank you, Paul, and hello everyone. You will have seen today's announcement.
And I'm going to quickly go through the document that's been put on the website and
just give you a few comments as we go through each page.
There are very detailed points made over there. But the highlights are, we've agreed
to a purchase of 19.3% of United Spirits. We've agreed that with United Breweries
Holdings. In addition, the shareholders of USL will now be asked to approve a
preferential allotment that would enlarge the share capital by 10%. This will provide
funds to USL to fund capex and working capital, and to pay down debt. We then have
a mandatory obligation to launch an MTO for 26%, which we will now do. And as
Paul said, were the MTO to be fully subscribed, we'd have a majority holding and our
investment would be GBP1.3b.
As Paul said, this is a transformational transaction for Diageo in India, and therefore I
think it's important to remind you of the strength of USL.
United Spirits is clearly the market leader in India, and has had very strong growth for
many years. It enjoys strong brands across categories and price points. And I think
the route to market strength and the exceptional supply footprint that this company
has, gives us a great platform from which to position ourselves to look at the future
growth in this very attractive market.
USL has a strong position and is well positioned to capture the growth in India.
Those of you who were at our Latin America conference in Miami earlier this week
will recognise the consumer trends and the emerging middle class growth that's
happening in India. In India the numbers are staggering. We are talking about going
from 120m middle class today to 600m by 2025. Also we have increasing wealth and
a consumer base that knows and aspires to premium spirits brands.
So this platform of USL and Diageo does indeed give us a winning partnership that
will enable us to exploit the very strong consumer trends and growth opportunities in
India.
If you look at slide eight, you can see the position that USL enjoys in the various
categories and price points. It is a tremendous portfolio. We have great scale brands
that are represented across product categories and price points. And that gives us the
ability to capture the natural trade-up that will happen up the pyramid as consumers
move into beverage alcohol and move up the ladder.
Similarly on page nine, you can see the exceptional supply base and the distribution
network this company has. This route to market is going to be very important
competitive advantage for us again to build the combined consumer opportunities and
brands and innovation opportunities that we see in this marketplace.
Slide 10, if we look at the financial metrics for USL, we're talking about a business
that's over GBP1b in turnover, and an EBITDA of GBP150m. The terms of our
transaction means we expect these results will be reflected in Diageo's consolidated
accounts when we complete.
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Page 11 gives you more detail on the transaction structure and shows the breakdown
of the different stages of the transaction. It's -- I just wanted to highlight, it’s
important to recognize that the structure of this transaction means that the company
itself will directly benefit because a good slug of cash flow will go into the company.
Diageo will fund this transaction through cash and debt. And we expect we can do
that and retain our single A rating, given our financial strength.
The next slide has the transaction structure highlights, as if you work through the
numbers, USL will benefit directly by nearly GBP400m through the preferential
allotment in the treasury shares that will go into the company. Our intention is to
build this company through a combination of Diageo's strengths and the continued
shareholding by UBHL and Vijay. And Vijay will continue as the Chairman of the
Company. We do believe that's the best platform by which we can continue strong
growth into the future.
As we've laid out today, we also have a number of agreements in place which will
ensure that we have a significant shareholding and investments in USL.
This transaction structure has been put together in the way that will ensure it will
deliver good returns for the Diageo shareholders as we work to deliver and build a
stronger business in USL.
On the next steps and timeline, today's announcement will be followed by -- we
clearly have to get the regulatory approvals in India. There will be a review by SEBI,
and that process has to be completed before we can issue the tender offer. We would
expect to complete on this transaction towards the end of the first quarter 2013 and
subject to us getting all the regulatory approvals.
Finally, in addition to USL, we announced today a joint venture in United National
Breweries of South Africa. It's a joint venture in the sorghum beer category. It's an
interesting category for us. As you know, we have a strong position in Africa in the
beer business. And as we've looked at building more accessible entry level positions
in beer, like Senator Keg in Kenya, we see this as a very interesting opportunity to tap
into again the emerging consumer that's stepping into branded beverage alcohol.
So that is another element of a joint venture that we're announcing today.
