The Hindu Business Line : The spirit in synergy

THE turning point arrived when the pugnacious Manu Chhabria suddenly gave up fighting on an April morning in Mumbai's Jaslok Hospital three years ago. At 56, Chhabria, the Dubai-based Jumbo Group's founder chairman, was a challenger, and possibly the only serious threat, to UB Group Chairman Vijay Mallya's plans to lord over the Indian spirits market.

As Chhabria succumbed to an ill-timed heart failure, leaving behind a badly divided family, it was Mallya's chance to firm up his grip over the Indian Made Foreign Liquor (IMFL) market, the most lucrative and visible segment of the domestic alcoholic beverages industry. So, when Mallya signed a Rs 1,300-crore agreement with Vidya Manohar Chhabria, Jumbo Group's Chairperson and the wife of the late tycoon, to acquire Shaw Wallace & Co Ltd it was not entirely unexpected but what surprised many observers was a rather quiet climax, which was a direct contrast to those pitched battles fought over the last two decades. The deal brings SWC, the second largest domestic spirits company, into the UB fold. It is already the leader in IMFL business with control over three spirits companies - McDowell & Co, Herbertsons and TDV. The SWC acquisition gives him a monstrous size, accounting for 50 per cent of the IMFL market, which is touted as one of the world's fastest expanding liquor markets.

This strike, which places him as the world's second largest spirits marketer by volume, comes 20 years after he first set his sights on SWC. In 1985, he joined forces with Chhabria, who had then emerged as a raider on the Indian corporate scene through leveraged buyouts, to acquire the foreign shareholders of SWC in the hope of merging it with the UB Group at a later date. As Mallya came under the FERA lens, Chhabria took charge of the acquisition in the face of stiff opposition from the SWC operational management led by S. P. Acharya, only to sideline his partner and keep the company to himself. This spawned perhaps the fiercest rivalry in the liquordom, which sapped at least a few hundred crore rupees annually between the two players in marketplace and courtroom battles. It is slipping into history as Mallya, now closer to 50, finally gets what he wanted when he was hardly 30, an acquisition which he had first strategised in his youthful exuberance soon after taking over the reins of the UB Group following his father Vittal Mallya's demise in 1983.

How it adds to UB's muscle

The acquisition, which is expected to achieve financial closure by June 30, will take UB's combined IMFL volume to 56 million cases in an industry pegged at about 112 million cases. UB through its three companies closed 2004-05, with depletions of nearly 40 million cases, while SWC is learnt to have reported a figure of a little over 16 million cases. In the wake of the SWC takeover, Mallya's spirits business stands to gain from augmented synergies in sourcing and manufacturing, and better streamlining of marketing functions and corporate structures. Further the scale and size may position him to leverage himself better in tackling the regulators who decide on wholesale pricing in many key markets. Somewhere towards the middle of the current financial year, Mallya is expected to start consolidating his spirits interests into a single entity under the name of United Spirits Ltd. McDowell & Co, Herbertsons and TDV will initially merge even as SWC will be subsequently brought into this unified fold. "Some of the gains are immediate and visible. For instance, the merger will result in four different corporate offices and their functions being absorbed into one," says Ravi Nedungadi, President & CFO, UB Group. The acquisition of SWC, according to Nedungadi, could result in synergistic gains of over Rs 100 crore from the second financial year, progressively moving up thereafter . "There is scope to improve operational efficiencies in the SWC system, and similarly there are some learnings which UB too can take from them," he adds. Some of the industry observers believe that operational streamlining and resultant gains alone may not shore up the profitability - the SWC deal is entirely debt-financed by ICICI Bank - as cost push pressures can seriously erode some of the synergistic profits. The volatility in the price of raw materials like molasses and extra neutral alcohol (ENA), spike in bottle costs and spiralling freight charges can undo some of the potential gains from consolidation. Further, Mallya needs to tread cautiously in brand management, with the SWC acquisition boosting the UB spirits portfolio to 130 brands. The brand list includes 13 millionaire brands - those with annual sales of over one million cases (nine from UB and four from the SWC stable) - which is perhaps the largest array of blockbuster brands for any spirits company in the world. "All our millionaire brands will receive the same level of attention they used to get," says Vijay Rekhi, President of UB Spirits Division, even as he talks about applying mind to brand management issues.

Observers say there are tough calls in the short run. For example, they point out a potential conflict between SWC's Royal Challenge and McDowell's Signature whiskies in the premium segment, or between White Mischief and Romanov vodkas in the regular priced segment. A dextrous price and imagery differentiation is an obvious hint from UB, but there are experts who believe that a `preferred brand' strategy is critical given the resources a brand gulps down to sustain itself in the marketplace. "There are management challenges. We need to identify brands that are core, brands that can be milked, and those which are tail brands," says Deepak Roy, President, TDV. While Mallya may have top brass with diverse skills to tackle management difficulties, it calls for effective utilisation of the same as there are multi-cornered challenges that could impact his tightrope walk to profitability. And the management act becomes crucial as UB may find it difficult to demonstrate that bigger size and brand power brings pricing power, as the State itself is the wholesale agent in an increasing number of markets across the country.

