 "It is difficult to manage a business based on intangible assets: Prof. Leonardo Luca Etro")
When Tata Motors acquired Jaguar Land Rover (JLR) for $2.3 billion in 2008, many were sceptical about the success given the downturn in the market. Fear proved to be real as Tata Motors posted a consolidated net loss of Rs 2,500 crore in the fiscal year ending March 2009 (its first annual loss in at least seven years). However, two years later, JLR had turned around spectacularly, accounting for more than half of Tata Motors’ business. The company posted a 100-fold increase in profit in the three months ending September, 2010, with the UK subsidiary beginning to generate profit.
This is an example where a company from an emerging economy (Tata Motors, India) acquired a high-end manufacturing brand from a developed economy (JLR, the UK) and generated value not just for the acquirer but also for the target company. This is a rare exception, opines Prof. Leonardo Luca Etro, Professor of Accounting, Control, Corporate and Real Estate Finance, SDA Bocconi, Italy. He explains that it is not easy to come across instances of value creation for the target company when acquired by a firm based from emerging economies.
According to Prof. Etro, who has been tracking cross boarder M&A transactions for quite a period of time, firms from developing countries find it difficult to run organisations which are based on intangible assets (in other words high-end branded products). He cites an example of Guru Fashion brand from Italy which lost its premium brand image post acquisition by an Indian organisation.He believes that while firms from developing economies perform well in capital-intensive industries, they fail to do justice for branded products.
In conversation with Rakesh Rao, Prof. Leonardo Luca Etro sheds more light on latest trends in M&A transactions, funding challenges for SMEs and entrepreneurship.
Kindly share with us some of your research interests?
My current research interest is in M&A transactions from emerging countries to developed markets. I analyse the impact of transaction on value creation for the acquirer (bidder) and its effect on valuation in the M&A deals (post-acquisition) involving advisors. In addition, I am also looking at the difference in value creation (after the acquisition) involving leading advisory firms and other lesser known advisory firms.
Besides, I am studying the effect (positive or negative) on the value creation when an M&A deal is announced involving a government-owned company (located in emerging countries). Some study suggests that when Chinese government owned companies announce acquisitions in the developed markets (US or Europe), the reaction is negative as investors feel that takeover decisions are driven not by economics, but from political or strategy point of view. I would like to study if this observation is true even for other BRICS countries – i.e. Brazil, Russia, India and South Africa.
Do you think the kind of government (democratic, authoritarianism, etc) is a factor that decides the outcome of the M&A deal involving government-owned companies?
Initial impression is yes. Countries governed bya single party rule couldhave overarching influence on the state-owned companies, while countries having multi-polar democratic systems may have limited influence on the strategic decisions taken by state-owned companies. Countries closer to American-style of doing business have more freedom to do transactions.
Have firms from emerging countries bidding for companies in developed markets been successful in creating value for shareholders?
When the target is an organisation that creates high-end branded products, I do not think there is a value creation for the target company.If one takes the examples of Italian companies (involved in the food & beverages and fashion businesses) that were acquired by firms from emerging markets, there has not been a value creation for the target company as these companies lost their brand perception after the takeover.I think emerging market firms are not well-equipped to run organisations (having high-end brands) as it is difficult for them to manage business based on intangible assets.
Take the example of Guru, one of Italy’s leading fashion brand. After this brand was acquired by an Indian firm in 2008, the brand lost traction and brand premium amongst its customers since the new owner decided to focus on non-branded products.
On the other hand, firms from emerging countries can add value in the target companies, which are involved in capital-intensive industries. As you are aware, manufacturing activity has been shifting from developed countries to developing countries as it is cost-effective. As a result, firms located in emerging countries are adept at adopting strategies to cut down production cost as they have to run their businesses in a cost-competitive marketplace.
For this reason, I believe Arcelor-Mittal may be a right bidder for Italy’s Ilva, Europe's largest steel plant by output capacity, as it could result in value creation for the organisation.
Have you seen a jump in M&A transactions involving firms from emerging economies?
As per some studies, firms from emerging countries now account for about 30 per cent of the total M&A transactions globally compared to 12.5 per cent five years back. Firms from BRICS countries accounted for about 60% of the total M&A transactionsinvolving firms from emerging markets. Indians and Chinese firms are the most active in the M&A space. This probably could be due to the prevailing political and economic situation in these two countries as firms are relatively free to carry out overseas acquisitions. Most of the transactions are occurring in sectors such as energy, telecommunications, automotive, and engineering.
Has globalisation opened up new avenues of financing for businesses today?
