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, 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 them to understand the mechanism of LBO. Through the Tata-Tetley deal the case attempts to give students an understanding of the practical application of the concept.
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, 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)2 by any Indian company. This method of financing had never been successfully attempted before by any Indian company. Tetley’s price tag of 271 million 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 minimize 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 value-added tea market in India by launching Kanan Devan tea3 in poly pack.
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 up gradation program at a cost of Rs 1.6 billion.
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. (See Box item to know about the basics of LBOs). 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
Structure of the Deal
The purchase of Tetley was funded by a combination of equity, subscribed by Tata tea, junior loan stock subscribed by institutional investors (including the vendor institutions Mezzanine Finance, arranged by Intermediate Capital Group Plc.) and senior debt facilities arranged and underwritten by Rabobank International.
Tata Tea created a Special Purpose Vehicle (SPV)-christened Tata Tea (Great Britain) to acquire all the properties of Tetley. The SPV was capitalized at 70 million pounds, of which Tata tea contributed 60 million pounds; this included 45 million pounds raised through a GDR issue. The US subsidiary of the company, Tata Tea Inc. had contributed the balance 10 million pounds.
The SPV leveraged the 70 million pounds equity 3.36 times to raise a debt of 235 million pounds, to finance the deal. The entire debt amount of 235 million pounds comprised 4 tranches (A, B, C and D) whose tenure varied from 7 years to 9.5 years, with a coupon rate of around 11% which was 424 basis points above LIBOR.
The Way to Go
Some analysts felt that Tata Tea’s decision to acquire Tetley through a LBO was not all that beneficial for shareholders. They pointed out that though there would be an immediate dilution of equity (after the GDR issue), Tata Tea would not earn revenues on account of this investment 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.