Presented By:Sameep Bansal

Topics coveredCase Study – TATA TetleyDefinitionsReal Life ExamplesCharacteristicsMethods of LBOFinancing LBOSources of GainConclusion with help of Case solution.

Case Study - TATA TetleyTata Tea one of the largest company in the world was

sheltered from competition by a protectionist Indian government for most of its history.

In 1999, Tata Tea company faced several new challenges: Upcoming deregulation. Changing consumer tastes. Ban on tea imports scheduled to be lifted in 2001

Majority of the company’s tea is sold in India, with 12% total international sales only.

Possibility of future stiff competition from Nestle, Sara Lee Corporation, and Associated British Foods.

Possible Strategies/Solutions

To enhance its position in the current brand

Acquire a well-known brand

Some disturbing questions???Tata Tea company has to beat the growing global

competition – but how? Any possibilities for further growth in the Indian

stagnant market? If popular brand in India can penetrate into the global

markets? Perhaps it would need to develop a brand of

international demand or taste.Or acquire an other company These questions become more urgent as Tetley Tea,

well-known in the US and UK, unexpectedly comes up for sale. Provide refernce

Pros and Cons of acquiring TetleyPros Acquiring Tetley would mean capturing the

higher end of the value chain Tetley is well-established in international markets Tata’s gross margin is 36%, while Tetley’s is a

more efficient 55% The combination of the two companies would

allow for synergies that competitors couldn’t match

Opportunity to buy a brand the likes of Tetley is rare

Pros and Cons of acquiring Tetley - Cont

Cons Tata had already tried acquiring Tetley five years

prior and failed Tata may have difficulty raising the required £200-

300 million purchase price The £200-300 million asking price is much higher

than the £190 million the company was valued at in 1995

The sheer size of the transaction could prove unwieldy

Wouldn’t investing in building its own global brand be more efficient than buying a foreign brand?

FinallyTATA choose to acquire Tetley.

The major challenge was financingThe value of Tata Tea was $114 million.Tetley was valued at $450 million.

The solution was provided by Leverage Buy outing the Deal.

LBO = DefinitionBuyout: The purchase of a company or a controlling

interest of a company's shares.

Leverage buyout: The acquisition of a company using debt and equity finance. As the word leverage implies, more debt than equity is used to finance the purchase, e.g. 90% debt to 10% equity. Normally, the assets of the company being acquired are put up as collateral to secure the debt. (Beatrice Foods by Esmark, Levis Strauss, etc.)

Going Private: Refers to transformation of a public corporation into a privately held firm.

Example of LBO in Daily life

Mortgaging a Home.

Buying a Car/Taxi, financed by bank.

Other Similar Term

Management buy-out (MBO) - A private equity firm will often provide financing to enable current operating management to acquire at least 50% of the business they manage. In return, the private equity firm usually receives a stake in the business.

CharacteristicsLBOs are a way to take a public company private, or put a

company in the hands of the current management, MBO.

LBOs are financed with large amounts of borrowing (leverage), hence its name. Debt:Equity ratio can go more than 90:10

LBOs use the assets or cash flows of the company to secure debt financing, bonds or bank loans, to purchase the outstanding equity of the company.

After the buyout, control of the company is concentrated in the hands of the LBO firm and management, and there is no public stock outstanding.

How LBO is done?Ref: The McGraw-Hill Guide to Acquiring and Divesting Businesses

Asset PurchaseStock Purchase

The choice is dictated by balancing Legal, Financial, Tax and Accounting advantages and disadvantages.

Asset Purchase

Suitable for Small and Medium sized transactions.

Allows selection or rejection of assets and liabilities.

Leads directly to price allocation and stepped up asset value, that are part of Tax and Accounting aspects of transactions.

Stock Purchase

In Stock purchase , the target shareholders simply sell their stock and all their interest in target corporation to the buying group and then the two firms may be merged.

This method cannot be used if one or more minority share holders refused to sell.

Successful StrategyFinding cheap assets – buying low and selling

high (value arbitrage or multiple expansion)

Targetting firms with low Q-Ratio (Market Value/Asset Value)

Unlocking value through restructuring:Financial restructuring of balance sheet –

improved combination of debt and equityOperational restructuring – improving operations

to increase cash flows

Scanning target CompanyHistory of profitability.

Predictable cash flows to service financing.

Low current debt and high excess cash.

Strong management team - risk tolerant.

Known products, strong market position.

Little danger of technological change (high tech?).

Low-cost producers with modern capital.

Take low risk business, layer on risky financing.

LBO FinancingLBO sponsors have equity funds raised from institutions

like pensions & insurance companies

Balance from commercial banks (bridge loans, term loans, revolvers).

Banks concentrate on collateral of the company, cash flows, level of equity financing from the sponsor, coverage ratios, ability to repay (5-7 yr)

Some have “Mezzanine Funds” as well that can be used for junior subordinated debt and preferred

Occasionally, sponsors bring in other equity investors or another sponsor to minimize their exposure

SPV – Special purpose vehicleIn our case SPV - Tata Tea Great Britain Ltd.,

was created.The cash flow from the Tetley and hence this

SPV, was used to repay the debt.SPV merged with TATA after repayment of

the debt.

Sources of GainsLBO ‘s are done at high premium price.The premium paid is 40% or more than average

stock value of last two months.

What are the sources of these gains?Tax Savings.Management Incentives.Asymmetric Information and under pricing.

Tax SavingsMost of the premium paid is financed by Tax

savings.

New company can operate Tax free for as long as 4-5 years.

In this time period the debt/equity ratio is pulled down from 10 to 1.

Often the LBO is sold after this time horizon or reverse LBO is done.

Management IncentivesControl and hence stakes are with few people.Incentives of Management increases.Dividends are not necessary.Debt payment is effective substitute for dividend

payment.To save company from the Bankruptcy.Restructuring of the acquired firm saves

substantial amount of costs.Changes in marketing strategies.Employee reductionEconomies of Scale.

UnderpricingInvestors have more information on the value of

firm than public shareholders.Investors buy firms that have low Q-Ratio.Net value of the firm may still be higher than

LBO price paid.Such firms are generally resold at much higher

price after the new management brings the firm to its true value by restructuring activities.Example, Kohlberg Kravis Roberts and Thomas H Lee

Company started in 1970’s, seas opportunity in inefficient and undervalued corporate.

Tata – Tetley LBO; Solution First Leveraged Buy-out ( Rs. 2,135 cr)

– Instant access to Tetley’s worldwide

operations, combined turnover at Rs 3,000

crores.

Financial Innovation at its best

SPV created to ring fence risk with equity

contributed by Tata Tea and Tata Tea Inc

– Debt of 235 mn pounds raised in the form

of long term debt and revolver; charge

against Tetley’s brand and assets.

– Tata Tea’s exposure only to the extent of

equity component of 70 mn pounds

March 2000

Tata Tea Limited

Acquisition of 100% equity stake in Tetley Tea (UK)

INR 21,350,000,000

March 2000

Tata Tea Limited

Acquisition of 100% equity stake in Tetley Tea (UK)

INR 21,350,000,000