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Is it ever too early to leave a business?
Arati Menon Carroll | June 05, 2007
Late last month, Tata Tea [Get Quote] vice chairman R K Krishna Kumar hurriedly asked for a conference call with the media and analysts. The somewhat chaotic huddle, albeit over the telephone, was called to announce Tata Tea's exit from one of its prized acquisitions - Glaceau.
Just nine months ago, the Tata group had jubilantly announced the mega-bucks acquisition - then the largest in the Indian private sector - when it bought a stake in American beverage maker Glaceau (also called Energy Brands Inc) for $677 million (Rs 3,148 crore in the exchange rate of the time).
The mood this time was slightly different. The Tata group was selling its 30 per cent stake in Glaceau to beverage juggernaut Coca-Cola for $1.2 billion - a 77 per cent acquisition premium. It is Coca-Cola's costliest buy in its 115-year history and also the Tata Group's biggest earnings from a stake sale.
At a time when the rest of India Inc (including the Tatas themselves) are on a buying binge, accounting for the most high profile global acquisitions in recent time - Tata Steel-Corus, Hindalco-Novelis, Suzlon-REpower, to name just a few - Tata Tea, the second largest tea company in the world, was letting go.
Companies are known to exit from unprofitable businesses or knock off parts of their business that do not fit into overall strategy, but in this case, it was an unlikely exit. Glaceau was an important part of Tata Tea's future strategy in developed markets. Plus, it was a high-growth brand. "Rating agencies certainly wouldn't be impressed; Tata Tea's stock rating is back to its pre-Glaceau days," says Nikhil Vora, Partner, SSKI Securities.
What seemed to be a strategy play entry by Tata Tea had turned into a private equity-type divestment.
In fact, a high profile management consultant only half-jokingly suggests, "Taking its cue from this success, the Tatas should think of setting up a venture fund to generate funds for their global ambitions."
But Tata Tea is no private equity fund. Glaceau, a manufacturer of new-age buzzy brands of vitamin-enhanced waters and energy drinks, was little known to the Indian market when the Tatas set their eyes on it last year. The Tatas offered a strong acquisition rationale. Unlike Tetley, the UK tea brand that Tata Tea acquired in 2002, Glaceau was not a market leader. But it had the potential to be one.
Glaceau was a part of the high-growth slice of the American beverage pie - the enhanced and flavoured waters market. This segment, growing in excess of 31 per cent annually, is expected to grow in value to $8.6 billion in 2010.
In comparison, carbonated soft drinks declined by 0.6 per cent in 2006, according to American trade publication Beverage Digest. Glaceau, with its $175-million turnover in 2005 and $355-million in 2006, has been recording triple-digit growth. It is expected to end 2007 with a turnover of around $700 million. In Glaceau, the Tatas saw "a strong US and potentially global brand".
For Tata Tea, black tea consumption was on a decline in its key markets such as the UK and in other developed markets such as the US, owing mainly to an ageing population. The company sensed the urgency to target high growth categories as consumers were graduating to healthier beverages.
Also, it already had a market leader in Tetley in the UK and Canada, but was not yet a force to reckon within the US. So the company believed it could use Glaceau's perceived goodwill to push its own health tea variants such as green tea and others through the American company's distribution channel.
Darius Bikoff, founder-CEO, Glaceau, had said at the time of the Tata deal that his company had an 80 per cent presence in smaller format outlets in 2005-06. Plus, as Coca-Cola points out in its post-acquisition presentation to investors, the brand had made inroads into large chains like Safeway, CVS and Target in the US. In Krishnakumar's words then, Tata Tea was gunning for a "larger share of the stomach".
It all made perfect sense. That is, until Coke guzzled Glaceau at 11.7 times its 2006 revenue. Right at the start of the conference call in May, Krishnakumar declared that Tata Tea did not want to stay on in Glaceau as a minority shareholder. "If we owned a majority stake, our response would have been completely different," he added.
In the current context, the Tatas were fighting a losing battle. But that could have been avoided. In fact, Tata Tea was given the option by Rabo Bank, its merchant bankers for the deal, to invest in a majority stake - 65 per cent by some counts. By the group's own admission, it had the option to increase its stake in Glaceau up to at least 40 per cent.