So maybe let me just wrap here saying this is a transformational investment for
Diageo. We believe this will benefit USL and the structure of this transaction is set
up in a way that it delivers value for all shareholders. It's good for the USL
shareholders; it's good for the Diageo shareholders. India becomes Diageo's second
largest market by net sales after the United States. And this transformational
investment, as Paul said, will be EPS accretive in year two, and EP positive in year
six.
So those are the highlights. Why don't we now take questions? Deirdre is on the line
from New York, and Paul and I in different locations in London. So I'll ask the
Operator to take over from here and handle the questions.
Q&A Session
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Melissa Earlam – UBS
Good morning. A couple of questions, please. You mentioned that the USL
transaction would be earnings accretive in year two. What kind of incremental
investment are you expecting in year one that defers that earnings accretion? Is that a
step up in marketing, is that unwinding some of the less profitable volume? Can you
just give a little more detail around that?
And then in terms of your returns profile, what assumption over the six-year period
are you making in terms of the reduction of import tariffs for Scotch within your
investment case? Thank you.
Paul Walsh – CEO
Hi, Melissa. Paul here. In year one it is definitely increasing in marketing, and
reducing volumes on the lower margin businesses. Our projections do not assume any
duty reduction on scotch. We would hope that we will see some reduction in duty
levels, but we do not bake any of that into these projections.
Melissa Earlam
Great, thank you.
Paul Walsh
Thank you.
Andrew Holland – Societe Generale
Yes, thanks very much. A couple of questions. Are there any antitrust implications
from the fact that you will also now own Whyte & Mackay Scotch Whisky business?
Is there any angle that we need to be aware of there?
And secondly, I have to say -- I suspect I'm not alone in thinking this -- that a 20 times
multiple looks high, particularly when you're up against a forced seller. Are there, or
were there, any other bidders that caused the multiple to be that high?
Paul Walsh
Well, let's take the multiple question first. First of all, it's 20 times on historic
numbers. Historic numbers were depressed for reasons that we articulated. The
business will now get an infusion of working capital that will allow it to go forward
and build its brands far more efficiently. Equally, if you look at similar transactions
in that market, 20 times is not high at all. 25 times, 30 times, would be the numbers
for precedent transactions. Equally, we are buying into the leader in the marketplace
and into a market that is vibrant, dynamic, and if you look at the GDP projections and
the demographics, it is a very exciting market and a place we have concluded that we
want to be.
Regarding a distressed seller, this is a publicly quoted company. So that's not really a
relevant issue.
I'm sorry, the first -- going back to your first question?
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Andrew Holland
Yes, related to Whyte & Mackay, is there any -- ?
Paul Walsh
Whyte & Mackay. We will have to have that discussion with the regulators, and we
will make our decision accordingly. This deal is not hinging on Whyte & Mackay.
Andrew Holland
Okay, so were you to have to dispose of it, that doesn't affect the outcome?
Paul Walsh
No. Not at all.
Andrew Holland
Thank you.
Paul Walsh
Thanks.
Alex Molloy – Credit Suisse
Good morning. A question please on how concrete your plans are in two areas.
Firstly, in helping USL carry on on this journey to focusing on their more premium
brands. And secondly, helping USL put together an insourced rather than outsourced
and potentially more efficient production platform.
Paul Walsh
Ivan, do you wish to speak to that one?
Ivan Menezes – COO
Sure. Sure. I think on the trend of premiumisation, USL in the last couple of years
has been -- has moved the focus. We think we can accelerate it. If you look at the top
fifth 20% of the volume generates about half the contribution in that company. And
it's the fastest-growing piece of the marketplace. So we think there's tremendous
value in this business by accelerating premiumisation. It's where the consumer's
going. It's where the highest growth rates are. So that is a big piece of opportunity
we see going forward.
On the supply base, yes, today they have a combination of captive and third party
suppliers. It is a very advantaged network, because as you know, India is highly
regulated state by state, and the company has production facilities in 28 states. We
clearly will be looking at the issue of do we take more captive production in-house.
We haven't made those decisions yet. And we will clearly examine it on the basis of
the economics and the returns. But the starting point we see is a very strong supply
footprint, which indeed is a competitive advantage in that marketplace.
