Are India Inc's global M&As worth it?

DEBATE

With the stock markets and rating agencies giving a thumbs down to big acquisitions, it's time to take another look at such activity.

Rashesh Shah
CMD,
Edelweiss Capital

There's a 50-70% debt component in most M&As, and at higher costs "" that's a factor which needs to be factored in

Recently, we have seen a spurt in M&A activity, especially Indian corporates buying overseas companies. The question we need to ask is how much risk is embedded in these acquisitions?

Acquisitions are akin to regular investments in a project or venture. In a bull market, there is easy availability of capital and optimism about the future. This fuels growth plans, which are expressed by undertaking fresh projects or acquisitions. The corollary is that usually asset values are 'fully' priced in a bull market and the acquirer has to be confident of extracting additional value post acquisition.

It is important to evaluate the purpose and the benefit of acquisitions. We know that many acquisitions fail to deliver the required value. However, it should be noted that acquisitions made for the stock market or for egoistical reasons "" the 'bigger at any cost' syndrome "" are the ones which often have immediate market impact, but fail most often.

On the other hand, acquisitions made for long-term strategic reasons deliver value slowly, but are value enhancing in the long run. One of the positive developments has been that Indian markets have not unabashedly cheered on the larger acquisitions; markets have actually given a short-term thumbs down to a lot of these acquisitions. This underscores the maturity of the India market and Indian corporates.

The mode and cost of financing is also an important determinant of risk. Most Indian corporate acquisitions are funded by 50-70 per cent debt. Acquisition financing is usually 300-500 basis points more expensive than traditional loans for operations or expansions. Hence, this form of financing has to have a higher threshold for return on investments. In a make-versus-buy decision, usually 'buy' is a bit more expensive in today's world.

This greater expensiveness is set off by quicker time-to-market, no gestation period, and in many cases, an evolved management team. This is especially important for overseas markets where make or greenfield projects present more uncertainties.

Last, most large companies in India have strong balance sheets and global credit availability is easy, with rates being 'reasonable'. Hence, for these companies, the leverage effect may not be unmanageable. Small companies with weak balance sheets may find acquisitions "" funded by leverage "" difficult to manage. These companies should use a judicious mix of equity and debt, maybe a bit more equity to fund acquisitions.

To conclude, the key parameters to watch are reasons for acquisitions, the mode of funding, cost of funding, and the overall balance sheet strength of the acquirer.

Sanjay Bhatia
President,
PHDCCI

With globalisation, Indian firms compete with imports in even local markets "" you have to judge M&As keeping this in mind

Most of the big-ticket acquisitions made by Indian companies were through the leveraged buy-out (LBO) route funded partly by private equity funds, financial institutions and, of course, through internal resources. It has to be borne in mind that for takeovers by India Inc worth several billion dollars, the outflow of dollars has been minimal. At the same time, the charge of the private equity funds and others on the profitability and assets of the merged or acquired company will be substantial, which has to be paid through the future profits or cash flow of the company.

The pertinent question is whether our corporations have overstretched themselves. I don't think so. First, I feel that India Inc is now in an unprecedented trajectory of growth, where it focuses on both domestic and global markets somewhat in a similar manner. The concept of a dominant leader in the domestic market will soon undergo a change thanks to a gradual reduction of the tariff wall. Sooner or later, imports are going to be cheaper than what they are now. That would mean that corporations, to stay in the race, should be competitive both domestically and internationally. The effort of India Inc to go global is not only symbolic of its strength and reach but also a calibrated policy to shore up its competitiveness by achieving economies of scale and scope.

Secondly, in many areas, especially in the knowledge-driven industry, we have to consolidate ourselves. Our IT majors are reckoned everywhere. Yet, their size and scope are small compared to Microsoft, Dell or IBM. The result is that many-a-time, we have to be content with the status of a vendor or sub-contractor to large American and European corporations. That stage should change and in certain areas, we can emerge as global players and prove our worth in executing high-end projects. M&As are the preferred route to achieve that position.

Thirdly, a paradigm shift is taking place in the image of India, which has been considered mainly as a supplier of goods and services, including software services. We have to emerge as a strong manufacturing hub, capable of producing high quality and price competitive manufactured goods. Slowly, we are making progress towards that. We are reckoned as a major player in steel, foundry, auto components and so on, thanks to some of the LBOs carried out in recent months. That list has to expand and can be accomplished through the M&A route rather than by setting up greenfield projects in an alien land.

Let me also touch upon the flip side of the spectrum. What happens when there is a global recession? We cannot become a global player and also insulate ourselves from its fallouts. It is a cyclical reality. Fortunately, now we have enough foreign exchange reserves to bail us out in case of a global slowdown.