In the Spotlight – Diageo, United Spirits

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The long-running discussions between the world's largest spirits maker, Diageo, and India's United Spirits over a possible stake purchase collapsed this week. Michelle Russell examines the fallout.

Both companies claimed to have called off the talks, which have continued for around eight months, after the liquor makers failed to agree on the price of any stake.

The decision to back off from talks could be seen as disappointing for United Spirits as it would have helped improve the company's balance sheet.

Trevor Stirling, beverages analyst at Sanford C Bernstein, said a deal between Diageo and United Spirits would have been "a big positive" for the UK company because it would have given it access to the Indian group's distribution networks.

United Spirits claims to have distribution to 99% of India's 64,000 alcohol retail outlets and controls more than two third of India's spirits market.

However, Stirling added that Diageo would have been reluctant to strike a distribution deal in conjunction with another drinks group without having direct control of it.

Diageo did confirm yesterday that the long-running talks to buy a stake had collapsed due to a disagreement over the company's valuation.

"It hasn't proved possible for Diageo to resolve points of difference between the two parties, principally valuation," the company had said in statement.

Bangalore-based United Spirits said Diageo's offer didn't fairly value the owner of Scottish whisky maker Whyte & Mackay, Ravi Nedungadi, CFO of parent company UB Group, told Bloomberg this week.

United Spirits, meanwhile, told just-drinks last week that it is closing in on investment from private equity. This, plus share sales, may be enough to see off any immediate debt issues at the group.

Diageo this week warned of a tough 2010 after cost savings helped the drinks giant to hit guidance in its fiscal full-year, despite flat like-for-like sales and a fall in pre-tax profits.

Net sales for the 12 months to the end of June were flat against the year before on a like-for-like basis, with like-for-like volume sales down 4%, as the global economic downturn put the stoppers on growth.

Pre-tax net profits for the year fell by GBP0.1m, to GBP2bn. Diageo's shares fell 4.4% in London, with traders at Charles Stanley citing management's "downbeat outlook" as the catalyst for selling.

The "opaque" profits outlook is "disappointing," said Simon Hales, a London-based analyst at Evolution Securities. "The market hoped to see a repeat of the 4-6%," he said, rating the stock as neutral.

In a conference call following the release of the results yesterday, when asked if walking away from the long-running talks with Vijay Mallya's United Spirits in India was a missed opportunity, Walsh said: "I know his price expectations, you don't. So, I still say no."

Diageo said it will now "pursue the potential it sees for its brands in India separately from United Spirits."

It already has a 50-50 joint venture with Radico Khaitan, the country's second-biggest liquor company, but this only commands around a 10% market share.

Meanwhile, United Spirits, is reportedly set to start looking for a new strategic partner next year. Other players, such as Bacardi, are believed to have sniffed around United Spirits in the past. But, if the world's largest spirits maker, with no major acquisitions to swallow, is baulking at the price - what of everyone else?

For now, United Spirits will have to come to terms with private equity investors or opt for a rights issue to deleverage its debt-laden balance sheet, which is leveraged nearly three times.

The company's shares fell 56% last year on concern over its ability to repay debt.

United Spirits borrowed $625m to acquire Scotland-based Whyte & Mackay for around $1.2bn in 2007. But, debt payments have eased since the firm secured funds from a share sell-off this summer.

For all the comments from both sides, there is still a 'never say never' feeling about Diageo and United Spirits. Both companies must be aware of the potential strategic advantages.

Should a private equity succeed in buying into United Spirits, as seems likely, who is to say that it would not sell out to Diageo in the end? All private equity groups look for an exit strategy before signing on the dotted line.

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