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Alex Molloy
Thank you very much.
Olivier Delahousse – Natixis
Yes, good afternoon, everyone. I was wondering if you could give us some flavour as
to your plans, or are you including in the investment case some upside on the
imported, I mean Diageo existing portfolio, meaning in Mey Icki, I mean in the
Turkey deal, the positive impact on the imported portfolio seems to have been pretty
striking. And I was wondering whether you have -- you can comment on that, what
are your plans regarding this case, which could be similar. Are you -- despite the fact
that you're not baking in duty reduction, you might still see some higher upside on the
imported brands? Thank you.
Paul Walsh
First of all -- it's Paul here, then I'll ask Ivan to comment -- we will keep this business
quite separate to our imported spirits business at this stage. At some point in time
there will be the opportunity to leverage the distribution power of USL. But our
experience is that that needs to be done with some care. I think the Turkey situation
was quite different, although the analogy is a fair one. And longer term I would
certainly expect to see that kind of leverage take place. But I think we have to be a bit
more cautious in our approach in that regard. But Ivan -- ?
Ivan Menezes
No, I just echo that. I think in the long term there will be more synergy. As of now
we will keep the premium international spirits run through Diageo India. And as we
had said earlier, we are not assuming any change in the tariff structures. So those are
not built into our business case.
Olivier Delahousse
Thank you.
Martin Deboo – Investec
Afternoon, gentlemen. My first question I guess would just be picking up what you
just said, Paul. So if we were going to use Mey Icki as one sort of precedent
transaction, and Shui Jing Fang as another, this -- I think what you're saying to us is
this is more of a Shui Jing Fang model, at least for the time being rather than a Mey
Icki model. Am I right to understand that?
I've just got a follow-up, if I could just say it. I then was going to push you a bit
harder on what are the synergies here in your minds, both quantified and in terms of
where they arise. There's an implication of what the synergies are in your ROIC/
WACC statement. But can you be more specific on the synergies, in pounds, shillings
and pence terms. Sorry. That's it.
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Paul Walsh
Yes. First of all, I -- this is not a Shui Jing Fang. We will be looking to have certain
outlets as handled by the USL sales force, looking to our brands far sooner than we
would have expected in China. So it's not quite as fast as Mey Icki, nor is it as
planned in the case of Shui Jing Fang.
We think there are real opportunities around innovation. We think there are
opportunities in operations. And those will help with some of the synergies. But we
have been prudent in our timeline to realize those benefits.
Ivan?
Ivan Menezes
Yes, I would say it's definitely more integrated than Shui Jing Fang. If you look at the
route to market of USL, it reaches 64,000 outlets today. It's got dedicated distributors
that are well capitalized and have a lot of clout. It's got a very strong executional
capability. We will look to be leveraging that across the portfolio. As Paul said, it's
not where -- we will do that carefully, because today if you look at our reserve brands
in India, they're doing exceptionally well. And that, we would want to keep the
capability on our reserve brand development.
So this will integrate more than Shui Jing Fang, but we will keep it -- we will get
synergies through that. I would see a brand like Smirnoff getting tremendous
synergies over time. I would see a brand like VAT 69 get tremendous synergies
through distribution over time. And we built some of those into the model. So there
is value in the international spirits being able to tap into the route to market strength
that USL gives us.
Martin Deboo
Ivan, one quick follow-up. Would it fair to say then that you'll certainly keep the
super-premium parts of the portfolio separate, but you will look opportunistically at
opportunities in the heart of the portfolio? Is that a fair inference to draw from what
you've just said?
Ivan Menezes
Yes, that's fair, and also you need to understand India operates state by state. So we
will look at this carefully and build it over time. And that's what Paul indicated to
you. We're going to run the businesses separately for now. And then we will look by
brand, by state, examine the synergies and we factor that into our models, a slow
evolution of how we market and build these brands over time. But we will also -- we
need to keep the strength we have in building the premium end of the portfolio. And
so we don't want to lose that. So the going in position is Diageo India, and USL will
stay separate, and then synergies will evolve and we expect them to be stronger than,
say, in the case of Shui Jing Fang in the next, say, three years.
