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The Leveraged Buy Out Deal of Tata
The Leveraged Buy Out Deal of Tata
The case 'The Leveraged Buyout Deal of Tata & Tetley' provides insights into the concept of
Leveraged Buyout (LBO) and its use as a financial tool in acquisitions, with specific reference to
Tata Tea's takeover of global tea major Tetley. This deal which was the biggest ever cross-border
acquisition at that time, was also the first-ever successful leveraged buy-out by any Indian
company. The case examines the Tata Tea-Tetley deal in detail, explaining the process and the
structure of the deal. The case helps to understand the mechanism of LBO. Through the TataTetley deal the case attempts to give an understanding of the practical application of the concept.
"We were very clear that the burden on Tata tea should be such that the company would be able
to absorb it. And it would not materially affect Tata Tea's bottomline."
- N.A.Soonavala, Vice-Chairman, Tata Tea.
"It was important to make the right decision on the comprehensiveness of the transaction. The
model has been driven by existing and future earnings potential of the Tetley group and the
resultant post-acquisition cash flows to immediately justify the business and financial model."
- Rana Kapoor, MD, Rabo India Finance Ltd., Commenting on the deal.
Introduction
In the summer of 2000, the Indian corporate fraternity was witness to a path breaking
achievement, never heard of or seen before in the history of corporate India.
In a landmark deal, heralding a new chapter in the Indian corporate history, Tata Tea acquired
the UK heavyweight brand Tetley for a staggering 271 million pounds. This deal which
happened to be the largest cross-border acquisition by any Indian company at that time marked
the culmination of Tata Tea's strategy of pushing for aggressive growth and worldwide
expansion.
The acquisition of Tetley pitch forked Tata Tea into a position where it could rub shoulders with
global behemoths like Unilever and Lawrie. The acquisition of Tetley made Tata Tea the second
biggest tea company in the world. (The first being Unilever, owner of Brooke Bond and Lipton).
Moreover it also went through a metamorphosis from a plantation company to an international
consumer products company.
Ratan Tata, Chairman, Tata group said, "It is a great signal for global industry by Indian
Industry. It is a momentous occasion as an Indian company has been able to acquire a brand and
an overseas company." Apart from the size of the deal, what made it particularly special was the
fact that it was the first ever leveraged buy-out (LBO) by any Indian company. This method of
financing had never been successfully attempted before by any Indian company. Tetley's price
tag of 271 mn pounds (US $450 m) was more than four times the net worth of Tata tea which
stood at US $ 114 m. This David & Goliath aspect was what made the entire transaction so
unusual. What made it possible was the financing mechanism of LBO. This mechanism allowed
the acquirer (Tata Tea) to minimise its cash outlay in making the purchase.
Tata Tea was incorporated in 1962 as Tata Finlay Limited, and commenced business in 1963.
The company, in collaboration with Tata Finlay & Company, Glasgow, UK, initially set up an
instant tea factory at Munnar (Kerala) and a blending/packaging unit in Bangalore.
Over the years, the company expanded its operations and also acquired tea plantations. In 1976,
the company acquired Sterling Tea companies from James Finlay & Company for Rs 115
million, using Rs 19.8 million of equity and Rs. 95.2 million of unsecured loans at 5% per
annum interest. In 1982, Tata Industries Limited bought out the entire stake of James Finlay &
Company in the joint venture, Tata Finlay Ltd. In 1983, the company was renamed Tata Tea
Limited. In the mid 1980s, to offset the erratic fluctuations in commodity prices, Tata Tea felt it
necessary to enter the branded tea market. In May 1984, the company revolutionized the valueadded tea market in India by launching Kanan Devan tea in polypack.
In 1984, the company set up a research and development center at Munnar, Kerala. In 1986, it
launched Tata Tea Dust in Maharashtra. In 1988, the Tata Tea Leaf was launched in Madhya
Pradesh.
In 1989, Tata Tea bought a 52% stake in Karnataka-based Consolidated Coffee Limited-the
largest coffee plantation in Asia, in order to expand its coffee business. In 1991, Tata Tea formed
a joint venture with Tetley International, UK, to market its branded tea abroad. In 1992, Tata Tea
took a 9.5% stake in Asian Coffee-the Hyderabad based 100% export oriented unit known for its
instant coffee, through an open offer. This offer was the first of its kind in Indian corporate
history. Later, in 1994, Tata Tea increased its stake in Asian Coffee to 64.5% through another
open offer. This helped it to consolidate its position in the coffee industry. In 1995, Tata Tea
unveiled a massive physical upgradation program at a cost of Rs 1.6 billion. The upgradation
program, spread over four years, was meant to improve its production facilities. In the same year,
the company, along with a Sri Lankan partner, bid successfully for a group of 20 tea estates in
the famous Watawala plantations in Sri Lanka.
In 1996, Tata Tea felt the need to develop into a truly national brand. It identified an opportunity
to enter the leaf tea segment in the South. Between 1996 and 1998, the company launched Tata
Tea Premium in Karnataka, Andhra Pradesh, Kerala and Goa.
In December 1999, Kanan Devan was relaunched in Kerala in an entirely new pack along with a
fresh advertisement campaign. The company also planned to relaunch Kanan Devan in other
markets. The new pack, with the revamped Tata logo, incorporated modern graphics with bolder
branding whilst retaining the core properties associated with the brand. The back panels on the
pack were also made more interactive and informative.
To meet the demands of the American market, Tata Tea Inc. - a wholly owned subsidiary of Tata
Tea Limited was set up in Florida to package and market instant tea in the US. The tea was
produced in Tata Tea's factory in Munnar and then processed in Florida. The company
also launched Snapple, a ready-to-drink iced tea, in the US. In 2000, it was one of the largest
selling ready-to-drink teas in the US.
