BREAKINGVIEWS - Diageo pays heady price for Indian spirits

Whisky bottles are displayed for sale at a shop in Hanoi June 6, 2012.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

By Quentin Webb

LONDON Nov 9 (Reuters Breakingviews) - Diageo (DGE.L) is paying a heady price for Indian spirits. The British group, already the world's biggest maker of top-shelf drinks, is finally taking control of United Spirits, by far India's largest drinks outfit. Like a shot of unrefined hooch, the $2 billion deal's financials are harsh to the taste at first. With age, however, the deal may become more appealing.

Under the three-stage agreement, worth up to $2.05 billion, Diageo will acquire a maximum 53.4 percent of United Spirits, first by acquiring shares from companies linked to chairman Vijay Mallya. It will then buy newly issued stock, and shares from outside investors via a subsequent mandatory offer, all at the same 1,440 rupee price.

Diageo has sought a piece of United Spirits for a long time. An earlier round of talks fizzled in 2009. But Mallya, who keeps a stake and remains as chairman, is now in a tighter spot. His loss-making and debt-laden Kingfisher Airlines (KING.NS) urgently needs fresh capital. So the puzzle is why Diageo has not secured better terms.

An historic EBITDA multiple of 20 times looks full - even by the standards of emerging markets spirits, where drinks giants usually compete for the few available targets. Synergies are sparse. And it will take six long years for the deal's return to exceed its 12 percent cost of capital. By contrast Diageo gulped down a Turkish raki maker last year for 9.9 times EBITDA, vowing an economic return within 5 years.

All that would be harder to swallow than backwoods moonshine, were this deal taking place in the stagnant Old World. But growth drives valuation. India's middle class is mushrooming. Diageo reckons overall alcohol sales in the country should grow 15 percent annually for the next five years. Even if Diageo cannot beat the market rate, that implies a doubling of sales by 2017. And persuading drinkers to move upmarket from cheaper brands, like Bagpiper whisky, should fatten margins.

Chief Executive Paul Walsh has smartly reoriented Diageo, buying into Brazilian cachaça, Ethiopian beer, Guatemalan rum, and Vietnamese spirits, as well as raki. He steps down in 2014. With the aim to make a majority of sales from faster-growing emerging markets by 2015, he just lacks a final prize: clinching Jose Cuervo tequila.

CONTEXT NEWS

- On November 9 Diageo Plc, the world's biggest spirit maker, said it agreed to buy as much as 53.4 percent of India's United Spirits Ltd (USL), in a multi-stage deal worth up to 1.285 billion pounds.

- Diageo will first buy a 19.3 percent stake from Vijay Mallya's United Breweries (Holdings) Ltd (UBHL) and four related companies for 1,440 rupees a share, or 57.3 billion rupees in total. USL will then issue new shares at the same price to Diageo, for another 10 percent of the company's enlarged share capital. Diageo will then make a mandatory tender offer to outside shareholders for a further 26 percent of the company, again at the same price.

- The deal values USL, India's biggest spirits company, at 20 times EBITDA for the year ended March 31, and its shares at a premium of more than 35 percent to the price on September 24, the last day before the companies said they were in talks. Diageo expects to complete the deal in the first quarter of 2013.

- Mallya will remain chairman of the company and his UBHL group will retain a stake of 14.9 percent, before any dilution.

- Shares in Diageo stood 0.6 percent higher by 1207 GMT at 1,799 pence. Shares in United Spirits closed 1.3 percent higher at 1,360.5 rupees before the deal's official announcement.

- For Diageo statement: click link.reuters.com/kes83t

(Editing by Rob Cox and Emily Plucinak)