Martin Deboo
Helpful, thank you.
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Jon Fell – Deutsche Bank
Yes, John Fell. Couple of things. Can I follow on on the Whyte & Mackay question?
Do you regard that as a brand which will slot into your portfolio and have
international growth opportunities in the longer run? Or is that more attractive to you
as a source of spirit, really, and distilling capacity?
And then secondly on the South African, little additional venture that you've disclosed
today. Is that something that you've had to run past your partners in Brandhouse?
And is there potential for that being folded into Brandhouse at some point?
Paul Walsh
Let me take the second question first. Yes, our partners are aware of this. It would
not be folded into Brandhouse. It's a separate category, very different business.
Regarding Whyte & Mackay, we do not feel that we need Whyte & Mackay as a
production resource. We have announced already some major plans for development
of our scotch footprint in Scotland. And we don't see that changing.
From a brand point of view it has an interesting position in certain markets, but also
we have brands that could also occupy that space.
So we are somewhat ambivalent, and we will look to the brand and we will look to
see how the regulators feel about this and make our decision accordingly. As I said at
the outset, Whyte & Mackay is not a swing issue here.
Jon Fell
Thank you very much.
Paul Walsh
Thank you.
Ann Gurkin - Davenport
Hello, and congratulations.
Paul Walsh
Thanks, Ann.
Ivan Menezes
Thank you, Ann.
Ann Gurkin
I believe United Spirits once had operating margin in the range of 20%. Is that a
target you can get back to over time, do you believe?
Paul Walsh
Yes.
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Ann Gurkin
Yes? Okay, great. And then are there opportunities to use their assets to manufacture
Diageo brands in India now?
Paul Walsh
There could be, yes.
Ann Gurkin
Okay, great. And then a final question. Are you still in a position to do additional
transactions if they should come up over the next year?
Paul Walsh
Yes.
Ann Gurkin
Okay, great. Sure. All right, congratulations, thank you.
Paul Walsh
It depends what sort of transaction you're talking about but yes, this doesn't really use
a lot of our firepower in that regard.
Ann Gurkin
Fair enough. That sounds great, thank you.
Paul Walsh
Thanks.
Ivan Menezes
Thank you, Ann.
Anthony Bucalo
Great. Good day, everybody. The question's for Ivan. On the previous call, Dr.
Mallya gave what I would describe as a diplomatic non-answer about pressing for
changes in the tariff rules. Would you be able to give a less diplomatic answer on that
question?
And second question is, just curious what your rationale is for getting involved in
sorghum in South Africa when you are more of a premium drinks company and
sorghum tends to be more on the lower end of the drinks spectrum.
Ivan Menezes
Yes, sure. Let me take -- our approach on -- as you know, we are working very hard
to push the Indian government for access and duty reduction. And with this
transaction, and with Dr. Mallya's support, I think we're in a far better position to push
that agenda. So that's kind of what he said. And we will be working it. But we are
not counting on it, as Paul indicated, in the economics of this transaction. But there's
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no question we'll be in a better position to drive that agenda with the Indian
government.
As regards sorghum beer, this is a business that Dr. Mallya owned. It was important
for him to bring it into the transaction structure. As we look at entry level
opportunities in Africa, we see this as an interesting opportunity in which to build
some skills and capability. And as I referenced to you, we saw what we did with
Senator Keg in Kenya and had a lot of success there. And we actually think even with
government, because this is the stepping stone from outside illicit alcohol coming into
the regular market. So we think it'll be a good -- it's not a huge business. We will
run it separately in the joint venture. And we expect to get very good learning out of
it. But it was clearly part of what Vijay wanted us to do as part of this transaction. So
we have gone into it with the view that let's get some good learning and see if we can
take it across to other parts of Africa as well.
Anthony Bucalo
Great, and just one quick question. Obviously the LatAm presentations were very
dense at the beginning of the week. Is there another -- is there an emerging market
where you feel like you have a play book that can be used in India? Or are you
starting from -- is this a unique market where you're starting from a different base?
