Glenboden M & A Originations

Carlsberg & Heineken must raise bid for Scottish & Newcastle to avoid endless arbitration over Baltika

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Origination Status S&N initiates legal action against Carlsberg over BBH joint venture, October 2007
Asset Scottish & Newcastle plc (UK), global no. 7 beer producer
Buyer Carlsberg A/S (Denmark), global no. 5 beer producer, together with Heineken NV (Holland), global no.4 beer producer
Seller shareholders of Scottish & Newcastle plc
Financial Terms initial bid price of 7,6 bln GBP for 100% of shares, represents enterprise value P/S of 2,3 and P /EBITDA of 13,6 (2006A)
Buyer Rationale Carlsberg to gain market leadership in Russia and France, Heineken in UK
Seller Rationale management holding out for higher valuation to recommend to shareholders
NBs legal disputes over the 50:50 Baltika JV could potentially torpedo the deal
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Carlsberg’s bid for S&N is every bit as hostile and acrimonious as predicted. S&N’s management quickly rejected it, and has initiated legal proceedings against Carlsberg, over the ‘jewel in the crown’ that is their Baltika JV in Russia, in an attempt to wrest full control of Baltika. Such arbitration proceedings are notoriously lengthy and costly; this means that if the two sides don’t come to a valuation agreement ‘out of court’, then the whole deal will drag on for years.

Carlsberg was no doubt hoping that it would be cheaper (pro rata), and even simpler given how JV agreements are often drafted, for Carlsberg and Heineken to buy the whole of S&N plc, than for the former to just buy out S&N’s 50% of the Baltika JV. That’s because, with a staggering 35% growth rate and 30% EBITDA margin in H1 2007, and the no.1 market position in Russia with 37% share, Baltika might well command a valuation of even 50% of that of S&N as a whole, especially given recent precedents in Russian M&A and the very high multiples involved.

Obviously S&N’s management are fully aware of this ‘discrepancy’, and are doing whatever they can to prevent their shareholders from selling below ‘fair value’, to avoid a major embarrassment. So, they’re using whichever legal levers they can find in the Baltika JV agreement. There are likely to be a number of these, because JV agreements typically contain provisions, governing everything from conflict of interest to sale of shares to third parties, which taken together enable only one outcome - that one partner has to buy out the other at fair value.

Predictably therefore, S&N’s claim is that certain of Carlsberg’s actions trigger the requirement for them to sell their 50% stake in Baltika to S&N. That would enable S&N to exhibit a significantly higher break-up value than currently calculated by analysts and valuers, especially if the relevant clauses in the JV agreement contain a buy-out formula that didn’t envisage the gold rush that is now Russia in general and Baltika in particular; that would allow the ‘fair value’ of 50% of Baltika, paid by S&N to Carlsberg, to be significantly below its negotiated market value (to cut a long story short).

We believe that, if the parties decide to go the route of litigation or arbitration, then this would be very unwise because JV arbitrations are notoriously lengthy and costly. First the arbiters must be selected; then submissions made by both parties, with ample time intervals between them. Then cross –examinations of so-called witnesses, meaning the waste of a lot of senior management time and nerves. Official experts might have to be appointed also, if it goes that far, by both sides, to make determinations of damages and valuations. All of this allowing teams of lawyers to spend months debating issues like causality, the applicability of benchmarks, the definition of fair value.

Obviously the consolidation story implicit in this deal is very compelling, with its 180 mln GBP in annual cost synergies. But in our view the value of the Baltika JV in the equation is so high, probably way beyond the expectations of the two parties when they formed it, that the fight to be ‘the partner who buys out the other one’ could torpedo the whole takeover story. The only reliable way to avoid this is for Carlsberg and Heineken to raise their overall bid for S&N, and thus ‘cut the Gordian knot’ of legal wrangles over Baltika. That’s because, at the end of the day, its very hard for any legal system to enforce a final, conclusive and comprehensive settlement on warring parties to a JV.

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