Tata Tea's latest acquisition promises fantastic growth over themedium-term but for now it will only hurt the bottomline.Tata Tea is seeing renewed optimism armed with new products and newermarkets thanks to its recent acquisition. After three globalacquisitions - Tetley, Good Earth and Jemca - this time the companyhas 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 isof an enhanced water company."The acquisition is in line with the global expansion strategy ofTata Tea in the beverage segment," says Percy Siganporia, managingdirector, Tata Tea.Late last month, Tata Tea announced the acquisition of a 30 per centstake 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 tocapitalise on the convergence trends in the beverage sector."Consumer demand is shifting from carbonated soft drinks tonon-carbonated, functional beverages," says Siganporia.Glaceau has grown at a CAGR of 200 per cent since its inception in1996. The company's revenues have grown from $1.6 bn in 2001 to $3.1bn in 2005. Glaceau today sells around 50 lakh bottles daily and stillleads the industry in innovation with natural, low-and-zero caloriebeverages.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 percent to touch $8.6 bn (Rs 39,560 crore) in 2010.This sounds great for Tata Tea considering the fact that tea, as asegment, is showing muted growth. Another advantage is that, this spacehas very few players like Glaceau, Gatorade and Hansen. Also, as ananalyst points out, Coke's internal resistance to get into thiscategory 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 thestrong distribution network Glaceau has. It will set the platform todistribute its teas in US.The company's distribution network spreads across 40 states in the USwhere the company is the market leader. It has the third largestdistribution network in the US beverages industry, after Coca Cola andPepsiCo. Although currently Tata Tea is looking at growing only in theUS markets, it plans to look at other regions in the future."The key to widening reach is being able to retain and increase thenumber of distributors. Glaceau scores on this count as the company hasgiven stakes in the company to its distributors," says an analyst.Moving ahead, the management wants to synergise the operations of TataTea and Tata Coffee in order to grow into a beverage company, whichwill help it have a single-minded focus. The acquisition of Glaceau canbe seen as a step in this direction. This move will cushion the companyagainst the seasonality in the tea and coffee business.Glaceau's product range comprises smart water (electrolyte enhancedwater) and variants of vitamin water and fruit water. Tata Tea'smanagement finds this the hottest segment in the functional beveragesegment. The $80 bn carbonated soft drinks market in US had beenstagnating for a while and in 2005 showed negative growth.This is where the opportunity lies for Tata Tea armed with Glaceau. Thecompany expects the sales turnover of Glaceau to double to $700 mn overa year from $355 mn achieved by the company in CY05.Glaceau expects to grow at over 70 per cent CAGR over the next 3-5years 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 Teacould see substantial appreciation on its investment.COST OF THE DEAL: $677 MNUpside:*Diversification to a segment set to grow at 31.8 per cent CAGR totouch $8.6 bn by 2010*30 per cent stake in Glaceau that is set to grow at over 70 per centCAGR over 3-5 years.*Access to a strong distribution in US panning 40 statesFlipside:*Increased debt burden*Margins to be hit by around 15 per cent*No contribution to bottomline till 2009The bitter sideHowever, the acquisition is being funded through debt, which will havea negative impact on the bottomline of Tata Tea.As per a Motilal Oswal report, the debt levels of Tata Tea group areexpected to rise from Rs 1,700 crore in FY06 to over Rs 5,200 crore byFY07. 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 inTata Tea GB. Of this Rs 890 crore, Rs 420-Rs 460 crore would be raisedthrough a preferential issues of shares with attached warrants to TataSons.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 140crore to pay interest on its borrowings."We expect the earnings of Tata Tea to take a hit of around 15 percent on account of debt servicing," says Nikhil Vora, vice president- research, SSKI Securities."The acquisition will have a marginal impact on Tata Tea'sfinancials over the next year or two, but will be positive in themedium and long-term," says RK Krishna Kumar, vice-chairman, TataTea.Even though analysts see this move in a positive light, there lies acertain ambiguity. As Glaceau is a private company it is not mandatoryfor 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 anaverage EBITDA (earnings before interest, tax, depreciation andamortisation) margin of 24 per cent over the past couple of years andtraded at 18 times EBITDA.Similarly, Pepsi and Coke which are witnessing stagnation in salesgrowth are valued at 15 times EBITDA.Assuming Glaceau also enjoys similar margins, the company should haveclocked an EBITDA of approximately $85 million last year. Applying a 15times 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 orthree times expected CY06 revenues, the shift from a stagnant teabusiness to a rapidly growing beverages business and business re-ratingwill more than compensate," says Vora.Moreover, since the company has ruled out the possibility of anydividend pay-outs till 2009, Glaceau would not contribute anything toTata Tea's bottomline. The value in the investment will be unlockedonly when the company comes out with an IPO, the time line for which isyet to be decided.However, analysts are bullish on the tea business itself. They seevalue coming in from the specialty teas and newer geographies thecompany is entering.Tata Tea is in the process of hiving off its north India plantationsbusiness to emerge as a pure branded global player. This is expected toprovide a further boost to the profitability of the company.A Motilal Oswal report states that the sector is showing strong volumegrowth across product categories with improving pricing power forleading players."Even, if we set aside the Glaceau acquisition, the fundamental storyin Tata Tea remains intact. We are seeing a growth of 7.5 per cent forthe next two years which is good considering the kind of business theyare in," says an analyst.However, the market does not seem to think so. The stock price hasfallen 8 per cent since the announcement. Even though the stock mightnot be a star performer in the medium term, it does have value for apatient investor.The company's sales grew 11.47 per cent y-o-y for the June quarter toRs 798.92 crore while its profits went down 6.59 per cent to Rs 82.51crore.At the current market price of Rs 766.30, the stock trades at 14.23times its FY06 earnings. As per SSKI estimates, it is trading at 12.5times and 11.2 times its expected FY07 and FY08 earnings.
No comments:
Post a Comment