On The BATwagon

ITC has been frustrating BAT'S attempt to launch its international brands like 555, Benson & Hedges, Kent and Lucky Strike in India. Now BAT has opted for the Hyderabad-based VST to launch its global brands in the country. And the gameplan is interesting, to say the least. VST is floating a rights issue through the instrument of zero coupon fully-convertible debentures of Rs 135 each in the ratio of 36 debentures for every 100 equity shares to mop up around Rs 75 crore.

While the current market price for the VST scrip is hovering around Rs 85, the deliberate high pricing could discourage shareholders from picking up the shares. BAT has already applied to the government for permission to pick up the unsubscribed portion of the proposed issue. What BAT is apparently hoping for is that by picking up all the rights offers that are renounced by shareholders because of the high price, it will be able to raise its stake in VST from the present 32 per cent to 51 per cent. And launch its international brands through a company it has control over. Malcolm Fry, VST's chief executive, is already in London, supposedly working out the financial details to bring in resources to enhance the holdings.

BAT has a 34 per cent stake in ITC but successive CEOs of the Calcutta-based company have been determined to stay independent of the British giant's diktats, leading to repeated confrontations over the last few years. "To promote its brands, BAT Will force us to kill our own premium brands like India Kings and Classic," says a senior ITC official. Though BAT spokesperson Michael Prideaux has declared that the launching of the international brands in India will be in consultation with ITC, BAT seems to have decided that VST is a safer vehicle.

So in September last year, BAT Shifted Fry out of the ITC board to VST. But if Fry's agenda was to establish full BAT control over the company, the October raids and the subsequent arrest of various top bosses of ITC for FERA violations delayed the process.

According to industry sources, BAT plans to attack ITC on two counts: raise its stake in VST and launch the global brands, and increase its governing clout in ITC by asking various friendly FIIS to pick up ITC shares from the market. The latter tactic could perhaps explain the present zooming of ITC share prices.

True, the company has produced excellent results this year but this does not warrant such a boom, say analysts. Many of them feel this is a reflection of FIIS purchases on behalf of BAT. In the last few months BAT has increased its ITC holdings marginally, while the FIIS and the foreign banks have raised their stake to about 10 per cent. This raises ITC's foreign holdings to about 44 per cent.

If the FIIS are picking up these shares on behalf of BAT, then the Indian FI's with 34 per cent equity have been left far behind. So the public holding of 24 per cent will play a crucial role in any proxy war between BAT and ITC. It is even being rumoured that BAT is poised to make an open offer to shareholders to pick up their stakes. But if this is true, BAT Will still have to reckon with formidable ITC chairman Y.C. Deveshwar. He is a more adroit adversary than his predecessor, K. L. Chugh and has so far managed to repulse all BAT efforts to discredit him, say ITC insiders. What is more, he has restored much of ITC's battered image by combining good results with excellent public relations. He has the ears of the top echelons of the government, and has made it clear in his closed door meetings with selected journalists that the partnership between ITC and BAT must be that of equals and ITC's interests must be protected at all cost.

The main reason for BAT's keenness to control ITC could be the imminent invasion by BAT's worldwide rivals for the burgeoning Indian cigarette market. Before introducing its top brands, BAT wants to have a much greater say in ITC. It has decided to initially introduce its top drawer brands, 555 and Benson & Hedges, followed by Lucky Strike and Kent. It has been beaming awareness ads for the first two brands for some time. Breathing down BAT'S neck is its archrival Philip Morris, which owns Marlboro, the world's biggest tobacco brand. Along with Marlboro, Philip Morris apparently intends to launch other global brands like Virginia Slims, L&M and Basic. The third player will be another US tobacco major, RJR Nabisco with Camel, Winston and Salem. All these brands are expected to hit the stalls by early next year.

But they face a problem. Currently foreign cigarette multinationals are not allowed to set up fully owned subsidiaries and their only option is to form joint ventures with Indian partners with a stake not exceeding 50 per cent of the total equity. This should have been an advantage for BAT as ITC dominates the Indian cigarette market and controls 8O per cent of the filter king sales with its three brands: India King, Classic and Gold Flake. But this strength of ITC has become a stumbling block in the BAT-ITC partnership.

BAT has a number of options. It can produce its brands under licence with ITC. But it is reluctant to take this route without management control. The second option is to form a joint venture with ITC to produce, distribute and market its brands. While BAT is not averse to this proposal, ITC won't touch it. The ITC top brass feel that sooner or later BAT, With its much stronger financial muscle, will call the shots and, after establishing its brands supported by the ITC network, compete with the ITC brands. ITC also wants to ensure that even if these brands are produced under licence with ITC, BAT cannot subsequently with draw them by setting up a separate company. In short, it's a simple question of trust, and that seems to be in short supply right now between BAT and ITC. Both BAT and ITC, however, realise that they have to close ranks to take on the invaders.

BAT seems to have opted for the VST route. But VST does not come anywhere near the distribution strength or production facilities of ITC. If BAT takes this option, ITC's brands will come in direct competition with BAT's. A top ITC executive was not particularly worried by this threat. He felt ITC brands enjoyed sufficient brand equity to hold their own. Another industry source pointed out that kingsize filters alone will not sustain foreign majors. Like scotch bottlers, to make their Indian operation viable they will have to go downmarket and produce brands for other segments also. ITC is aware of this but feels its citadel is well protected by the phalanx of Gold Flake, Scissors, Bristol, Berkley, Wills and Capstan.

Meanwhile, BAT is gearing up on all fronts to acquire majority stakes in VST. The lead managers to the issue have been advised to look into three avenues: (a) to pick up the rights through the usual renunciation route; (b) to exercise the provisions of Section 80 (D) of the Indian Companies Act to allot the unsubscribed shares to whoever the management feels will help the prospects of the company; and (c) to deliberately price the conversion price high so that there is less demand for the debentures. Each debenture will be converted at the end of 12 months from the date of allotment at a price discounted 20 per cent to the three-month average of the daily closing price of the equity shares at the BSE, with the maximum limit being Rs 135 for a Rs 10 share. From all appearances, BAT is hell-bent on taking control over VST, and as things stand, there are high chances of success.

While Deveshwar appears to have the support of the government, he has apparently not as yet received an unequivocal assurance to protect ITC from a foreign multinational. The Finance Ministry is also worried about sending wrong signals to foreign investors by stopping a foreign company from acquiring management control through legitimate ways. But industry watchers feel that the ITC drama could be nearing its final act.