KKR's play shows Treasury's potency

Treasury Wine Estates' rejection of a takeover offer from private equity group Kohlberg Kravis Roberts should give the market confidence in the struggling company's potential upside.

After weeks of speculation that Treasury Wine has been receiving approaches for its troublesome US wine business, it emerged that it had been engaged in discussions about a potential bid for the entire company from the giant private equity group Kohlberg Kravis Roberts.

It is not a surprise that Treasury, struggling through a difficult mistake-ridden year and with a brand new chief executive, should get an approach from private equity.

Even before it was demerged from Foster’s in 2011, there had been a proposal from another private equity firm, Cerberus Capital. Private equity groups have historically been players in the sector.

Nor is it surprising that Treasury would reject the approach, after discussions with KKR after that group proposed a $4.70 a share, $3 billion scheme of arrangement offer in mid-April.

Until four months ago, when Treasury lowered its guidance for this financial year by $40 million, Treasury shares had traded above the proposed offer price. With new CEO Michael Clarke hitting the ground running and confident that he can improve the group’s performance, Treasury’s directors are backing him to turning around the group’s recent poor performance.

KKR had asked that its approach be kept confidential. However, Treasury disclosed it to the ASX today after it says it learned that KKR and its advisors had spoken to one or more of its shareholders after the market closed yesterday -- a tactic presumably designed to begin generating external pressure on the board.

There has been a lot of speculation around Treasury in recent weeks, with the group forced to deny rumours that it had been approached by Pernod Ricard and Constellation Brands with offers for its troublesome US wine business.

Only last week Treasury denied the Constellation speculation and declared the US business was not for sale. It said that it saw the US market as a key plank of its future growth platform. Until today, however, there’d been no suggestion of a bid for the entire company.

The rejection of its proposal after several weeks of negotiation puts KKR in an awkward position because, unlike some of its private equity peers, it has no history of aggression. It doesn’t make hostile offers.

Without the Treasury board’s support and co-operation there can be no scheme of arrangement, which is private equity’s preferred takeover structure because of the certainty of outcomes it produces: either complete success or complete failure. KKR now knows that the price of that co-operation is materially more than $4.70 a share.

Along with its disclosure of the approach and its rejection today, Treasury unveiled a bit more detail on Clarke’s near term plans for the group. It said that from July 1, it will lift its consumer marketing spend by about 50 per cent relative to this financial year’s spending.

It also plans to reduce its cost base by $35m in 2014-15 to offset the extra spending, with Clarke saying that over the past three years overhead costs had increased at the expense of investment in the group’s brands.

Despite the presence of KKR in the background, Treasury isn’t promising an immediate uplift in the group’s performance, saying trading conditions in Australia remained difficult, with intense competitor activity and a challenging retail environment.

Clarke said that while the business was working hard to deliver the revised guidance given in January (before he was appointed), he wasn’t prepared to engage in short-term practices to the detriment of the group’s long-term objectives.

Clarke has made it clear since he joined Treasury in March that he is confident that there is a lot of upside in the business, particularly within the premium segments that he wants Treasury to focus on. He has a very good track record of improving under-performing businesses.

He’s also well aware (as presumably KKR would be) that a decade-and-a-half of global oversupply in the industry has shifted into a far more balanced supply-demand equation, with demand for premium wines strengthening.

Treasury has the best part of $500m tied up in non-current inventory of mainly premium wine with which to leverage the profitability of that stronger demand.

The fact that KKR, one of the biggest and most sophisticated of the private equity groups, has approached Treasury ought to provide the market with some confidence there is considerable upside within the group if Clarke's strategies can be executed well. Private equity goes after big value up-lifts, not incremental changes to earnings.