Ivan Menezes
Well, actually, in many respects, I think what -- if you look at the business we are
getting into, it has a tremendous platform. And the pace of middle-class spirits
development, if you just go back over the past 30 years and what USL has built into,
frankly I think it's going to give us a lot of learning as we look at developing
emerging middleclass spirits opportunities across Africa, Asia and Latin America. So
I think this is a good case where we will go and learn a lot, bring our skills to help
premiumisation, but I would expect us to be able to look at leveraging what we learn
here, and drive it into places like Africa and Asia in terms of building the emerging
middle class spirits opportunities there, which as you know, and as you heard in our
Latin America presentation, is a key area of focus for us.
So it's a real win-win. We'll bring premiumisation to India, and I think we can take
learnings from here to other parts of the world.
Anthony Bucalo
Great, thanks so much.
Andrea Pistacchi
Hi, good morning. I have two questions, please. First one is on the historic financials
that you've presented for United Spirits, and in particular margin. Will there be any
significant differences in these profitability levels when you consolidate into your
accounts, given different accounting standards?
The second question is on the financing of the deal. What are you considering, what
is the cost of debt related to this deal, please?
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Paul Walsh
First of all, we don't envision any changes in accounting standards. So there's not
going to be anything going on there in how we consolidate.
Deirdre, do you want to take the financing question?
Deirdre Mahlan – CFO
Hi. First, I would -- let me just say on the accounting questions, we're not -- we
haven't finished going through all the purchase accounting. But we're not expecting
any significant or substantial differences in terms of the underlying financials at the
base USL business.
On the actual rate of debt, it is consistent with our current borrowing rates.
Andrea Pistacchi
Perfect, thank you.
Ian Shackleton – Nomura
Yes, congratulations, Paul and Ivan, on getting there on this one. Just a couple of
quick questions. In your existing Indian business, you are pushing some local spirit
products like Rawsons Reserve. I just wonder whether you'd continue with that,
given the announcement today?
And the second question was really thinking about United Spirits itself and its level of
leverage. It looks to me as about INR33b or so of cash going into United Spirits. Are
you reasonably happy then with the level of gearing is at a more sensible level going
forward in that business? Or is there any further cash going in at some stage?
Paul Walsh
We don't think there's need for further cash. But clearly the cash that we are putting
into the business helps that gearing situation, Ian.
Regarding Rawsons, it's early days for that brand. Clearly we will modify our
innovation thinking now, because whilst we would have been competing, we will now
try and build from some of the brands that are already available to us. But specifically
on Rawsons, we'll continue to develop that brand.
Ian Shackleton
Just a quick follow-up. On the tax rate you've got at United Spirits, I think
historically it's been running around the 30% type level, are there things you can do to
actually reduce that? When we think about how we should model that going forward?
Paul Walsh
I'm going to ask Deirdre to comment on the tax rate.
Deirdre Mahlan
Yes, Ian, I think it's premature to make specific conclusions on the tax rate. We still
have to work through all of the specific elements of the structuring and how it will be
handled. But we'll come back to you on that.
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Ivan Menezes
We've assumed no change in our modelling. So -- but we'll clearly have to go into it
and look at it. But in the economics that are presented, we're holding the tax rate.
Ian Shackleton
Okay, thanks very much.
Shrilan Mistalak -- TRowePrice
Yes, hi. Hi, everybody. I do not know whether you've answered this question, but
my question is on the management structure of United Spirits. So can you talk a little
bit about the management that you are either deputing or putting in place there, and
does that depend on the outcome of the open offer? And how soon are you going to
make those changes?
Paul Walsh
Well, first of all, let me say that USL has got a strong management team. Irrespective
of the take-up of the MTO, we have the right to appoint the Chief Executive, and the
Chief Financial Officer, and we will reserve our right to make other changes as and
when appropriate. But you shouldn't conclude that we feel there is a need for
wholesale change.
Shrilan Mistalak
Great, so as of now the current management team just stays in place, yes?
Ivan Menezes
That is correct.
Paul Walsh
As of now, as of now, we've announced a deal, we've got to get regulatory approval.
We have rights under our contract to appoint Chief Executive, Chief Financial
Officer, but also bear in mind that this is a strong management team.
Shrilan Mistalak
Sure. Okay, thank you.