But there's no swatting the fly

With SWC in the UB fold, Radico Khaitan Ltd (RKL) emerges as the distant second-largest player in the IMFL industry. RKL, owner of 8 PM Whisky, is learnt to have closed the previous financial year with sales of 9.5 million cases. Mohan Meakins Ltd, a traditional powerhouse with the legendary Old Monk Rum, follows next with about seven million, while Seagram, which is part of the French drinks giant Groupe Pernod Ricard, occupies the fourth slot with six million cases. At around five million cases and below there are a few more companies with reasonable clout in the marketplace. This list includes Kishore Chhabria's BDA Ltd, makers of Officers' Choice Whisky, and other big names of yesteryear such as Jagatjit Indistries Ltd, with flagship Aristocrat Whisky, and Khodays with brands like Peter Scot Whisky and Hercules Rum.

The competition, the other half of the IMFL market, still possesses an effective brand arsenal even though many of them, especially those in the hands of family-run businesses, may have seen considerable erosion in value and esteem. Admits a UB official: "Mohan Meakins, for example, can put up a better show and perhaps almost double its sales only if it gets its act together." However, industry analysts feel that Seagram is the company to watch out for in the future because of its brands and financial muscle for the long haul. With a portfolio that includes whiskies such as Royal Stag, Imperial Blue and Blenders Pride, it is the only transnational to make the cut in the domestic market, and has showcased its profitable brand building ways. The company has stayed focused on organic growth for over ten years but now it could be the time to look at acquisitions as well. "Consolidation will now gather momentum," says Abhishek Khaitan, MD of RKL. His company, with a strong balance sheet, would consider leveraged buyouts "if the price is right." But the process could well be kicked off by a recent entrant, Mason & Summers Alcobev Ltd, a start-up company floated by Ramesh Vangal, a former strategic investor and Chairman of Seagram Asia-Pacific, in alliance with Inver House, one of the world's largest bulk Scotch suppliers. After making an unsuccessful bid for SWC, Vangal, could be on the lookout for another reasonably big target, especially one of those drooping family-run companies, the observers say.

Interestingly, the competition has not viewed Mallya's snapping up of SWC with much concern, as they feel a marketplace devoid of the battles between the two would help in shoring up the industry's profitability. "It will help in controlling indiscriminate discounting of stocks and trade incentives, pushing up the overall profitability," says Khaitan.

It is estimated that between UB and SWC they splurged Rs 200 crore - Rs 250 crore annually as trade incentives. Further, rivals say, UB needs to address its own profitability concerns and is expected to pitch for aggressive price increases when the States call for annual tenders. "We feel the industry will now be more cohesive in asking (for price increases and better taxation policies)," says Rekhi of UB. "The bottomline," an industry rival says, "is that UB just cannot afford to get stretched further (after gulping down SWC). They have to take us along in addressing problems regarding industry structures and policies that is limiting profitability." A UB insider concurs: "There is still plenty of competition left. Even a regional bully who can stretch you in a few markets is bad enough." Growth at the expense of others should not be a strategy for Mallya now, because he does not need it, adds an industry observer.

Valuation is the way forward

As we go to press, UB top officials have had an interface with the investor community in Mumbai giving them a peek into the future plans. Mallya says he wants to unlock value after consolidating his sprits interests under United Spirits, and has set a timeframe of 18-24 months to achieve that. UB and its Chairman have been sensitive to profitability concerns, and have shown some urgency in addressing the same.

Analysts believe that Mallya will now move to bolster market capitalisation. There are already hints that United Spirits could be looking at a street valuation of nearly Rs 10,000 crore ($ 2 billion), as it sets out to unlock value by roping in a strategic partner or by going in for an overseas listing (which is said to be closer to Mallya's heart). But if Mallya is to realise his avowed ambition to emerge as the world's largest spirits marketer, United Spirits needs to discuss merger (akin to what Brazilian brewer AmBev managed with global brewing giant Interbrew perching it on the top of the world's beer market) with one among the other top three global spirits companies - Diageo, Pernod Ricard & Allied Domecq. (Media reports in recent days suggested that Pernod Ricard, along with Fortune Brands, is making a bid for Allied Domecq, which will push the combine to the top slot by dislodging Diageo.) United Spirits, which almost entirely mops up its volume within India, requires considerable dressing up prior to sitting at the negotiations table. But are the global spirits giants really keen on the Indian market, as the spirits business here is subject to varied policy structures in each federal State and continues to suffer from regulators' archaic outlook? If they are, what made them stay away?

The Indian spirits market is projected to grow between 8 and 10 per cent, according to Roy of TDV. As Mallya plays the valuation tune, the entire IMFL industry stands to benefit, as a higher price for United Spirits will also prop up the rivals' value. An industry rival, in his grudging admiration for Mallya, says: "He has had tremendous luck all through his life. But will it last the whole hog?" Right now, even he can't help wishing Mallya's luck a full run.

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