Finance Case Study - The Leveraged Buy Out Deal of Tata & Tetley|Finance|Case Study|Case Studies

The Leveraged Buy Out Deal of Tata & Tetley

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Case Details:

Case Code : FINC001
Case Length : 7 Pages
Period : 2000
Pub. Date : 2001
Teaching Note : Available
Organization : Tata Tea Tetley
Industry : Food, Beverages & Tobacco
Countries : India

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This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.

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De-Mystifying LBO

The Tata-Tetley deal was rather unusual, in that it had no precedence in India. Traditionally, Indian market had preferred cash deals, be it the Rs.10.08 billion takeover of Indal by Hindalco or the Rs. 4.99 billion acquisition of Indiaworld by Satyam.

What set the deal apart was the LBO mechanism which financed the acquisition. (See Box item to know about the basics of LBOs). The LBO seemed to have inherent advantages over cash transactions. In an LBO, the acquiring company could float a Special Purpose vehicle (SPV) which was a 100% subsidiary of the acquirer with a minimum equity capital.

The SPV leveraged this equity to gear up significantly higher debt to buyout the target company. This debt was paid off by the SPV through the target company's own cash flows. The target company's assets were pledged with the lending institution and once the debt was redeemed, the acquiring company had the option to merge with the SPV...

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Structure of the Deal

The purchase of Tetley was funded by a combination of equity, subscribed by Tata tea, junior loan stock subscribed by institutional investors (including the vendor institutions Mezzanine Finance, arranged by Intermediate Capital Group Plc.) and senior debt facilities arranged and underwritten by Rabobank International.

Tata Tea created a Special Purpose Vehicle (SPV)-christened Tata Tea (Great Britain) to acquire all the properties of Tetley. The SPV was capitalised at 70 mn pounds, of which Tata tea contributed 60 mn pounds; this included 45 mn pounds raised through a GDR issue. The US subsidiary of the company, Tata Tea Inc. had contributed the balance 10 mn pounds.

The SPV leveraged the 70 mn pounds equity 3.36 times to raise a debt of 235 mn pounds, to finance the deal (Refer FIGURE I). The entire debt amount of 235 mn pounds comprised 4 tranches (A, B, C and D) whose tenure varied from 7 years to 9.5 years, with a coupon rate of around 11% which was 424 basis points above LIBOR...

The Way to Go?

Some analysts felt that Tata Tea's decision to acquire Tetley through a LBO was not all that beneficial for shareholders. They pointed out that though there would be an immediate dilution of equity (after the GDR issue), Tata Tea would not earn revenues on account of this investment in the near future (as an immediate merger is not planned). This would lead to a dilution in earnings and also a reduction in the return on equity. The shareholders would, thus have to bear the burden of the investment without any immediate benefits in terms of enhanced revenues and profits. From the lenders point of view too there seemed to be some drawbacks...

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