Paul Walsh
Thank you.
David Park -- Carmignac
Hi, everyone, and thank you for your time today.
Paul Walsh
You're welcome.
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David Park
Several questions. Could you explain the logic of why you're only looking to increase
capital by 10% when potentially you could actually increase it more, inject that capital
into the company to utilize for future developments, rather than depending on the 26%
tender offer and giving that capital to the market?
And then following on from that, from the numbers that I look at, the potential control
that you could have on USL ranges from 40% to 53%, depending on how the tender
offer goes, and of course, taking a stake, further stakes from UBHL. What level
would you be happy at? Is 40.9% good enough for you and comfortable enough for
you?
And then lastly, if you could just discuss on what your thought process is regarding
the stakes in United Breweries and also the cricket team as well as Whyte & Mackay,
if you wish to hold onto those assets or if you wish to dispose at a later date?
Paul Walsh
Well, first of all, bear in mind we are, in acquiring the 27%, we are legally obligated
to launch a mandatory tender offer for the 26%. Even with the 27%, and the fact that
UBL -- the holding company shares have to be vaulted alongside of ours, we believe
we have sufficient control. I'm relaxed on that continuum. I believe even if there is
no take-up, we've got everything that we need. But we will see what the shareholders
put to us.
Regarding the brewery holding, I think there is a small amount held by USL. Clearly
we would view that as not particularly strategic. And I think that's all. I think the
other elements are held elsewhere. Ivan?
Ivan Menezes
Yes. No, your other question on Whyte & Mackay and the cricket team. The cricket
team is in USL. It clearly is one of the brand-building mechanisms for Royal
Challenge. So we envisage it continuing. But clearly when we get in, and once we
complete on this deal, we will look at all of that in terms of really understanding the
most effective way to leverage it.
Paul Walsh
And certainly the Formula One team is separate.
Ivan Menezes
Yes. The Formula One team is separate.
Paul Walsh
Yes.
David Park
Sorry, one last question. In terms -- could you elaborate at the speed and evolution on
how you're introducing deploying Diageo's products into India, if you choose to do
so?
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Paul Walsh
I think it is very premature for us to start to give a roadmap of how we'd deploy our
products. And the reason for that is, this is competitively sensitive information. And
we haven't got the deal approved yet.
David Park
Okay. But you will elaborate on that in the future, as things develop?
Paul Walsh
When the time is right. Yes.
David Park
Okay. Thank you very much.
Paul Walsh
Thank you.
Patricia Quo -- Bloomberg
Hi, I have a question with regard to the financing again. How much is the amount of
a total debt financing that you will need to raise for -- to fund this transaction? And
which banks are providing it?
Paul Walsh
Deirdre, did you hear that?
Deirdre Mahlan
As we said in the commentary, we have a strong cash flow. We will fund it at the
time when the individual funding elements are required, we will fund using our
available cash and/or debt. We have access to significant amounts of commercial
paper as well as debt capital markets. And so we will utilize those facilities.
Patricia Quo
Like new facilities, you're trying to get into? Basically you would just tap into your
existing CP program?
Deirdre Mahlan
Exactly.
Patricia Quo
Thank you so much.
Mitch Collett -- Goldman Sachs
Hi, there. I guess just to stay on the financing. Can you maybe help me understand
why the cost of financing wouldn't be lower than your current average rate? I would
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have thought if you were going to issue some debt, as you seem to be suggesting, you
might at some point, you'd be able to get a more attractive rate of financing.
And then secondly, I guess a broader question. You've talked about how this deal
takes you to 45% exposure in EMs and your medium-term target is 50%. I guess
you've done several deals over the last couple of years. Would I be right to assume
that the path to 50% from here is probably more organic than inorganic, given the
transactions you've done? Or is that not -- ?
Paul Walsh
I'll ask Deirdre to talk about the financing. But certainly with regard to the 50% goal,
I think we'd all conclude it's time to reset that goal. And the way that it will be
improved upon is very much through out-performance of the assets that we've
acquired, not just this one, but Mey Icki, Vietnam, Shui Jing Fang, Ethiopia, etc etc.
