India - Rising power in International M&A

Table of Contents

Chapter I

- Introduction

- Waves of M&A activity

- Triggers

Chapter II

- India’s coming of age

- Motivations of Indian firms

Chapter III

- Tata conquers British marquees

- Suzlon bags REpower

- Mittal Steel makes its mark

Chapter IV

- Trends & Patterns of Indian acquisitions abroad

- Why India leads China in cross-border M&A

- Conclusion

Introduction

Mergers and Acquisitions have long been part of global corporate history and have played a vital role in shaping the business landscape of each decade. With the passage of time, the sheer volume and size of M&A transactions have reached unprecedented levels. While some have welcomed this, a prominent section of observers is sceptical about the rationale behind such “megadeals”.

This field has undergone tremendous transformation not only in terms of deal sizes and volumes but also in terms of the ‘deal makers’. Mergers and acquisitions which was until a few years back an almost exclusive domain of organisations from developed countries, ones that had the financial muscle and political leverage to pull-off such deals, has now reformed with new entrants like India, China, Brazil, Russia, Indonesia, South Korea, Mexico etc cutting important deals beyond geographical and political boundaries. In other words, countries and firms which were until recently just investment destinations and takeover targets respectively have taken a bold step and come forward to compete with the conventional corporate heavyweights.

M&A activity has manifested itself in waves and each wave is driven by business and economic conditions prevalent at that point in time.

M&A deals whether hostile or friendly have been a hot topic of discussion among observers, analysts and despite all the flak they have received one cannot deny that the M&A phenomenon is here to stay and will continue playing the role of a catalyst in business environments.

Waves of M&A activity

History has recorded heightened M&A activity in different periods and this aggregation of M&A activities at a specific point in time is called a “wave”. Such aggregations are clearly visible and can be classified into 5 distinct waves. Each of these waves is different in industry focus, transaction types, capital structures, presence or absence of hostile takeovers, megadeals etc and a result of favourable economic factors like falling interest rates, booming stock market, expanding economy etc. Numerous studies have indicated that M&A activities rise when the cost of capital falls and is countercyclical to bond yields.

These waves are caused by a combination of various economic, regulatory and technological changes/shocks like a booming economy leads to a surge in aggregate demand prompting companies to quickly expand operations through M&A (since internal growth is much slower) to meet this rise in demand, lifting of regulatory restrictions pertaining to an industry or trade, path breaking technological innovations/discoveries replacing obsolete technology etc. The starting date and duration of each of these waves are not precise although the ending dates of those that ended in wars or financial disasters, like the 1929 crash or the bursting of the Millennium Bubble, are more definite.

First Wave (1895-1904) “Merger for Monopoly”

This wave occurred after the depression of 1883 and the most important feature of this wave washorizontal mergers. After the depression, the economy and capital markets experienced a boom and the rapid pace of technological innovations boosted production inducing firms to look for much more share of the market to sell their produce. This triggered industry consolidations and major monopolies were formed during this period.

The first billion-dollar mega-merger was announced during this wave with the establishment of U.S. Steel which was formed by combining Carnegie Steel and Federal Steel plus several other steel companies like American Tin Plate, American Steel Hoop, American Steel Sheet, American Bridge, American Steel & Wire, International Mercantile Marine, National Steel, National Tube & Shelby Steel Tube. U.S. Steel was a steel goliath as it controlled one half of the American steel industry and accounted for as much as 75% of the American steel-making capacity!

Some of today’s greatest industrial giants like DuPont Inc, General Electric, Standard Oil (with 85% market share), Eastman Kodak, American Tobacco Inc (90% market share) and Navistar International have their roots in this wave.

Finally, with the enforcement of the Sherman Antitrust Act (1890) in 1902, mergers among major competitors were curtailed and this took the steam out of the first wave.

Second Wave (1925-1929) “Merger for Oligopoly”

The predominant characteristic of this wave wasvertical combinationsin which firms worked towards integrating their backward operations into supply and forward operations into distribution thereby gaining complete control over the value chain. This made firms self-sufficient by reducing dependence on external suppliers and distributors. The main outcome of this wave was the formation of large public utility holding companies. The boom in stock market prices and volumes that followed the recession of 1923 stimulated this wave and the stock market crash of 1929 marked the end of it.

Industrial giants like General Motors, IBM, John Deere and the Union Carbide Corporation were born in this wave. A distinguishing feature of this wave was the significant use of debt to finance deals. Debt in the capital structure of companies enabled investors to earn high returns but also brought downside risk along with it in case of an economic slowdown.

