While United Spirits stock can remain pressured in the short term, the Karnataka High Court ruling annulling sale of its shares by its parent company to Diageo does not alter long-term fundamentals, according to experts.
In a setback to the Diageo-United Spirits deal, the Karnataka High Court on Friday annulled the sale of United Spirits shares by its parent firm United Breweries (Holdings) Ltd, in light of existing claims of Kingfisher Airlines’ creditors.
Lenders of Kingfisher Airlines had filed a “winding-up petition” against UB Holdings, the corporate guarantor for many of its liabilities.
The court arrived at that judgment after overturning an earlier order that allowed the original share sale in lieu of a deposit.
Background: Diageo-USL deal
In November 2012, British spirits maker Diageo announced it would purchase 53.4 percent in USL in a deal valued at Rs 11,166 crore.
The stake was to be purchased through a mix of open offer (26 percent), share sale by parent company and subsidiaries (19.3 percent) and a preferential issue of shares (8.1 percent).
However, thanks to a muted response to the open offer, Diageo could only buy 0.04 percent in United Spirits. Consequently, stake sales by UB Holdings (6.98 percent), other subsidiaries of the UB Group (8 percent), a preferential issue (10 percent) and open market purchases (1.35 percent) meant Diageo ended up having about 26.37 percent in USL.
Kingfisher lenders, including BNP Paribas, Rolls-Royce and others, initiated a claim in the Karnataka High Court against the sale of 6.98 percent stake by UB Holdings.
HC order likely to be challenged
As per media reports, UB Holdings is likely to file an appeal in the Supreme Court when it opens in January.
“If the SC grants a stay, the shareholding will not change till it delivers an order,” a Kotak Securities report says. “In case the apex court upholds the HC’s decision, nearly 7 percent equity will go back to UB Holdings and its stake in United Spirits will increase while that of Diageo will fall from 26.4 percent to 19.4 percent.”
Did UB Holdings under-price USL shares?
A point that that was raised during court proceedings was that the sale of United Spirits shares was under-priced by United Breweries and that the sale should have taken place at a price decided by a court-appointed valuator considering UB Holdings was the subject of a winding-up petition.
Under a winding-up petition, a court orders liquidation of a company’s assets and a valuator sells assets to pay for the lenders’ claims.
This means that “there is a likelihood that the stock sale may not happen at the historically-fixed price of Rs 1,440 but possibly at a different price from hereon,” Nikhil Vora, Managing Director of IDFC Securities, says.
What does this mean for Diageo?
The development, however, is unlikely to affect management control of Diageo, Korak says, pointing out that as per their agreement voting control of shares held by the UB Group will be with Diageo till earlier of four years from the date of transaction or in case Diageo assumes majority shareholding in the company.
In fact, even at the time when Diageo had announced the acquisition of the 7 percent stake, it was aware of the litigation risk and had pointed to its existence.
In a press statement it said: “It is possible that, if a winding-up order were to be passed in respect of UBHL, Diageo Bidco could lose title to the shares acquired today from UBHL.”
The worst-case scenario, if the SC upholds the HC's decision, is that Diageo would lose 7 percent stake in United Spirits and cash that Diageo had paid for the stake will be returned. “If UB Holdings is not able to return the cash, Diageo can initiate recovery proceedings against the company,” the Kotak report says.
“Subsequently, Diageo can increase its shareholding either through open market purchases or through another open offer. It could also bid for the UB Holdings' shareholding as and when a liquidator organizes sale of assets of the company.”
View on USL stock
In view of the ongoing litigation and the uncertainty surrounding the deal, United Spirits is likely to remain volatile in the short term, says a report by brokerage firm Morgan Stanley. It, however, added that it remained “overweight” on the stock and that the HC ruling did not change the long-term fundamental view.
Morgan Stanley adds that in view of the developments, there has been a clear premium attached to the stake since Diageo was expected to increase its stake in the firm.
“It’s fair to presume that there is a material downside to the stock in the near term,” says Vora. “Does it alter anything for United Spirits? My view is that that Diageo’s shareholding is not under any risk but going back from 19 percent to 27 percent is now a different ask.”