Tata Tea one of the largest company in the world was sheltered from competition by a protectionist Indian government for most of its history.
In 1999, Tata Tea company faced several new challenges:
Changing consumer tastes.
Ban on tea imports scheduled to be lifted in 2001
Majority of the company’s tea is sold in India, with 12% total international sales only.
Possibility of future stiff competition from Nestle, Sara Lee Corporation, and Associated British Foods.
To enhance its position in the current brand
Acquire a well-known brand
Some disturbing questions???
Tata Tea company has to beat the growing global competition – but how?
Any possibilities for further growth in the Indian stagnant market?
If popular brand in India can penetrate into the global markets?
Perhaps it would need to develop a brand of international demand or taste.
Or acquire an other company
These questions become more urgent as Tetley Tea, well-known in the US and UK, unexpectedly comes up for sale. Provide refernce
Pros and Cons of acquiring Tetley
Acquiring Tetley would mean capturing the higher end of the value chain
Tetley is well-established in international markets
Tata’s gross margin is 36%, while Tetley’s is a more efficient 55%
The combination of the two companies would allow for synergies that competitors couldn’t match
Opportunity to buy a brand the likes of Tetley is rare
Pros and Cons of acquiring Tetley - Cont
Tata had already tried acquiring Tetley five years prior and failed
Tata may have difficulty raising the required £200-300 million purchase price
The £200-300 million asking price is much higher than the £190 million the company was valued at in 1995
The sheer size of the transaction could prove unwieldy
Wouldn’t investing in building its own global brand be more efficient than buying a foreign brand?
TATA choose to acquire Tetley.
The major challenge was financing
The value of Tata Tea was $114 million.
Tetley was valued at $450 million.
The solution was provided by Leverage Buy outing the Deal.
LBO = Definition
Buyout : The purchase of a company or a controlling interest of a company's shares.
Leverage buyout : The acquisition of a company using debt and equity finance. As the word leverage implies, more debt than equity is used to finance the purchase, e.g. 90% debt to 10% equity. Normally, the assets of the company being acquired are put up as collateral to secure the debt. (Beatrice Foods by Esmark, Levis Strauss, etc.)
Going Private: Refers to transformation of a public corporation into a privately held firm.
Example of LBO in Daily life
Mortgaging a Home.
Buying a Car/Taxi, financed by bank.
Other Similar Term
Management buy-out (MBO) - A private equity firm will often provide financing to enable current operating management to acquire at least 50% of the business they manage. In return, the private equity firm usually receives a stake in the business.
LBOs are a way to take a public company private, or put a company in the hands of the current management, MBO.
LBOs are financed with large amounts of borrowing (leverage), hence its name. Debt:Equity ratio can go more than 90:10
LBOs use the assets or cash flows of the company to secure debt financing, bonds or bank loans, to purchase the outstanding equity of the company.
After the buyout, control of the company is concentrated in the hands of the LBO firm and management, and there is no public stock outstanding.
How LBO is done? Ref: The McGraw-Hill Guide to Acquiring and Divesting Businesses
The choice is dictated by balancing Legal, Financial, Tax and Accounting advantages and disadvantages.
Suitable for Small and Medium sized transactions.
Allows selection or rejection of assets and liabilities.
Leads directly to price allocation and stepped up asset value, that are part of Tax and Accounting aspects of transactions.
In Stock purchase , the target shareholders simply sell their stock and all their interest in target corporation to the buying group and then the two firms may be merged.
This method cannot be used if one or more minority share holders refused to sell.
Finding cheap assets – buying low and selling high (value arbitrage or multiple expansion)
Targetting firms with low Q-Ratio
(Market Value/Asset Value)
Unlocking value through restructuring:
Financial restructuring of balance sheet – improved combination of debt and equity
Operational restructuring – improving operations to increase cash flows
Scanning target Company
History of profitability.
Predictable cash flows to service financing.
Low current debt and high excess cash.
Strong management team - risk tolerant.
Known products, strong market position.
Little danger of technological change (high tech?).
Low-cost producers with modern capital.
Take low risk business, layer on risky financing.
LBO sponsors have equity funds raised from institutions like pensions & insurance companies
Balance from commercial banks (bridge loans, term loans, revolvers).
Banks concentrate on collateral of the company, cash flows, level of equity financing from the sponsor, coverage ratios, ability to repay (5-7 yr)
Some have “Mezzanine Funds” as well that can be used for junior subordinated debt and preferred
Occasionally, sponsors bring in other equity investors or another sponsor to minimize their exposure
SPV – Special purpose vehicle
In our case SPV - Tata Tea Great Britain Ltd ., was created.
The cash flow from the Tetley and hence this SPV, was used to repay the debt.
SPV merged with TATA after repayment of the debt.
Sources of Gains
LBO ‘s are done at high premium price.
The premium paid is 40% or more than average stock value of last two months.
What are the sources of these gains?
Asymmetric Information and under pricing.
Most of the premium paid is financed by Tax savings.
New company can operate Tax free for as long as 4-5 years.
In this time period the debt/equity ratio is pulled down from 10 to 1.
Often the LBO is sold after this time horizon or reverse LBO is done.
Control and hence stakes are with few people.
Incentives of Management increases.
Dividends are not necessary.
Debt payment is effective substitute for dividend payment.
To save company from the Bankruptcy.
Restructuring of the acquired firm saves substantial amount of costs.
Changes in marketing strategies.
Economies of Scale.
Investors have more information on the value of firm than public shareholders.
Investors buy firms that have low Q-Ratio.
Net value of the firm may still be higher than LBO price paid.
Such firms are generally resold at much higher price after the new management brings the firm to its true value by restructuring activities.
Example, Kohlberg Kravis Roberts and Thomas H Lee Company started in 1970’s, seas opportunity in inefficient and undervalued corporate.
Tata – Tetley LBO; Solution
First Leveraged Buy-out ( Rs. 2,135 cr)
Instant access to Tetley’s worldwide operations, combined turnover at Rs 3,000 crores.
Financial Innovation at its best
SPV created to ring fence risk with equity contributed by Tata Tea and Tata Tea Inc
Debt of 235 mn pounds raised in the form of long term debt and revolver; charge against Tetley’s brand and assets.
Tata Tea’s exposure only to the extent of equity component of 70 mn pounds
March 2000 Tata Tea Limited Acquisition of 100% equity stake in Tetley Tea (UK) INR 21,350,000,000