Diageo could be forced to buy remaining shares in USL

India’s stock market regulators are mulling whether to force Diageo to offer to buy the 44% of the shares it does not own in United Spirits Limited (USL), the sub-continent’s largest spirits group.

Ivan Menezes, chief executive of Diageo.

The debate centres on last year’s controversial US$75m payment from Diageo to Vijay Mallya to secure his severing links with USL and standing down as the company’s non-executive chairman. Did that deal bring about a change of control at USL? If it did, then Diageo could be required to make an “open offer” to buyout other USL shareholders.

India’s Economic Times has quoted a senior official at the country’s Securities and Exchange Board (Sebi) as saying “Our view is that before the settlement agreement was entered into there was dual control of Mallya and Diageo in USL, but now there is a change of control.”

For its part Diageo is quoted as saying: “It is clear that Diageo has been in control of USL since we started fully consolidating USL results in July 2014. We are, therefore, very clear that there was no change of control in February 2016 [when the Mallya deal was concluded].”

Should the securities board decide against Diageo and require it to make an offer to other USL shareholders, the ruling would be embarrassing for the world’s biggest premium spirits company. But equally, the outcome may not be completely unwelcome.

USL holds a commanding position in the Indian market, one which Diageo chief executive Ivan Menezes believes will account for 10% or more of the group’s business within a few years. Holding a larger stake would bolster that prospect.

Despite being overshadowed by the burgeoning recovery in the key North American market, Diageo said its Indian business “continued to strengthen” in the six months to 31 December with net sales growth of 4%.

While Diageo’s buoyant free cash flow and solid balance sheet would enable it to fund such an open offer without undue stress to its investment and capital expenditure plans, it is not clear at what price it would be required to pitch any offer. Its present 55% stake cost approximately £1.2 billion.

Equally, it is not clear how many shareholders would accept an offer. Many refused to sell to Diageo during the 2012/13 takeover saga and with USL’s prospects appearing increasingly attractive under Diageo’s direction, they may well wish to hold on to their shares and enjoy Menezes’ predicted upward ride.