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What the Battle Between Diageo & Vijay Mallya Over United Spirits

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What the Battle Between Diageo & Vijay Mallya Over United Spirits What the battle between Diageo & Vijay Mallya over United Spirits means for the company Binoy Prabhakar, ET Bureau May 10, 2015, 06.53AM IST On May 5, 2014, United Spirits, India's largest liquor company, received a letter that reeked of trouble. It was sent by lawyers representing a creditor that claimed to have advanced loans totalling Rs 200 crore to Kingfisher Airlines, a company promoted by United Spirits chairman Vijay Mallya. The lawyers said United Spirits had stood guarantee to the loans and Kingfisher (grounded since October 2012) had defaulted on payments as well as interest of Rs 79 crore. Ergo, United Spirits must pay a total sum of Rs 279 crore due to the creditor, they demanded. United Spirits contested the claim, stating it had no knowledge about the loan transactions or the guarantee. But in a curious turn of events, the creditor informed the company on July 31, 2014 that it had no claim or demand because its lawyers had not accounted for an addendum to the loan agreement that freed United Spirits of any obligation. The sequence of events above, recounted by the auditor BSR & Co in the USL Annual Report for 2013-14, underscores the difficulties UK's Diageo Plc, the world's biggest drinks company, has encountered since it agreed on November 9, 2012 to buy a majority stake in United Spirits from Mallya's United Breweries Holdings Ltd (UBHL) through a complex shareholder agreement (see A Far-From-Smooth Takeover). United Spirits is also owed Rs 1,337 crore by UBHL, the parent company of UB Group. It is unlikely the company will ever recover the money because they are unsecured loans. (Public sector lenders of Kingfisher, led by State Bank of India, which are owed Rs 7,500 crore by the airline, have a better chance because their loans were sanctioned against collateral. The 17 banks took possession of Kingfisher House, a property in Mumbai, in February 2015 and are due to put it up for auction.) These contentious financial transactions explain why United Spirits delayed reporting its fourth-quarter earnings thrice last year. It finally did in September 2014. United Spirits launched an enquiry into its accounting practices soon after, culminating in the decision of the board on April 25 asking Mallya to step down. Anand Kripalu, who was handpicked by Diageo as chief executive officer in October 2013 and took office on May 1, 2014, led the enquiry. He was assisted by a London team of audit firm PwC. Mallya refused to resign. He released a statement on April 25 declaring that the PwC report was based on half- truths and twisted facts and Kripalu, the former head of Cadbury India, was merely parroting the report. The United Spirits board said it will approach shareholders to seek Mallya's removal. Diageo, which owns nearly 55% of United Spirits, also said it would review its shareholder agreement with Mallya. United Spirits has refused to publicly share the findings of the internal enquiry report. On Thursday, it informed the Bombay Stock Exchange that the report contained sensitive information that would benefit competitors and invite defamation from persons accused of wrongdoing. Shaken and Stirred A protracted boardroom battle looms and none of the parties are likely to emerge unscathed. Mallya said he was surprised by the allegations against him because Diageo had conducted an extensive due diligence exercise at United Spirits over four months during which details of all transactions were disclosed to them. The Rs 200- crore notice by the creditor belies that claim. The financial irregularities establish that the due diligence by Diageo, a company whose products are sold in no less than 180 countries, was far from perfect. They also call into question the audit of PwC despite its protestations that it stopped auditing United Spirits books after 2011. The forensic audit by PwC's London team finds fault with transactions by United Spirits between 2010 and 2012 — possibly regarding loans advanced by United Spirits to UB Group entities that were used to keep Kingfisher aloft — while the statutory audit conducted by the Indian team of PwC gave a clean chit in at least two of those years. But the party with the highest stakes is undoubtedly Diageo. The company, owner of brands such as Smirnoff vodka and Johnnie Walker whisky, has had a chequered history in India. In 2002, its operations in India came to a stop when it sold Gilbey's Green Label, a successful whisky brand, to UB Group. The company was back four years later. It dropped a long-held strategy of focussing only on its global labels and turned its attention to creating domestic brands. Diageo was looking to emulate the success of arch rival Pernod