Analysts reckon, in retrospect, the Tatas were slow to move. And Coca-Cola was swift to seize the opportunity. So was the exit unavoidable? Or could there have been strategic rethinking at play here? The company did not respond to queries sent by the strategist.
But a senior consultant says, "Strategic shifts happen all the time; it might mean that at some point the Tatas concluded differently about potential value extraction. That also indicates a company is more acutely responsive to industry shifts and its own capital structures."
According to him, the exit was less situational and more on account of a re-evaluation of business portfolio. In fact, a week after the Glaceau exit, the Indian markets are abuzz with reports that Tata Tea might take a 42 per cent stake in Himalayan, an upmarket mineral water brand owned by NRI Dadi Balsara. This could not be confirmed at the time of going to press.
In terms of market reality, some of it had changed since the Tatas acquired Glaceau. Glaceau, then a No. 3 in the US enhanced water market, had graduated to the No. 2 spot behind Pepsi's Propel. Also, the beverage alliance between Coca-Cola and Nestle [Get Quote] had been narrowing down to just focusing on ready-to-drink teas, that too outside of the US. That left Coca-Cola in the US to scout for other non-tea opportunities on its own.
Even in the Tata Group's case, Glaceau's acquisition happened before its mega $12-billion Corus buyout. This could have led to the group taking a re-look at its assets. "It's not unusual for exits to be used as a source of finance.
A client recently sold its profit-making packaging business so it could make investments in its core business," says Gaurav Khungar, executive director, KPMG.
Another management consultant agrees, "It is perfectly legitimate to use one group company's equity to pay off another's debt." He points out to the example of conglomerate General Electric. "Even in GE's history there have been several unexpected exits from well performing companies, either for cash, or renewed portfolio," he adds.
Plus, experts point out that there isn't a "right" time to hit the exit button. According to an article, "Learning to let go: Making better exit decisions" in The McKinsey Quarterly, "researchers who studied the entry and exit patterns of businesses across industries found that companies are more likely to exit at the troughs of business cycles - usually the worst time to sell".
In that sense Tata Tea has made an opportunistic exit. Chasing hot new markets and cult brands do not always guarantee long-term returns. Quaker Oats had high hopes for its $1.7 billion acquisition of then new-age brand Snapple in 1994. Quaker then suffered a sales decline and ended up selling the brand short for $300 million in 1997.
"Given average private equity premiums of 25-30 per cent, the 77 per cent jump in less than a year was a windfall," says a consultant. Plus, ultimately for the Tatas the opportunity cost of losing Glaceau was significantly lower than it was for Coke.
Although Coke leads Pepsi in the US CSD (carbonated soft drinks) market at 42.9 versus. 31.2 per cent market share, Pepsi is growing faster across beverage categories. According to Beverage Digest, Pepsi grew at 4.3 per cent in 2006, compared to Coca-Cola's 0.2 per cent in the US. As the CSD segment was declining by 0.6 per cent, PepsiCo's growth came from its bottled water and energy drinks like Propel, Gatorade and Aquafina.
Besides, while Glaceau may have only clocked $355 million revenue in 2006 against Coke's $24.09 billion, Coke's 3.9 per cent volume growth contrasts heavily with Glaceau's more than 100 per cent volume growth.
Coca-Cola's case is as certain as the fact that Tata Tea has issues in the days to come. With the Glaceau exit, Tata Tea might be able to write off its debt from the Tetley acquisition. However, as Krishnakumar said, the company will aggressively pursue acquisition opportunities in the days to come.
As of now, there are several potentials doing the rounds, including the recently spun-off American beverages business of Cadbury Schweppes - a safer long-term bet for distribution strength. Or, as a senior management consultant says, the company could look at acquiring coffee or tea brands, core to their business, in developing markets.
However, valuations in the current time are to understate, inflated. That means any acquisition of a similar size, or even smaller scale, might not be cheap in the short term. Any delay in acquiring a potential target could also lead to a crucial loss in time to market, especially in the intensely competitive US market.
"There's nothing that stops us from exploring a joint partnership with Coca-Cola in the future," says Krishnakumar. But with Nestl� around, that seems unlikely. Also, Himalayan when it happens is unlikely to have as big a presence in the US as Glaceau.
So was the Tata exit from Glaceau well justified? For now, at least the reaction from Indian stock markets seems to suggest so.Additional reporting with Govindkrishna Seshan and Prasad Sangameshwaran