The real M&A test is yet to come

The mergers and acquisitions scenario is hotting up in India. According to PricewaterhouseCoopers, the value of M&A deals announced in the first six months of 2005 was $6.9 billion, compared to $2.9 billion in the first half of 2004, and more than the $5.2 billion in the whole of 2004. At this rate, the value of M&A activities in the country may touch $15 billion in 2005.

Last year, M&A activities were largely restricted to IT and telecom sectors. They have now spread across the economy. As Businessworld recently reported, this is the fourth wave of corporate deal-making in India.

The first happened in the 1980s, led by corporate raiders such as Swaraj Paul, Manu Chhabria and R P Goenka, in the very early days of reforms. In view of the license raj prevailing then, buying a company was one of the best ways to generate growth, for ambitious corporates.

In the early 1990s, in the liberalised economy, Indian business houses began to feel the heat of competition. Conglomerates that had lost focus were forced to sell non-core businesses that could not withstand competitive pressures. The Tatas, for instance, sold TOMCO to Hindustan Lever. This second wave of M&As, was largely driven by corporate restructuring.

The third wave started about five years ago, driven by consolidation in key sectors like cement and telecommunications. Companies like Bharti Tele-Ventures and Hutch bought smaller competitors to establish a national presence.

What makes the most recent wave of M&As different from the three previous ones is the involvement of global players. Foreign private equity is coming into Indian companies, like Newbridge's recent investment in Shriram Holdings.

Multinational corporations are also entering India. Swiss cement major Holcim's investment in ACC and Oracle's purchase of a 41 per cent stake in i-flex solutions (for $593 million) are good examples.

Meanwhile, Indian companies, sensing attractive opportunities outside the country are also venturing abroad. Tata Steel has bought Singapore-based NatSteel for $486 million. Videocon has bought the colour picture tubes business of Thomson for $290 million.

Such global forays have become a possibility because foreign exchange is no longer a scarce commodity. They have also become a necessity because in globalising industries, only players with global scale and reach can survive.

At the same time, the difficulties involved in making M&As click must not be underestimated. A paradigm shift is likely in the coming years. Friendly deals could give way to aggressive ones.

In future, we may see hostile bids and leveraged buyouts. Most M&As so far have been cash deals. With the Sensex crossing 9000, stock deals may become more common. As the appetite for deal making increases, the valuation is also bound to go up. In short, exciting times are ahead.

A study by Prashant Kale of University of Michigan, and Harbir Singh of Wharton, on M&As between 1992 and 2002, concluded that in the initial years of economic liberalisation, Indian companies failed to create sufficient value from acquisitions, as compared to MNCs.

However, with the passage of time, Indian companies have begun developing the necessary capabilities to create more value from deals. But returns on acquisitions fell after 1998.

Presumably, in the earlier period (1992-1997) there were many low-hanging fruits waiting to be plucked, in a relatively undeveloped market for corporate control. But after 1998, acquisitions have become more expensive. So much more has to be done to squeeze value out of them.

A rising stock market means that buyers will have to pay a higher premium. And the higher the premium, the harder the company will have to work to create value for shareholders.

Which means M&A deals will have to be selected and structured with a lot of deliberation after studying carefully the potential for generating synergies. Especially so when studies indicate that globally, in two out of every three M&A deals, the projected synergies fail to materialise.

Consequently, shareholder value is destroyed. In short, the M&A scenario in the country is heading for a paradigm shift. Misplaced optimism should give way to cold business logic.