Diageo won't get much out of its inquiry: Blame is on shoddy due diligence of United Spirits

In M&A literature, due diligence is not a mere fad or buzzword. The person taking over a company–whether through the merger route or the acquisition of controlling interest route–does so only after his auditor or management consultant has done a thorough job of sifting through the accounts and other documents of the target company.

To be sure, sometimes there are issues and problems not reflected in the accounts, simmering as they do outside accounts of the target company. In the event, the one doing the due diligence can be pardoned if his eyes and ears are unable to catch such issues.

But Diageo Plc has every reason to be peeved with the one who did the due diligence of United Spirits in the run-up to the takeover of USL because the issues were adequately flagged in the accounts – only the due diligence analyst had to delve deep into them not gloss over them.

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Diageo has now ordered an inquiry into the loans given by United Spirits to United Breweries and its group. UB is still Vijay Mallya’s baby but USL is not, having been sold off to the unsuspecting Diageo.

Diageo’s rearguard action can only be termed as bolting the doors after the horses have fled. The money involved is not small. The decision to launch an inquiry came after USL posted a net loss of Rs 4,488 crore for 2013-14, mainly due to a provisioning of Rs 1,123 crore for bad loans and a one-time exceptional expense of Rs 3,235 crore on sale of Scottish subsidiary Whyte & Mackay.

Both smack of less than painstaking efforts made by the one who did the due diligence for Diageo before it acquired controlling interest in United Spirits.

In fact, bad loans include Rs 200 crore guaranteed by United Spirits to the grounded Kingfisher Airlines. Banks which took this guarantee must be ruing their decision in retrospect with the guarantor too proving to be built of straws.

Like the clutch of banks nursing a huge NPA of over Rs 7,000 crore owed by Kingfisher, a UB-promoted company and hence a Mallya-promoted company, Diageo too seems to have been taken in by the charms of the flamboyant promoter who now says without batting an eyelid that his vibes with Diageo are as fine as ever.

Some of the bad loans also include amount owed by debtors who have a counterclaim on United Breweries and who say that they will not pay up unless UB pays up. Who says banks alone can be victims of financial contagion?

The Indian company law must share the blame both for Kingfisher and United Spirits malaise–it permits mindless diversion of funds by countenancing a 60% intercorporate loans and investments of a company’s net worth or 100% of its free reserves whichever is greater without seeking anybody’s approval save the unanimous resolution of the board.

And boards, by definition, are old boys’ club with backslapping camaraderie characterizing its actions. They can wink at all deals.

Diageo had gone for merger given the fact that the Indian legal system gives mergers a better protection than it gives to takeovers. Amalgamation or merger has to have the High Court approval whereas takeover needs nobody’s approval save compliance with the public offer mandate of SEBI takeover regulations at a price determined by the regulations.

High Courts in India have often come to the rescue of various stakeholders including the one taking over by mandating additional safeguards. In other words High Courts do a much better due diligence than the so-called experts in the field. The High Court would certainly have found something amiss in the inter-corporate loans and guarantees.

In the event, Diageo might have well bought a pig in a poke–over Rs 3,000 per share of what has now turned out to be a company made of straws. Like the Indian bankers facing a hue write off of Kingfisher loans, Diageo too might not get much out of the inquiry except the heart-tugging reiteration that it was slack in its pre-acquisition scrutiny of the target company.