But yes. In a full year we're pretty much well on our way to 50%. So we will reset
the target. Deirdre?
Deirdre Mahlan
Hi. On the debt, apologies, I did not mean to imply that the rate that we were using
was our current effective rate. The assumptions that we used on the financing model
was about 2.5%. We of course will avail ourselves of the best available rates at the
time, which may be slightly more, slightly less than that.
Mitch Collett
Okay, great. Thank you.
Olivier Delahousse -- Natixis
Thank you for the second question. Just back on the 50%, just wondering how you
get to 45% when it looked like you're currently already at 40%? And I understand
USL is 10%. So will that mean you're just crossing the 50% threshold this year, I
mean next year?
Paul Walsh
I think in the 45% you've got part years of different transactions. I think if you pro
forma'd it -- we're in the zone between 45% and 50%. And as I said a moment ago,
we will drive organic performance and the law of percentages means that we will
increase that 50% target.
Olivier Delahousse
Okay, thanks.
Pablo Zuanic -- Liberum Capital
Congratulations. Four quick questions. Number one, I understand the beer business
is separate, and that Heineken has a 37% stake there. But can you talk about
opportunities for greater integration between the two in terms of distribution, cost
synergies? And given that Heineken is involved in the ownership there, is there a
Diageo acquires majority stake in United Spirits Diageo plc
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potential for Diageo to eventually take a greater percentage of ownership in that
business? That's number one.
Number two, I know you say that by year six, there will be accretive year two,
economic profit within the next six years. But can you elaborate on the assumptions
in terms of sales growth and profit margins?
Number three, qualitatively, forgetting about your portfolio, but in terms of existing
USL portfolio, what can you do to accelerate sales growth of that business, if
anything, besides premiumisation?
And the last one, fourth, you will have 51% or more ownership, but is there a path for
an agreement through options and other mechanisms to increase that ownership to
100% eventually? Thank you.
Paul Walsh
Right, first of all, on ownership. I do not believe we need to get to 100% ownership.
I'm very happy to have local investors in that business. I think it gives a local face to
the business. It's a model that we pursue in other markets, and we're very comfortable
with it. So no desire to drive to 100%.
Regarding short-term ways to improve the business beyond just premiumisation, I
think the business needs to have more free access to funding, so that it can increase its
working capital and drive more effective sales growth. I think there's more we can do
on the marketing side. I think there's more that we can do on the innovation side.
I'll ask Ivan to give you some of the headlines around our assumptions. But what
we're not going to do at this stage is give you a roadmap to how we intend to drive
performance in this business, because again, that's competitively sensitive and we're
still awaiting regulatory approval.
Regarding United Breweries, we do not have any intention to seek synergies from
spirits and beer in the Indian market in the foreseeable future. And therefore that's not
going to be on our agenda. But Ivan, why don't you give the headlines around the
parameters of value creation through to year six? And by the way, EP year six uses a
12% WACC.
Ivan Menezes
Sure. We're looking again, as you would expect, a good premiumisation trends within
the portfolio of USL, so the top 20% of the volume growing faster, which has much
higher margins. So that net you work through it. And we would expect to have I'd
say solid double digit, low mid-teen EBITDA growth coming through in USL. And
reflected with premiumisation within the portfolio, which is supported by stepped-up
marketing investment, so we do see taking up the marketing investment in the
business. And then as Paul indicated, I think with judicious use of capital in that
business on the manufacturing and supply chain, we would also expect to get good
efficiencies come through and margin expansion. So those are some of the key
elements what's behind how we're looking at the business here.
Pablo Zuanic
Thank you for the question.
Diageo acquires majority stake in United Spirits Diageo plc
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Paul Walsh
Thank you.
Vivek Maheshwari -- CLSA
Hi, thanks for taking my question. First on the open offer and the shareholding
structure bit again. In case if you don't get this 26%, the tender offer, would you want
to increase your shareholding at some point of time, either through preferential
allotment or other ways after this?
Paul Walsh
Sorry, could you say that again? I didn't quite catch all of that.
Vivek Maheshwari
My question to you is, in case if this tender offer, your presentation mentions
maximum 26%, which I presume could be 0% to 26%.