For large corporations, globalisation has helped them expand their funding options, but the same may not be true for small and medium scale entrepreneurs (SMEs) Global investors will find it difficult to understand the business paradigm of these companies.Probably, banks are the most likely source of funding for SMEs.
SMEs often face critical problems in accessing finance. Do you think screening and risk evaluating methodologies for SMEs should be different from that of the established corporates?
Screening methodologies for funding have to be different as SMEs operate differently compared to large corporates. SME firms, in most cases, are run by an individual or by a family, and they have complete control over the business. These firms are not under pressure from the investors to increase profitability by large margins. Hence, financial institutions (who intend to fund SMEs) should not look at the profitability of the firm as the only guiding principle for granting finance. In addition, they should also focus on other aspects such as revenues, past relationship with the financial institutions, etc. Financial institutions should also focus on understanding the outlook of the entrepreneur.
What are the key challenges entrepreneurs’ face when funding their start-up ventures?
Start-up ventures should have right human resources in three critical aspects of the business – technical/engineering, commercial and finance - to derive success. If you donot have any one of these three, it will be difficult to run the business. Funding is the second largest concern for any start-up. Third is the business strategy and market reaction to the value preposition of the new business.For accessing funds, it helps if the proposed start-up can showcase a case history of a similar successful business models operational in other part of the world.
After financial crisis of 2008, liquidity has been a major challenge. How have corporates adjusted to this situation?
Good organisations did not have any major problems. Organisations with limited international exposure and low profitability were hit hard. These companies realised the importance of profitability as they had to recapitalise their business when the external environment was highly uncertain. Before the crisis, organisations were concentrating on revenues, however post 2008, profit is the focus area. Organisations also opened their doors to other non-conventional funding options such as private equity, venture capitalist, angel investors, etc.
Today, are banks better equipped to prevent (or face) 2008-like situation?
Banks are in a much stronger position todayin comparison to 2008 because they are obliged to do so. Looking at the result of the stress-test conducted by European Central Bank, only 25 European banks did not pass the stress-test. This can be considered to be good, given the slowdown in the European economic.However, tight monetary measures have madesurvival of small scale businesses challenging as they have to face more difficulty in accessing finance from banks.
Can governments (especially in developing countries) play a key role in unlocking entrepreneurial potential of the country by removing barriers to finance?
Easy access to fund can have positive effect on the entrepreneur spirit of the country. One of the reasons why the US has been a base for many highly successful start-ups is because the country offer enumerable amount of avenues to raise low-cost finance.
The government, from developing economies,should have fiscal policy that incentivises big corporates to invest in start-ups or entrepreneurial ventures outside their companies.This has the possibility of unleashing the entrepreneurial potential of young people and help start-ups to grow and generate employment for the country.
This is an example where a company from an emerging economy (Tata Motors, India) acquired a high-end manufacturing brand from a developed economy (JLR, the UK) and generated value not just for the acquirer but also for the target company. This is a rare exception, opines Prof. Leonardo Luca Etro, Professor of Accounting, Control, Corporate and Real Estate Finance, SDA Bocconi, Italy. He explains that it is not easy to come across instances of value creation for the target company when acquired by a firm based from emerging economies.
According to Prof. Etro, who has been tracking cross boarder M&A transactions for quite a period of time, firms from developing countries find it difficult to run organisations which are based on intangible assets (in other words high-end branded products). He cites an example of Guru Fashion brand from Italy which lost its premium brand image post acquisition by an Indian organisation.He believes that while firms from developing economies perform well in capital-intensive industries, they fail to do justice for branded products.
In conversation with Rakesh Rao, Prof. Leonardo Luca Etro sheds more light on latest trends in M&A transactions, funding challenges for SMEs and entrepreneurship.
Kindly share with us some of your research interests?
My current research interest is in M&A transactions from emerging countries to developed markets. I analyse the impact of transaction on value creation for the acquirer (bidder) and its effect on valuation in the M&A deals (post-acquisition) involving advisors. In addition, I am also looking at the difference in value creation (after the acquisition) involving leading advisory firms and other lesser known advisory firms.
Besides, I am studying the effect (positive or negative) on the value creation when an M&A deal is announced involving a government-owned company (located in emerging countries). Some study suggests that when Chinese government owned companies announce acquisitions in the developed markets (US or Europe), the reaction is negative as investors feel that takeover decisions are driven not by economics, but from political or strategy point of view. I would like to study if this observation is true even for other BRICS countries – i.e. Brazil, Russia, India and South Africa.
Do you think the kind of government (democratic, authoritarianism, etc) is a factor that decides the outcome of the M&A deal involving government-owned companies?
