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.

Diageo acquires majority stake in United Spirits Diageo plc

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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


16

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.


17

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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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

unites spirits announcement - qa transcript

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