In the summer of 2000, the Indian corporate fraternity was witness to a pathbreaking

achievement, never heard of or seen before in the history of corporate India.

In a landmark deal, heralding a new chapter in the

Indian corporate history, Tata Tea acquired the
UK heavyweight brand Tetley1 for a staggering
271 million pounds. This deal which happened to
be the largest cross-border acquisition by any
Indian company, marked the culmination of Tata
Tea's strategy of pushing for aggressive growth
and worldwide expansion.

The acquisition of Tetley pitchforked Tata Tea

into a position where it could rub shoulders with
global behemoths like Unilever and Lawrie. The
acquisition of Tetley made Tata Tea the second
biggest tea company in the world. (The first being
Unilever, owner of BrookeBond and Lipton).

Moreover it also went through a metamorphosis from a plantation company to an international

consumer products company.

Tata Tea was incorporated in 1962 as Tata Finlay Limited, and commenced business in 1963.
The company, in collaboration with Tata Finlay & Company, Glasgow, UK, initially set up an
instant tea factory at Munnar (Kerala) and a blending/packaging unit in Bangalore.

In 1984, the company set up a research and development center at Munnar, Kerala. In 1986, it
launched Tata Tea Dust in Maharashtra. In 1988, the Tata Tea Leaf was launched in Madhya
Pradesh.

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...

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.

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...

LBOs in India

LBOs completed in India are different from those in the U.S. and other developed countries which are
normally carried out by specialized investment funds. Here, they were carried out by business groups or
companies to acquire foreign companies with the help of newfound sources for providing large amount
of credit as a result of the liberalization of the Indian economy. Moreover, the target companies were
usually many times bigger than the Indian acquirers.  

The first global LBO in India was the acquisition of Tata Tea's acquisition of UK-based tea company Tetley
in March 2000. After that two other companies under Tata Group made similar transactions. They were
the acquisition of Corus Group by Tata steel and Jaguar by Tata motors.

Many other Indian companies have carried out LBO transactions after 2000. Birla Group company
Hindalco Industries' acquisition of Canada-based aluminum producer Novelis, Chennai-based oilfield
equipment producer Aban Offshore's acquisition of 33.76% stake in Norwegian oil rig producer Sinvest,
Vijay Mallya's UB Group's acquisition of Glasgow-based whiskey maker Whyte & Mackay, Dr.Reddy Lab's
acquisition of German generic drug maker Betapharm, Wind power major Suzlon's acquisition of
Germany-based RePower Systems are examples.

Pros and cons of LBOs

Even though hundreds of LBOs were completed in the 1980's and in the later period, studies show that
only a small faction of them created compelling shareholder value. Most of them gave the huge profits
to investing firms that orchestrated these transactions and exited later. But they destroyed many good
companies due to the over-leverage created by the LBO transactions.

Even in India, most of our celebrated overseas buyouts through LBO method are in trouble because of
the huge liabilities on the acquirer. These transactions, which were actually intended to increase
shareholder value, eventually ended up in depressing stock prices due to the huge debt pile. So the fact
is that those acquirers which use prudent use of debt funds in LBO transaction will only create real
shareholder value.