USL shareholders vote ‘yes’ to Diageo

At the second time of asking United Sprits’ shareholders have voted in favour of an agreement under which India’s largest spirits producer will manufacture some of Diageo’s key international brands including Smirnoff vodka and become its licensee and distributor in the Subcontinent.

Vijay Mallya, USL chairman

The approval will come as a relief to both companies as it is a cornerstone of the new arrangements between the two following Diageo finally purchasing almost 55% of USL for £1.9bn. Rejection of the scheme last November was a considerable embarrassment.

The agreement required a minimum 75% vote in favour from USL’s minority shareholders who initially rejected the plan amid concerns that they had been given insufficient financial information about how USL would benefit from the deal and because of continuing anxieties about the role and actions of VJ Mallya, USL’s non-executive chairman.

Following much behind-the-scenes discussion, the minority shareholders have now voted 76.33% in favour of the plan. They were urged to do so by USL’s independent directors, who issued a statement to that effect only days before the vote.

USL will now cease to be a simple agent for Diageo in India but take on the more lucrative role of licensee. Diageo will begin to run down its own Indian operations, generating economies of scale and other cost savings, including avoiding hefty import tariffs on those products manufactured in India . In the transitional period both companies will share advertising and marketing expenses based on net sales.

USL told the sceptical minority shareholders that it estimates the new arrangements will generate some £70m extra sales in the first year for the company.

Industry observers see the vote (albeit by a smaller majority than either USL and Diageo would have liked) as a turning point in USL’s recent fortunes and a keystone in Diageo’s ambitions in India.

An inquiry into previous accounting practices and loans to Mallya’s United Breweries Group continues but nobody questions that under Diageo USL’s probity will be unquestioned. It has voting control on the USL board and has appointed all the executive directors. Managing director and CEO Anand Kripalu said recently: “Our ambition is to transform the reputation of United Spirits and of the alcohol industry.”

Indeed, that reputation is already improving, as the vote demonstrates. Following three successive quarters of losses because of provisions over potential bad loans, USL’s net sales grew by 8% in the latest quarter compared with the same period in 2013 and the share price has gained 13% in the past couple of months.

Financial analysts say this is the harbinger of a long-term improvement under Diageo. In its own right USL is the world’s third largest distiller and has 40% of the Indian market for spirits, a market that is defined by very high tariff and duty barriers to entry. The leading importer of “Western-style” spirits is Pernod Ricard, which has had significant representation in India since it took over Seagram’s operations there as part of the break-up of the Canadian group in concert with Diageo in 2000.

Diageo’s brand portfolio

Diageo believes that 10% of its sales could come from India within a decade as it uses USL’s strong position to leverage demand for its premium international brands as well as profiting from USL’s powerful local brands.

In some ways the demographics are more attractive than those in China. Industry sources say that a net 17m people are added every year to those attaining the minimum legal age for alcohol consumption and that the middle class (the group most able to afford premium spirits) is expanding rapidly.

Alcohol consumption is becoming increasingly acceptable in India and the country’s low per capita consumption (0.9 litres per annum) bodes well, especially for Indian manufactured foreign liquor (IMFL). In time, that will provide a springboard for premium products such as scotch that cannot be produced outside their region of origin.

Further, they believe that as the Indian economy expands, tariff barriers will be eroded in the interests of promoting exports, thus further widening the market.