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| The perils of borrowing | | Since economic cycles are a reality, the timing and cost of acquisitions are critical. Hopefully, India Inc will remember that in the next round |
| Shobhana Subramanian / Mumbai May 22, 2009, 00:56 IST |
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It’s the rare leader who admits he’s made a mistake. So Ratan Tata’s candid confession that the Corus and JLR acquisitions, made by Tata Steel and Tata Motors respectively, may have been mistimed, comes as a pleasant surprise. Tata had told The Sunday Times that both the acquisitions had been made “at an inopportune time in the sense that they were near the top of the market in terms of price.” Whether the rest of India Inc is as honest about their misadventures or not, it’s a fact that India Inc’s first big brush with globalisation has left many bruised. And heavily in debt.
JSW Steel, for instance, is reportedly planning to sell the steel plants it bought in the US for $800 million, now that the losses have risen to around $60 million. Dr Reddy’s has just taken a goodwill hit of about Rs 1,000 crore and more for intangible assets, like Hindalco did a couple of months back. Vijay Mallya will have to part with a stake in his company if he’s to deleverage it to reasonable levels. So, while many of the acquisitions may have been well thought out and offered a good strategic fit, most buyers possibly ended up paying too much. There are those who have shown remarkable restraint—despite sitting on piles of cash Infosys bowed out of the race for Axon; now HCL Tech, which paid $672 million for it, is looking for money. In a downturn, even small amounts are hard to come by, especially if the leverage is high—analysts point out that Aban Offshore, which bought Sinvest, has a net debt to equity of over 10 times.
In a piece in the Harvard Business Review (HBR) on how ‘Emerging Giants are Rewriting the Rules of M&A’, management expert Nirmalya Kumar notes that a survey conducted by the HBR and the World Economic Forum in 2008 found that 50 per cent of CEOs from developing economies plan to finance their bids with internal resources and 46 per cent by issuing equity. They are not worried about diluting shareholdings because they have large shareholdings and can focus on generating long-term value. It would be interesting to know how many Indian CEOs said this because, at least in the Indian context, the majority of acquisitions, especially the larger ones, have been funded almost entirely by debt and that’s why even a company like Hindalco was in a bit of a spot when it came to the debt covenants. In fact, it was clearly cheap money and not internal accruals that prompted companies to venture forth in such haste; even the smallest of companies has borrowed to buy. Also, instead of issuing equity, most companies have opted for convertible bonds, which now run the risk of not getting converted, and so are, in effect, debt. Wockhardt is a case in point. Only when they were desperate for cash did Tata Motors andHindalco raise money through rights issues, at the bottom of the market.
Kumar has a valid point, though, when he points out that emerging market companies can create value from takeovers more easily than corporations from developed countries. US and European companies, he explains, are inhibited by slow-growing home markets and acquire rivals primarily to become bigger and thus create economies of scale. By contrast, when emerging market giants pursue cross-border acquisitions, they’re not looking for traditional synergies or trying to lower costs. They’re buying Western companies to gain complementary competencies—to learn to deploy assets such as technology and brands and capabilities such as new business models and innovation skills—that will help them become global leaders. That may be true especially in areas such as technology or even auto ancillaries. But, it’s not always true that operating costs aren’t an issue. While the emerging giant may know it can transform an acquisition’s economics simply by switching to low-cost resources and business processes in its home country, it doesn’t always work out that way. Many slow-growing companies with low margins, Kumar says, can be turned into fast-growing, high-margin enterprises by their acquirers.
But Baba Kalyani, probably the sharpest acquirer in the business, will tell you that there’s no way operating margins can be improved beyond a point. Look at how JSW’s US steel plants are struggling; only in a booming economy can those plants run at full capacity. It’s true, though, that Bharat Forge can absorb the technology and try and use it back home to service the same global clients that it caters for from its European plants. But even that is not always easy, as Dr Reddy’s has discovered in Germany. It is taking the drug major a lot of time to shift production offshore, because the regulations are so stringent. Again, Indian Hotels, for example, simply added to its chain of hotels and it has to run them in the cities where they are located, so operating costs are an issue. At the end of the day, therefore, since economic cycles are a reality, the timing of the acquisition and the price paid are critical. Hopefully, India Inc will remember that in the next round.
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