Ricard in India. The French distiller, thanks to its acquisition of Seagram in 2001, boasted a portfolio that contained global brands such as Glenlivet and Ballantine's as well as mass-selling domestic brands such as Royal Stag and Blender's Pride in India. Diageo launched a whisky brand called Haig in 2006. A year later, it created a joint venture with Radico Khaitan to produce and sell a whisky called Masterstroke Deluxe. Four year later, it launched Rowson's Reserve, a premium whisky, on its own for the Indian market. All three brands bombed. Abhishek Modi, CEO of Modi Illva India, a joint venture between Umesh Modi Group and liqueur maker Illva Saronno of Italy, said Rowson's Reserve was the last nail in the coffin for Diageo in India. "They were desperate to buy an Indian company that could help their Indian business going," he said. United Spirits, which then enjoyed a 40% market share, seemed a perfect fit (see Pluses for Diageo...). Combined, United Spirits and Diageo preside over 27 regional and 11 global million-case brands, according to The Millionaires' Club, which ranks spirits brands that sell over a million cases a year. United Spirits by itself owns four of the top 25 growth brands. Diageo also secured Unites Spirits' mighty nationwide distribution and production network of 64,000 outlets and 32 facilities. Finally, the company seemed to have found a firm footing in the world's second largest spirits market. Except things haven't played out in the manner Diageo would have liked (see ... And the Minuses). United Spirits posted its biggest ever loss in the March 2014 quarter. It faces legal setbacks. In 2013-14, sales dropped by 3 million from a year ago. Market share has been dropping steadily, hitting 35% in 2014-15 from nearly 50% about five years ago. Rivals Pernod Ricard and Allied Blenders and Distillers have been gaining at the expense of United Spirits, meanwhile. Officer's Choice whisky, owned by Allied Blenders, has been the fastest-growing brand across all markets and categories since 2011. Ahmed Rahimtoola, head of marketing at Allied Blenders, said overall sales grew 29% to 32 million cases in 2014-15. Officer's Choice, which falls under the regular whisky category (see Whisky: Sales and Categories), grew 16% despite the segment contracting 1%, he said. Nimble Competitors Pernod Ricard's progress has been even more remarkable. It happens to be the only liquor company to have tasted success with both imported and domestic liquor. India is now its fourth largest market. The company has given the freedom to teams in each market to develop the strategy of brands and portfolios. They are also responsible for production and plant management. Deepak Roy, CEO, Allied Blenders, said Pernod Ricard always had a great sales strategy. "They were never focussed on volumes. They believe in building brands," he said. In contrast, United Spirits seems hobbled by a sales dilemma — should it be focussing on premium global brands from the Diageo stable or the mass-selling brands from its own portfolio? (Diageo won minority shareholder approval in January 2015 for United Spirits to make, sell and distribute its products.) One category or certain brands within a category seem to be hurting due to this confusion. Take Royal Challenge whisky. The brand's prices were slashed last year to compete with Pernod Ricard's Royal Stag and Allied Blenders' Officers Choice Blue. In Rajasthan, for example, a 750 ml bottle of Royal Challenge Classic Premium Whisky costs Rs 440 compared with Rs 433 for 750 ml of Royal Stag Deluxe Whisky. The price cuts propped up volumes. United Spirits said the brand grew 27% in 2013-2014. But industry observers said the "repositioning" of Royal Challenge was a departure from the company's so-called premiumisation agenda — an affinity to sell premium brands rather than the cheaper mass-selling brands. United Spirits justified the price cut as part of a constant endeavour to reach new consumers. But the attention of chief competitor Pernod Ricard on premium brands such as Blender's Pride (Indian) and 100 Pipers (imported) has been unwavering. The company began to use grain spirit in the blend rather than molasses, which give Indian whiskeys the flavour of rum, forcing others to follow suit. Molasses has also turned expensive after the government began using molasses-distilled ethanol as fuel to reduce the dependency on petrol. The premium segment comprises only 4% (5-6 million cases a year) of the total Indian whisky market, but in terms of value, the segment is worth more than Rs 2,000 crore and is growing at a scorching pace. Rahul Gagerna, president, sales and marketing, Radico Khaitan, said premiumisation is the future of the liquor industry. "Volumes matter, but margins matter more because a company has to constantly innovate and put money into marketing," he said.
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