Case Study LBO

Tata Tea and Tetley

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 taeover of glo!al tea
"a#or Tetley$ This deal which was the !iggest ever cross%!order acquisition,
was also the first%ever successful leveraged !uy%out !y any &ndian co"pany$
"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 postac!uisition cash flows to
immediately "ustify the business and financial model."
% Rana a!oor, "#, Ra$o %ndia &inance Ltd.,
%ntroduction
&n the su""er of '(((, the &ndian corporate fraternity was witness to a
path!reaing achieve"ent, never heard of or seen !efore in the history of
corporate &ndia$
&n a land"ar deal, heralding a new chapter in the &ndian corporate history,
Tata Tea acquired the )* heavyweight !rand Tetley for a staggering '+,
"illion pounds$ This deal which happened to !e the largest cross%!order
acquisition !y any &ndian co"pany, "ared the cul"ination of Tata Tea's
strategy of pushing for aggressive growth and worldwide e-pansion$
The acquisition of Tetley pitch fored Tata Tea into a position where it could
ru! shoulders with glo!al !ehe"oths lie )nilever and Lawrie$ The
acquisition of Tetley "ade Tata Tea the second !iggest tea co"pany in the
world$ (The first !eing )nilever, owner of BrooeBond and Lipton)$
.oreover it also went through a "eta"orphosis fro" a plantation co"pany
to an international consu"er products co"pany$
/atan Tata, 0hair"an, Tata group said, 1&t is a great signal for glo!al
industry !y &ndian &ndustry$ &t is a "o"entous occasion as an &ndian
co"pany has !een a!le to acquire a !rand and an overseas co"pany$1 A!art
'rom the si(e o' the deal, )hat made it !articularly s!ecial )as the 'act
that it )as the 'irst ever levera*ed $uy-out +LBO, $y any %ndian
com!any. This "ethod of financing had never !een successfully atte"pted
!efore !y any &ndian co"pany$ Tetley-s !rice ta* o' ./0 mn !ounds +1S
2345 m, )as more than 'our times the net )orth o' Tata tea )hich stood
at 1S 2 003 m. This David & 2oliath aspect was what "ade the entire
transaction so unusual$ 3hat "ade it possi!le was the financing "echanis"
of LBO$ This "echanis" allowed the acquirer (Tata Tea) to "ini"i4e its
cash outlay in "aing the purchase$
The Tale o' Tata Tea
Tata Tea was incorporated in ,56' as Tata 7inlay Li"ited, and co""enced
!usiness in ,568$ The co"pany, in colla!oration with Tata 7inlay &
0o"pany, 2lasgow, )*, initially set up an instant tea factory at .unnar
(*erala) and a !lending9pacaging unit in Bangalore$
Over the years, the co"pany e-panded its operations and also acquired tea
plantations$ &n ,5+6, the co"pany acquired :terling Tea co"panies fro"
;a"es 7inlay & 0o"pany for /s ,,< "illion, using /s ,5$= "illion of
equity and /s$ 5<$' "illion of unsecured loans at <> per annu" interest$ &n
,5=', Tata &ndustries Li"ited !ought out the entire stae of ;a"es 7inlay &
0o"pany in the #oint venture, Tata 7inlay Ltd$ &n ,5=8, the co"pany was
rena"ed Tata Tea Li"ited$ &n the "id ,5=(s, to offset the erratic fluctuations
in co""odity prices, Tata Tea felt it necessary to enter the !randed tea
"aret$ &n .ay ,5=?, the co"pany revolutioni4ed the value%added tea
"aret in &ndia !y launching #anan $evan tea
8
in polypac$
&n ,5=?, the co"pany set up a research and develop"ent center at .unnar,
*erala$ &n ,5=6, it launched Tata Tea $ust in .aharashtra$ &n ,5==, the Tata
Tea %eaf was launched in .adhya @radesh$
&n ,5=5, Tata Tea !ought a <'> stae in *arnataa%!ased 0onsolidated
0offee Li"ited%the largest coffee plantation in Asia, in order to e-pand its
coffee !usiness$ &n ,55,, Tata Tea for"ed a #oint venture with Tetley
&nternational, )*, to "aret its !randed tea a!road$ &n ,55', Tata Tea too a
5$<> stae in Asian 0offee%the Bydera!ad !ased ,((> e-port oriented unit
nown for its instant coffee, through an open offer$ This offer was the first of
its ind in &ndian corporate history$ Later, in ,55?, Tata Tea increased its
stae in Asian 0offee to 6?$<> through another open offer$ This helped it to
consolidate its position in the coffee industry$ &n ,55<, Tata Tea unveiled a
"assive physical upgradation progra" at a cost of /s ,$6 !illion$$$
#e-"ysti'yin* LBO
The Tata%Tetley deal was rather unusual, in that it had no precedence in
&ndia$ Traditionally, &ndian "aret had preferred cash deals, !e it the
/s$,($(= !illion taeover of &ndal !y Bindalco or the /s$ ?$55 !illion
acquisition of &ndiaworld !y :atya"$
3hat set the deal apart was the LBO "echanis" which financed the
acquisition$ The LBO see"ed to have inherent advantages over cash
transactions$ &n an LBO, the acquiring co"pany could float a :pecial
@urpose vehicle (:@C) which was a ,((> su!sidiary of the acquirer with a
"ini"u" equity capital$
The :@C leveraged this equity to gear up significantly higher de!t to !uyout
the target co"pany$ This de!t was paid off !y the :@C through the target
co"pany's own cash flows$ The target co"pany's assets were pledged with
the lending institution and once the de!t was redee"ed, the acquiring
co"pany had the option to "erge with the :@C$$$
Structure o' the #eal
The purchase of Tetley was funded !y a co"!ination of equity, su!scri!ed
!y Tata tea, #unior loan stoc su!scri!ed !y institutional investors (including
the vendor institutions .e44anine 7inance, arranged !y &nter"ediate 0apital
2roup @lc$) and senior de!t facilities arranged and underwritten !y
/a!o!an &nternational$
Tata Tea created a :pecial @urpose Cehicle (:@C)%christened Tata Tea (2reat
Britain) to acquire all the properties of Tetley$ The :@C was capitalised at +(
"n pounds, of which Tata tea contri!uted 6( "n poundsD this included ?<
"n pounds raised through a 2D/ issue$ The ): su!sidiary of the co"pany,
Tata Tea &nc$ had contri!uted the !alance ,( "n pounds$
The :@C leveraged the +( "n pounds equity 8$86 ti"es to raise a de!t of
'8< "n pounds, to finance the deal (/efer 7&2)/E &)$ The entire de!t
a"ount of '8< "n pounds co"prised ? tranches (A, B, 0 and D) whose
tenure varied fro" + years to 5$< years, with a coupon rate of around ,,>
which was ?'? !asis points a!ove L&BO/$$$
The 6ay to 7o8
:o"e analysts felt that Tata Tea's decision to acquire Tetley through a LBO
was not all that !eneficial for shareholders$ They pointed out that though
there would !e an i""ediate dilution of equity (after the 2D/ issue), Tata
Tea would not earn revenues on account of this invest"ent in the near future
(as an i""ediate "erger is not planned)$ This would lead to a dilution in
earnings and also a reduction in the return on equity$ The shareholders
would, thus have to !ear the !urden of the invest"ent without any
i""ediate !enefits in ter"s of enhanced revenues and profits$ 7ro" the
lenders point of view too there see"ed to !e so"e draw!acs$$$
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