Paul Walsh
Yes.
Vivek Maheshwari
In case if there is hardly any tender by minority, would you again go in for
preferential allotment to increase your holding to -- because if the open offer doesn't
get through, only at 27%, so would you want to take it up if open offer or tender
doesn't go through?
Ivan Menezes
I can handle that, Paul. What we've laid out here in the core transaction structure
before we get to the MTO, is an alignment in the partnership with UBHL which will
give us Board control and management rights that will enable us to consolidate this
business, so even with the 27% and the aligned voting from UBHL.
I think we are taking a long-term view on this business in terms of how we look at
that point, how we would look at potentially taking up our holding over time. So I
think the construct of what we put in place, which was important to us, was to get a
construct that would give Diageo the ability with a high degree of certainty, to be able
to consolidate the results of this business into Diageo plc and that's what you see in
the core transaction structure. So the MTO will be what the MTO is. We're not
anxious about it one way or the other, because we've got the core agreement with the
preferential allotment and the share purchase agreement with UBHL and the purchase
of treasury shares, and the governance rights. That's the cornerstone of what we want
here.
Vivek Maheshwari
Okay, understood. One more on the margins. But as you mentioned that you expect
premiumisation, but in the same breath as you mention that Indian market, how
complex and it's controlled by different states. Do you think that -- your presentation
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says United Spirits has 13.7% margins last year. How easy or how difficult is it to
take up the margins, given it's such a complicated state structure in India?
Ivan Menezes
We see through a combination, as I said, of the premium end of the business going
stronger, which has higher margins, supply chain investments which can give us good
returns, marketing investments, which will drive the premiumisation. We do see a
route to improved margins, and feel very confident about it.
Vivek Maheshwari
Okay, and just one last question, if I may. On the debt side, United Spirits will still
have around INR50b of debt after -- assuming this INR33b. Is there any possibility of
a lower cost debt or anything, at what rate the company would be taking this debt?
And any possibility of a lower level of interest in case of once you acquire 27% here?
Ivan Menezes
I would say again, there's an infusion of capital that goes into the company that will
deleverage some. Let's not forget, this is an attractive business that from an operating
cash flow throws up good cash flow. I think the combination of Diageo's balance
sheet and USL, I think over time we will get this to the right place.
Vivek Maheshwari
All right. Thank you, and all the best.
Paul Walsh
Thank you.
Melissa Earlam -- UBS
Thank you, my questions have been asked already. Thanks.
Lakur Roder -- IDFC
Yes, thanks for this. Just a couple of things. One is, it's very clear that
premiumisation is the trend forward. But are you willing to compromise on a fair bit
of revenue and profit loss in United Spirits' books in India while you do the
premiumisation trend? That was one.
Paul Walsh
I don't think it's one or the other. I think it's actually both. And that's exactly what
you've seen in mainstream Diageo. We've built our reserve brands, but we've also
built our mainstream business.
Lakur Roder
Okay. Second was you've talked about Whyte & Mackay, you'd be pretty okay to let
go of it if need be as you move forward on United Brewery stock or treasury stock
which obviously is of no real consequence for your other shareholders in United
Spirits. And the cricket team? So how have you really valued United Spirits?
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19
Because to this date of the way the business was constructed, a lot of value that come
out from these businesses.
Ivan Menezes
I could take that.
Paul Walsh
Okay.
Ivan Menezes
Again, you need to understand, Diageo has the leading position in Scotch whisky. We
have good brands, good distilling, good Scotch whisky stocks. So as Paul said earlier,
Whyte & Mackay, we will deal with whatever the outcome is, as after we engage with
the regulators. It's not a big issue.
Lakur Roder
Okay. Okay. Cool for this and thanks a lot for this.
Paul Walsh
Thank you.
Paul Walsh
Well, first of all, thanks, everybody, for joining us at short notice. We appreciate your
interest. Hopefully from the things that we've had to say you can see that we are very
excited about this opportunity. This is a good business in a great market that we think
we can add real value to. And strategically it really does put us in a very, very strong
position in what will be a vital market for the future. So we're excited, we're delighted
with these arrangements. And again, thanks for being with us.
End
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