This month two of India’s biggest companies will ask their shareholders to buy more shares so as to keep their equity holdings in the firms intact. Both Tata Motors and Hindalco are making rights issues to fund overseas acquisitions, for which they borrowed $3 billion and $2.4 billion, respectively. What a pity they have to sell so many shares — their capital will expand by 33 per cent and 43 per cent, respectively — at a time when these can’t fetch them the best premiums. Besides, shareholders will be in two minds whether or not to pick up their quotas because profits per share for these companies will almost certainly be lower this year with business already dull and so many shares being added. In fact, if the economy doesn’t look up, their per share profits may not grow even next year.
One can’t really fault Indian corporations for wanting to become global players; that is clearly the way forward. Without a global presence Indian companies will find it harder to achieve economies of scale and diversify their risks. Selling better products to new customers in more geographies is what they need to do. And that’s been the rationale behind the innumerable overseas buyouts over the last three to four years. Fortunately, healthy balance sheets and strong cash flows allowed them to buy what they wanted. Also, flush-with-funds banks were willing to lend to them on easy terms. In retrospect, though, that was possibly not such a good thing because, in their eagerness to close out the deal, some acquirers probably ended up paying a little more than they need have.
With the benefit of hindsight, it now appears that Dr. Reddy’s need not have coughed up $570 million for Betapharm because it’s taking the company so much longer to extract the benefits than had been anticipated at the time. Not only have prices of generics in Germany come off because of regulatory changes, Dr. Reddy’s hasn’t been able to shift the manufacturing of Betapharm’s products back to India as quickly as it would have liked. Perhaps future buyers need to make sure they have enough of a cushion built into the price simply because the environment today is changing so rapidly. Suddenly, the cost of debt has risen sharply and there’s not enough of it available. Moreover, to make sure they’re not overloaded with the stuff, companies are being forced to sell their shares cheap. So, the cost of acquiring, say, a Novelis for Hindalco, is not just the price it paid — which itself was not low at nearly $6 billion — but now the cost of funding the purchase at higher interest rates. Novelis may be back in the black with a net profit of $25 million in the June 2008 quarter, but one doesn’t really know when the Canadian firm will create wealth for Hindalco’s shareholders. Or when the Jaguar and Land Rover businesses will start contributing meaningfully to Tata Motors’ bottom line.
Tata Steel has been more fortunate in that it was able to leverage Corus’ cash flows and besides, with steel prices ruling firm, Corus hasn’t done too badly. But a turn in the steel cycle could alter the scenario completely. Back home, Jet Airways overpaid heavily for Sahara — the tab was nearly Rs 2,000 crore — and is still paying for it. As are the company’s small shareholders. By the look of it the $220 million that Tata Coffee paid for Eight O’ Clock Coffee was on the high side; with EOC losing market share and requiring to make investments which will keep its margins under pressure, it could be a while before Tata Coffee actually sees strong cash flows.
This is not to say that companies shouldn’t have gone global or that the timing was wrong. There are many intangible benefits that the acquisitions bring with them and, to be fair, many of those are working well. Also, who could have guessed that oil would hit $145 or that the sub-prime crisis would assume such proportions? It’s just a pity that not too many companies now have the financial muscle to take advantage of the current global downturn when they would surely have found better bargains.
But that is apparently the way it works; companies do behave in counterproductive ways. A recent McKinsey survey of 200 global companies shows that fewer than half the companies in the segments studied made acquisitions in downturns rather than in periods of economic growth. Significantly, more companies divested businesses in downturns rather than in upturns. In other words, companies are more likely to buy high and sell low. The other finding was that of all the potential strategic moves companies can take to grow in a downturn, an aggressive acquisition strategy (defined as growth through M&A at a rate higher than that of 75 per cent of a company’s peers) created the most value for shareholders. Which means ideally, this is the right time for companies to go shopping. Even if it means taking on a little stress, it may be well worth it.