In order to tap the Japanese tea and coffee market, Tata Tea entered into a joint venture
with Hitachi of Japan - Tata Hitachi Sales Limited. Tata Tea had been serving as an agent for
Nippon Yusen Kaisha (NYK), one of the largest shipping companies in the world. In the mid
1990s, the
company formed a joint venture, Tata NYK, which aimed at playing a major role in tra
nsport operations and management of seaports, inland container depots, and container freight
stations.
De-Mystifying LBO
The Tata-Tetley deal was rather unusual, in that it had no precedence in India. Traditionally,
Indian market had preferred cash deals, be it the Rs.10.08 billion takeover of Indal by Hindalco
or the Rs. 4.99 billion acquisition of Indiaworld by Satyam.
What set the deal apart was the LBO mechanism which financed the acquisition.
LBO is defined as "acquisition of a company, financed by the borrowing of all the stocks or
assets of a public limited company by a small group of investors. This buying may be sponsored
by buy-out
specialists or investment bankers that arrange such deals and usually includes representati
on by incumbent management".
Typically the buying group forms a shell corporation to act as a legal entity making the
acquisition. In the stock purchase format, the target shareholders simply sell their stock and all
interest in the Target Corporation to the buying group and then the two firms may be merged. In
the asset-purchase format, the Target Corporation sells its assets to the buying group. The
original shareholders own the target
organisation, now merely a pool of cash to make investments with no tangible assets; th
e target
corporation issues a liquidating dividend to its shareholders or becomes an investment co
mpany,
using the pool of cash to make investments, whose proceeds are distributed to the shareh
olders.
Sometimes the management is the prime moving force in this process; then it is called
management buy-out (MBO).
In an LBO, debt financing typically represents 50% of the purchase price. The debt is secured by
the assets of the acquired firm and is usually amortized over a period of less than ten years. As
funds are generated by operations or from sale of assets of the acquired firm, the debt to be paid
off is to be
scheduled. The sale of assets occurs when the investor group is motivated to take contro
l in part because of what it considers unwise or ill-judged acquisitions by the firm in the past.
There may also be limited equity participation on the part of outside investors such as pension
funds and insurance companies, often with the provision that the equity interest will be
repurchased after a pre-determined period to provide a specific yield. Following completion of
the buy-out, the acquired company is usually run as a privately-held corporation rather than a
public corporation, at least for a period of time, after which resale of the firm at a profit is
anticipated.
The LBO seemed to have inherent advantages over cash transactions. In an LBO, the acquiring
company could float a Special Purpose vehicle (SPV) which was a 100% subsidiary of the
acquirer with a minimum equity capital.
The SPV leveraged this equity to gear up significantly higher debt to buyout the target company.
This debt was paid off by the SPV through the target company's own cash flows. The target
company's assets were pledged with the lending institution and once the debt was redeemed, the
acquiring company had the option to merge with the SPV. Thus the liability of the acquiring
company was limited to its equity holding in the SPV. Thus, in an LBO, the takeover was
financed by the target company's future internal accruals. This reduced the burden on the
acquiring company's balance sheet and made the entire takeover a low risk affair.
In the case of Tata Tea, its reserves at the time of the deal were just around Rs 4 billion,
precluding the possibility of making such a gigantic acquisition on its own. Neither could it
afford the debt burden associated with large borrowings. So, it opted for a leveraged buyout.
The deal was so structured, that although Tata tea retained full control over the venture, the debt
portion of the deal did not affect its balance sheet. The liability of acquisition was limited to Tata
Tea's equity contribution to the SPV. Also, the lenders had no recourse at all to Tata Tea in India.
Its dilutive impact on Tata Tea's earnings was also not substantial. One expert described it as "a
classic leveraged buyout of cross-border finance, without recourse to Tata tea, secured solely
upon Tetley's assets and cash flow". Interestingly, in the case of Tata Tea the deal helped satisfy
it, two major requirements of financing, minimum exposure for Tata Tea but at the same time
retaining 100% ownership of the company, a seemingly win-win deal indeed.
in the near future (as an immediate merger is not planned). This would lead to a dilution in
earnings and also a reduction in the return on equity. The shareholders would, thus have to bear
the burden of the investment without any immediate benefits in terms of enhanced revenues and
profits. From the lenders point of view too there seemed to be some drawbacks. Because of the
large amount of
debt relative to the equity in the new corporation, the bonds were typically rated below
the investment grade.
LBO as a concept did not seem to have found wide acceptance in the Indian financial s
ystem.
Given the high rates of interest in the country, such debt did not seem to be forthcomin
g, especially since banks and financial institutions seemed interested in deploying their funds in
high- return investments rather than in an LBO. Also a deal of this sort required the acquiring
company's SPV to be leveraged to a far higher extent than the generally acceptable level of 1:1 to
1:2 debt- equity ratio which Indian banks and financial institutions were comfortable
with. However, inspite
of all the odds, Tata Tea's acquisition of Tetley seemed to have set a new benchmark in
the corporate Indian history of crossborder acquisitions. It seemed to have generated considerable
interest and appreciation of the concept, as a viable alternative in Indian corporate circles
. It remained to be seen how many would follow this new path, nuptials of the leveraged kind.
LIBOR is an abbreviation for "London Interbank Offered Rate," and is the interest rate o
ffered by a specific group of London banks for U.S. dollar deposits of a stated maturity. LIBOR
is the base interest rate paid on deposits between banks in the Eurodollar market (A Eurodollar is
a dollar deposited in a bank in a country where the currency is not the dollar). It exists for
various currencies and for different maturities.