Tata Coffee: Prime time
Business Standard — June 27, 2006

Tata Coffee will be able to gain a significant presence in the US retail market via Eight O'Clock acquisition By buying out the $109 million Eight O'Clock Coffee (EOC) at a very reasonable two times sales, Tata Coffee has found its way into the world's largest coffee market ($21 billion). The biggest plus for Tata Coffee is the distribution reach that EOC has, which can be leveraged for products of Tata Tea too.

Tata Coffee, incidentally, is a 51 per cent subsidiary of Tata Tea. EOC is the third-largest coffee brand by volume in the US and is also the largest-selling whole bean coffee brand with a market share of 54 per cent. Besides, it is a profitable company with good operating margins, in the region of 25 per cent. Thus, not only is Tata Coffee buying into a profitable venture, it is also buying a significant retail presence in the US coffee market.

EOC is 2.5 times the size of Tata Coffee and so this is a big-ticket acquisition to be funded through a mixture of non-recourse debt and equity. The amount of debt that is to be raised is crucial. For the Tata Coffee shareholder, the larger the debt component, of the Rs 1,020 crore to be paid, the smaller the dilution in the equity. In all probability, the management will raise debt on the strength of the EOC balance sheet and repay it through EOC's cash flows.

At the current price of Rs 330, Tata Coffee trades at around 15 times estimated FY07 earnings, while Tata Tea trades at 12 times estimated FY08 earnings. Given the management's aggression and confidence in going ahead with such a big acquisition, which is required, if the business is to be scaled up, Tata Coffee looks set to go places.