When M&As don't work...

SMARTSHARE

One of the buzzwords in Indian business is "inorganic growth". Another is "consolidation". Both boil down to merger and acquisition (M&A) activity.

Telecom, for example, became M&A driven years ago and that is the global pattern. IT is another industry where takeovers are bread-and-butter. Boutiques with domain-skills abound.

When a major wants those domain-skills, it buys out a boutique. In pharma and biotech too, M&As occurs for similar reasons "" domain-skills, intellectual property and, sometimes, a foot in the door of a new market.

There are three stages to an M&A. Stage one is the targeting of the deal, the negotiations and the structuring. Stage two is the public announcement, followed by market-adjustment of share-price and valuations.

Stage three is the long and often painful marriage of two corporate cultures, along with associated downsizing, cost-cutting, exploitation of synergies and so on.

Using the obvious analogy, there are often marital problems even in relationships where courtship and union have been smooth. Statistically, it's more likely than not that any given merger will end in failure or underperformance.

Put it down to the fact that some corporate cultures are incompatible. In tech-driven industries, the corporate structures and research-driven cultures tend to be better suited to M&As. It's relatively easy for, say, a Hotmail to become an SBU of Microsoft or for Spectramind to plug into Wipro.

But even in tech, there can be problems. Do you remember the Compaq-HP hoo-hah? It was even worse when AOL and Time-Warner plighted their troth because the old media/new media blokes couldn't get along.

But tech-industry mergers by and large work. It seems far more difficult for old-economy businesses to make a go of mergers. Look at the Hindustan Lever track record. Nobody could question HLL's competence or commitment.

HLL has had M&As ranging from the Lakme, Tomco and Calcutta Chemicals takeovers, to the merging of group companies such as Brooke Bond and Lipton. I doubt that the results would be considered consistently up to expectations.

The risks multiply with cross-border mergers. The cultural differences are even more likely to be deal-breakers or post-deal dampeners. On the other hand, this is the cheapest route to a new market.

Tata Tea is clearly going that way. "Tea" has already built/acquired a formidable global brand and reputation. Tetley's a success. There's no apparent reason why the recently-announced stake in Energy Brands Inc (EBI) wouldn't work. It's a foot in the door in terms of entering a new business ( enhanced water) and it enhances distribution across the US. TT can sell the EBI brands in other markets.

The investment analysts seem positive. My reservations are on the grounds that mergers so often don't work. Whenever a merger has involved two listed Indian entities, my advice has been knee-jerk """Buy the target, sell the acquirer."

That isn't applicable here. You would anyhow have lost money selling "Tea" post-Tetley. Let's assume corporate cultures will mesh comfortably.

EBI has a fast-growing business with good projections. Fine! How much will reflect on TT's balance-sheet, given Tata Sons is splitting the cost? Why the minority stake? Is EBI worth a valuation of 3X FY06 turnover?

Is it worth $400 million-odd in debt? How much of an initial hit will TT take in EPS? (Some analysts say up to 15 per cent). The traders will have a field day as the analysts put wet towels to their heads and try to work out the answers.