Initial impression is yes. Countries governed bya single party rule couldhave overarching influence on the state-owned companies, while countries having multi-polar democratic systems may have limited influence on the strategic decisions taken by state-owned companies. Countries closer to American-style of doing business have more freedom to do transactions.
Have firms from emerging countries bidding for companies in developed markets been successful in creating value for shareholders?
When the target is an organisation that creates high-end branded products, I do not think there is a value creation for the target company.If one takes the examples of Italian companies (involved in the food & beverages and fashion businesses) that were acquired by firms from emerging markets, there has not been a value creation for the target company as these companies lost their brand perception after the takeover.I think emerging market firms are not well-equipped to run organisations (having high-end brands) as it is difficult for them to manage business based on intangible assets.
Take the example of Guru, one of Italy’s leading fashion brand. After this brand was acquired by an Indian firm in 2008, the brand lost traction and brand premium amongst its customers since the new owner decided to focus on non-branded products.
On the other hand, firms from emerging countries can add value in the target companies, which are involved in capital-intensive industries. As you are aware, manufacturing activity has been shifting from developed countries to developing countries as it is cost-effective. As a result, firms located in emerging countries are adept at adopting strategies to cut down production cost as they have to run their businesses in a cost-competitive marketplace.
For this reason, I believe Arcelor-Mittal may be a right bidder for Italy’s Ilva, Europe's largest steel plant by output capacity, as it could result in value creation for the organisation.
Have you seen a jump in M&A transactions involving firms from emerging economies?
As per some studies, firms from emerging countries now account for about 30 per cent of the total M&A transactions globally compared to 12.5 per cent five years back. Firms from BRICS countries accounted for about 60% of the total M&A transactionsinvolving firms from emerging markets. Indians and Chinese firms are the most active in the M&A space. This probably could be due to the prevailing political and economic situation in these two countries as firms are relatively free to carry out overseas acquisitions. Most of the transactions are occurring in sectors such as energy, telecommunications, automotive, and engineering.
Has globalisation opened up new avenues of financing for businesses today?
For large corporations, globalisation has helped them expand their funding options, but the same may not be true for small and medium scale entrepreneurs (SMEs) Global investors will find it difficult to understand the business paradigm of these companies.Probably, banks are the most likely source of funding for SMEs.
SMEs often face critical problems in accessing finance. Do you think screening and risk evaluating methodologies for SMEs should be different from that of the established corporates?
Screening methodologies for funding have to be different as SMEs operate differently compared to large corporates. SME firms, in most cases, are run by an individual or by a family, and they have complete control over the business. These firms are not under pressure from the investors to increase profitability by large margins. Hence, financial institutions (who intend to fund SMEs) should not look at the profitability of the firm as the only guiding principle for granting finance. In addition, they should also focus on other aspects such as revenues, past relationship with the financial institutions, etc. Financial institutions should also focus on understanding the outlook of the entrepreneur.
What are the key challenges entrepreneurs’ face when funding their start-up ventures?
Start-up ventures should have right human resources in three critical aspects of the business – technical/engineering, commercial and finance - to derive success. If you donot have any one of these three, it will be difficult to run the business. Funding is the second largest concern for any start-up. Third is the business strategy and market reaction to the value preposition of the new business.For accessing funds, it helps if the proposed start-up can showcase a case history of a similar successful business models operational in other part of the world.
After financial crisis of 2008, liquidity has been a major challenge. How have corporates adjusted to this situation?
Good organisations did not have any major problems. Organisations with limited international exposure and low profitability were hit hard. These companies realised the importance of profitability as they had to recapitalise their business when the external environment was highly uncertain. Before the crisis, organisations were concentrating on revenues, however post 2008, profit is the focus area. Organisations also opened their doors to other non-conventional funding options such as private equity, venture capitalist, angel investors, etc.
Today, are banks better equipped to prevent (or face) 2008-like situation?
Banks are in a much stronger position todayin comparison to 2008 because they are obliged to do so. Looking at the result of the stress-test conducted by European Central Bank, only 25 European banks did not pass the stress-test. This can be considered to be good, given the slowdown in the European economic.However, tight monetary measures have madesurvival of small scale businesses challenging as they have to face more difficulty in accessing finance from banks.
Can governments (especially in developing countries) play a key role in unlocking entrepreneurial potential of the country by removing barriers to finance?
Easy access to fund can have positive effect on the entrepreneur spirit of the country. One of the reasons why the US has been a base for many highly successful start-ups is because the country offer enumerable amount of avenues to raise low-cost finance.
The government, from developing economies,should have fiscal policy that incentivises big corporates to invest in start-ups or entrepreneurial ventures outside their companies.This has the possibility of unleashing the entrepreneurial potential of young people and help start-ups to grow and generate employment for the country.