Tata Tea is seeing renewed optimism armed with new products and newer markets thanks to its recent acquisition. After three global acquisitions Tetley, Good Earth and Jemca this time the company has announced a bigger and novel one - Glaceau Water Company.
This acquisition is Tata Tea's biggest in the US and novel because, unlike the other acquisitions which are of tea companies, this one is of an enhanced water company.
"The acquisition is in line with the global expansion strategy of Tata Tea in the beverage segment," says Percy Siganporia, managing director, Tata Tea.
Late last month, Tata Tea announced the acquisition of a 30 per cent stake in the US based Energy Brands, the parent company for Glaceau a pioneer in the enhanced water business.
The management describes the acquisition as a directional change to capitalise on the convergence trends in the beverage sector. "Consumer demand is shifting from carbonated soft drinks to non-carbonated, functional beverages," says Siganporia.
Glaceau has grown at a CAGR of 200 per cent since its inception in 1996. The company's revenues have grown from $1.6 bn in 2001 to $3.1 bn in 2005. Glaceau today sells around 50 lakh bottles daily and still leads the industry in innovation with natural, low-and-zero calorie beverages.
The enhanced and flavoured water market grew 57 per cent in 2005 to $1.9 bn (Rs 8,740 crore) and is expected to grow at a CAGR of 31.8 per cent to touch $8.6 bn (Rs 39,560 crore) in 2010.
This sounds great for Tata Tea considering the fact that tea, as a segment, is showing muted growth. Another advantage is that, this space has very few players like Glaceau, Gatorade and Hansen. Also, as an analyst points out, Coke's internal resistance to get into this category augurs well for other players.
The acquisition will help Tata Tea to strengthen its foothold in the 'exciting' (as the company describes it) US markets given the strong distribution network Glaceau has. It will set the platform to distribute its teas in US.
The company's distribution network spreads across 40 states in the US where the company is the market leader. It has the third largest distribution network in the US beverages industry, after Coca Cola and PepsiCo. Although currently Tata Tea is looking at growing only in the US markets, it plans to look at other regions in the future.
"The key to widening reach is being able to retain and increase the number of distributors. Glaceau scores on this count as the company has given stakes in the company to its distributors," says an analyst.
Moving ahead, the management wants to synergise the operations of Tata Tea and Tata Coffee in order to grow into a beverage company, which will help it have a single-minded focus.
The acquisition of Glaceau can be seen as a step in this direction. This move will cushion the company against the seasonality in the tea and coffee business.
Glaceau's product range comprises smart water (electrolyte enhanced water) and variants of vitamin water and fruit water. Tata Tea's management finds this the hottest segment in the functional beverage segment.
The $80 bn carbonated soft drinks market in US had been stagnating for a while and in 2005 showed negative growth.
This is where the opportunity lies for Tata Tea armed with Glaceau. The company expects the sales turnover of Glaceau to double to $700 mn over a year from $355 mn achieved by the company in CY05.
Glaceau expects to grow at over 70 per cent CAGR over the next 3-5 years and create an enterprise value of $10 bn (Rs 46,000 crore) compared to the present value of $2.2 bn. If this is true, Tata Tea could see substantial appreciation on its investment.
The bitter side
However, the acquisition is being funded through debt, which will have a negative impact on the bottomline of Tata Tea.
As per a Motilal Oswal report, the debt levels of Tata Tea group are expected to rise from Rs 1,700 crore (Rs 17 billion) in FY06 to over Rs 5,200 crore (Rs 52 billion) by FY07.
Tata Tea GB, a 100 per cent subsidiary of Tata Tea, will borrow $427 million to fund the acquisition.
Also, Tata Tea would infuse $192 mn (Rs 890 crore) as fresh equity in Tata Tea GB. Of this Rs 890 crore (rs 8.9 billion), Rs 420-460 crore (Rs 4.2-4.6 billion) would be raised through a preferential issues of shares with attached warrants to Tata Sons.
In addition, Tata Sons would also pump in $58 million (Rs 267 crore) equity into Tata Tea GB. The company would require around Rs 130-Rs 140 crore (Rs 1.3-1.4 billion) to pay interest on its borrowings.
"We expect the earnings of Tata Tea to take a hit of around 15 per cent on account of debt servicing," says Nikhil Vora, vice president, research, SSKI Securities.
"The acquisition will have a marginal impact on Tata Tea's financials over the next year or two, but will be positive in the medium and long-term," says RK Krishna Kumar, vice-chairman, Tata Tea.
Even though analysts see this move in a positive light, there lies a certain ambiguity. As Glaceau is a private company it is not mandatory for them to disclose their financials.
Thus there is no clarity on what the margins of the company look like. There are some hints though. A comparable company Hansen clocked an average EBITDA (earnings before interest, tax, depreciation and amortisation) margin of 24 per cent over the past couple of years and traded at 18 times EBITDA.
Similarly, Pepsi and Coke which are witnessing stagnation in sales growth are valued at 15 times EBITDA.
Assuming Glaceau also enjoys similar margins, the company should have clocked an EBITDA of approximately $85 million last year. Applying a 15 times multiple, the market-cap of Glaceau should be not more than $1,300 million, significantly less than what it has been valued at.
"Even though valuations look steep at six times its CY05 revenues or three times expected CY06 revenues, the shift from a stagnant tea business to a rapidly growing beverages business and business re-rating will more than compensate," says Vora.
Moreover, since the company has ruled out the possibility of any dividend pay-outs till 2009, Glaceau would not contribute anything to Tata Tea's bottomline. The value in the investment will be unlocked only when the company comes out with an IPO, the time line for which is yet to be decided.
However, analysts are bullish on the tea business itself. They see value coming in from the specialty teas and newer geographies the company is entering.
Tata Tea is in the process of hiving off its north India plantations business to emerge as a pure branded global player. This is expected to provide a further boost to the profitability of the company.
A Motilal Oswal report states that the sector is showing strong volume growth across product categories with improving pricing power for leading players.
"Even, if we set aside the Glaceau acquisition, the fundamental story in Tata Tea remains intact. We are seeing a growth of 7.5 per cent for the next two years which is good considering the kind of business they are in," says an analyst.
However, the market does not seem to think so. The stock price has fallen 8 per cent since the announcement. Even though the stock might not be a star performer in the medium term, it does have value for a patient investor.
The company's sales grew 11.47 per cent y-o-y for the June quarter to Rs 798.92 crore (Rs 7.98 billion) while its profits went down 6.59 per cent to Rs 82.51 crore. At the current market price of Rs 766.30, the stock trades at 14.23 times its FY06 earnings. As per SSKI estimates, it is trading at 12.5 times and 11.2 times its expected FY07 and FY08 earnings.
