May 20, 2020 / 10:03 AM / 6 days ago

Breakingviews - Diageo can go on India bender for virtual pittance

Brand manager Ewan MacIntosh holds a measure of whisky in the Barrel Room of the Diageo-owned Dalwhinnie Distillery in Dalwhinnie in the Scottish Highlands May 16, 2011.

MUMBAI (Reuters Breakingviews) - It’s a respectable time to reach for the bottle in India. Diageo, the UK liquor giant led by Ivan Menezes, has built up a roughly 56% stake in India’s $5.3 billion United Spirits, maker of McDowell’s and Signature whiskies. The business makes up almost one-fifth of Diageo’s global sales and was growing fast before the virus struck. Now Diageo has an opportunity to go on a bender and buy out the minorities for a virtual pittance. The price: its dividend.

It’s easy to see why the $80 billion distiller of Smirnoff and Tanqueray would be eyeing full control of its subsidiary. Diageo made its first big move on United Spirits in 2012, won control a couple of years later, and eventually agreed to pay its chairman, Vijay Mallya, a handsome sum to step down after inquiry found irregularities in the accounts. The disgraced booze baron now faces extradition from the UK for other dealings.

Any deal would be a coronavirus-induced cheap tipple in the world’s largest whiskey market. United Spirits is now trading at around 26 times the estimates of its forward EBITDA, more than its parent at 18 times, but near a five-year low. The business, selling over 1 million cases a year, was in good shape before the outbreak. The top line was growing faster than Diageo’s. A strategy to sell more premium drinks was also working, and it has successfully cut debt.

Profitability can still improve: United Spirits’ operating margin pales in comparison to its ultra-efficient parent. And other worries about a future tilt towards prohibition on the subcontinent seem overdone, not least because booze comprises a decent chunk of official tax revenues. Besides, Diageo has always been bullish on the long-term prospects of the market given low per capita alcohol consumption.

Mid-pandemic dealmaking brings its own challenges: Diageo is already in cash-conservation mode and has suspended buybacks. A bid for the rest of United Spirits at a 25% premium to the share price, or nearly $3 billion, might push net debt to 4 times its EBITDA, analysts at Jefferies reckon. That might force Maharashtra-born Menezes to sacrifice a consistently poured final dividend this year, estimated at about 1 billion pounds. But given Diageo’s bumpy journey in India, taking full control of the business would also be a moment to toast.

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