Corporate India comes of age with a spate of takeover attempts based on long-term strategies
IF the first wave of mergers and acquisitions (M&A) was triggered off by the first economic reforms and powered by transnational corporations (TNCs), the second wave, unleashed in the fifth year of reforms, is very different. And by the time it subsides, the second takeover blitz may prove to be bigger and more far-ranging than the first.
Sample the following takeover announcements and attempts in the last six months: Paper Products makes hostile bid for Sharp Industries, Akar Laminators joins the race. Modiluft faces hostile bid from NEPC. Essar offers to take over Sterling Computers, K.K. Bangur group takes over Powmex Steels, Rallis bids for Khatau Junker's agrochem unit, the Murugappa group company Universal Carborandum bids for Cut fast Abrasives. Gabriel gets the green light to take over Stallion Shox, and old takeover hand Ajay Piramal announces his intentions to pocket Abbott Laboratories. This glut heralds the birth of a mature—and indigenous—strategic framework for mergers and acquisitions.
In pre-liberalisation India, corporate takeover bids were few and far between. And many of those that did take place were of the nature of random kills. In the license Raj era, the average industrialist's ambition to expand his business empire was hemmed in by so many regulations that, when he heard of a company up for sale, he would go for it regardless of whether it suited his long-term business strategy or not. Unrelated diversification was the name of the game—by default. The new Indian corporate raider whohas emerged with the unshackling of the Indian economy is a very different animal. He isn't interested in random purchases, but in carefully thought-out attacks that will give him a focussed and long-term strategic advantage.
Of course, the first M&A wave—Coke-Parle, Hindustan Lever-TOMCO, Nestle-Nutrine—has hardly spent itself. Reportedly, at least four food and beverages TNCs—Brooke Bond Lipton India, Nestle, Pepsi Foods and Heinz—are still in the market for acquisitions. And the signs are already visible that the first wave will now concentrate on brands that have a strong franchise in particular regions of the country. "The acquisitions route is more attractive where the business is driven by intangibles like market development, brand equity and distribution network," says Vishal Marwaha, manager, Northern India, ANZ Grindlays Bank.
"For TNCs, the M&A route worked as a double-edged sword to cut competition on one hand while providing a much cheaper and quicker way to enter any business," says Vinayak Chatterjee, chairman, Feedback Ventures and Collaboration Services. The second phase, however, is fueled by more fundamental forces and a search for organic growth among Indian corporates.
"Unlike in the West where mergers and acquisitions activity is bankrolled by investment surge in the capital markets, in India the current mania seems to be unleashed by the internal environment heating up," says Chatterjee.
It was the license era psychology of growth at work any which way—and core competences be damned— when a hoard of corporates rushed into the new sectors—telecom, power, civil aviation and so on—that the reforms had opened up to the private sector. Not all of them had the financial strength or the technical expertise to run the businesses. "The recent spurt in merger and acquisition activity is to be seen as a correction for unsynergetic growth of the license era," says Vijay Kumar, chief, northern region, of ICICI Securities (I-SEC).
A typical example is the civil aviation sector that saw a rush of players grabbing air taxi licenses and launching operations. Citylink and Raj Air closed within a year of starting operations. Damania Airways, after a change of hands, is now known as NEPC Skyline. In fact, the Indian private airlines market is a classic case of an industry with too many players skirmishing for smaller and smaller shares of the pie. In such a business, the player who can generate the largest economies of scale—and in this particular case, the largest web of flight routes—is clearly destined to attain unassailable leadership status. Which is what the NEPC is attempting, as it tries to take over Modiluft and UP Air. The telecom sector, too, will witness several such buyouts, principally because all the licensees may not be able to pay up the huge license fees. "More and more sectors are likely to witness this kind of shakeout because in this emerging liberal environment, economies of scale and size would be imperative for survival and expansion as would be financial muscle," says K.S. Mehta, partner, S.S. Kothari & Co.
The writing on the wall is clear: the biggies will live on and prosper, the small companies may survive because their size gives them the agility to service customers better and in a personalised manner, but there is definitely no percentage any more in being a medium-sized player. With import duties slashed in almost all sectors, the also-rans have to either radically improve productivity, or sell out to corporates who run a better chance of fighting the global battle. "Corporates are realising that they either need to be big players or have a considerable amount of backward integration in operations to withstand competition," says Mehta.
This is what drives Bombay Dyeing supremo Nusli Wadia's move to acquire Orkay's polyester unit. The polyester industry is groaning under high raw material costs and heavy excise duties. Demand has not grown as expected and new capacities are coming up. The acquisition of the Orkay unit will enable Bombay Dyeing to become the second largest producer of filament yarn while providing it nearly 18,000 tonnes of DMT for captive consumption.
By taking over the Mahendra Khatau group company Khatau Junker, Rallis India will be able to further consolidate its leadership position by adding 30 per cent to its existing production capacity and enable it to step up exports. The KJL has a capacityto manufacture 1,500 tonnes of malathion, 800 tonnes of dimethoate and 600 tonnes of monoprotophos at its Ankleshwar unit. On the KJL's part, the company had expanded its agrochemical capacities a couple of years ago, but with import duties slashed and more players entering the market it found its capacities too small to be a significant player. Therefore, it decided to divest its loss-making agrochemicals division and concentrate on the more profitable dyestuff business.
SIMILARLY, M'esco is looking to be a bigger player in the shoe market by acquiring the Larsen & Toubro footwear unit in Gujarat. Paper Products is looking to strengthen its hold on the flex-ible packaging material market by acquiring Sharp Industries. The Bangur group hopes to achieve vertical integration by its takeover of Powmex Steel. "Corporates are looking to become focussed entities with a view to enhance shareholder value. Gone are the days when diverse businesses would mean hedged exposure. With institutions wanting to hedge their own way, an uncluttered balance sheet would add more to shareholder interest," says Marwaha. The McKinsey prescription of core competence has led corporates like Ceat Tyres to sell off its tyre cord businesto SRF or Siel Ltd to sell off its marine harvest business.
Coupled with these factors are two conditions unique to the prevailing economic scenario that could spur the next wave of corporate raiding. First, in the case of old established companies, promoter families have been divesting their stakes owing to a combination of factors like high income tax, wealth tax and the convertibility clause that led to financial institutions converting part of their debt into equity. "Now these managements will have to hike their financial stakes or face the possibility of a hostile takeover," says Mehta.
Second is the very low market capitalisation of many Indian companies compared with the gross investments already made in the businesses. Undervalued assets and a high replacement cost—what you would have to spend now to create the level of assets a company owns—make for a corporate raider's dream. He picks up a company cheap—in fact, he can often recoup his entire expenditure within a year by selling off real estate and other assets that do not appear on the balance sheet—and saves on start-up costs and time. "Companies where the shareholder value is not optimally perceived would be good candidates for takeovers," says Marwaha.
Given that there are at present dozens of companies that are selling on the bourses at as low as 30 per cent to 40 per cent of their replacement costs or sitting on prime real estate values not reflected in the balance sheet, the coming months may just see the corporate sharks on a killing spree. "If at present, only one hostile takeover happens in 10 years, 10 such cases would take place per year in the future," SEBI Chairman, D.R. Mehta, was recently quoted as saying by a financial daily. The second coming may just prove that Mehta was being conservative in his prediction.