Pyramid holding company (a type of capital structure), in which small groups of investors control big businesses through relatively small amount of invested capital, became popular during this wave. A similarity between the first two waves was the indispensability of investment bankers. They exercised huge influence on deals since they controlled majority of the capital available for financing such M&A deals. Clayton Act was passed in the U.S during this period to bolster antitrust enforcement.

Third Wave (1965-1970) “Conglomerate mergers”

In the wake of heightened anti-trust enforcement following the passage of Celler-Kefauver Act of 1950 to discourage horizontal mergers, firms took to diversifying operations and thus arose the era ofconglomerate mergers.

Strong economy and bull market of the 1960s aided M&A activity in this period. A very unique aspect of this wave was that relatively smaller firms targeted much larger ones for acquisition which was in complete opposition to the previous two waves.

Main outcomes of this wave were ITT and LTV. ITT, in its quest for diversification, acquired varied businesses like Avis Rent a Car, Sheraton Hotels, Continental Baking and other diverse operations like restaurant chains, consumer credit agencies, home building companies and airport parking firms! Many small and medium-sized firms also switched to diversification strategy by moving out of their core businesses.

The main factor responsible for the collapse of this wave was the poor performance of conglomerates formed during this period. Managers of these conglomerates, used to controlling operations in which they had expertise, were suddenly faced with an uphill task of overseeing varied activities, some of which they had no experience in!

Fourth Wave (1981-1987) “The Megamerger”

This wave was earmarked by more hostile takeovers, more use of financial leverage and more firms going private. The enhanced economic activity touched all sectors of the industry and was especially dominated by combinations of small and medium-sized firms.

Corporate raid became as a very profitable speculative activity pushing firms and financial institutions to form speculative partnerships. There was unprecedented increase in the size of M&A transactions during this wave with the total $ value paid in acquisitions rising sharply in addition to the average size of a typical transaction giving birth tomegamergers.

The rise of financial and international players on the M&A scene, which was until then dominated by the conventional industrial houses, was one of the hallmarks of this wave. Capital markets at this time were going through a complete makeover with the introduction of more innovative & sophisticated instruments and operations. Falling interest rates and rising stock prices fuelled economic activity in this wave. The mild recession of 1990 and the collapse of the junk bond market (that provided financing for many of the LBOs) led to the end of this wave.

Fifth Wave (1992-2000) “Strategic Restructuring”

After the recession of 1990-1991, the M&A market was buzzing again and the announcement of some major deals underscored the “paradigm shift” in M&A where new rules were being written about strategy, size and deal structure. An outstanding feature of this wave was the advent ofstrategic buyersthat acquired targets in the same line of business to create synergy value thereby reducing the influence of financial buyers i.e. LBO specialists. Deregulation in the banking industry, decline in national defence spending, reformed payment patterns by insurers (healthcare) and the rapid innovations in technology triggered comparatively higher M&A activity in these four sectors.

The burst of Internet bubble in March 2000 leading to slowdown of the U.S. economy and stock market halted the M&A movements in this wave. This is also known as the truly international merger wave since starting 1998 the value of deals in Europe was as large as in the U.S. In Asia, in addition to Japan, several other nations showed up on the M&A radar screen with some loosening of the tightly- controlled economies of these nations. Even Central & South America were for the first time buzzing with M&A transactions. All this was due to ripple effects being produced throughout the world economy due to strong expansionary activities in one part of the world.

Triggers

M&A is triggered by a variety of reasons ranging from strategic to speculative and often determine the type of merger undertaken. Some of these reasons have held ground for decades now and are potent explanations of many economic transitions.

1) Corporate Control – Certain groups like activist shareholders, private equity firms etc look for firms that are undervalued or those appearing to be doing a poor job with the “substance” of the business. Such groups effect a change of management in firms to replace the “inefficient” management with “efficient” one to make optimal use of firm’s resources and help it achieve its true value.

2) Synergy – Synergy value is created when the profitability of a combined unit is much greater than the profit generated by each individual unit i.e. 2+ 2 = 5. Combining two firms in the same area of business can lead to creation of synergy due to realisation of economies of scale. Heavy capital equipment industries such as the steel industry have substantial indivisibilities and hence greater benefits result from combining operations.

Operating economies of scale are more common in horizontal mergers and financial synergy is more common in case of conglomerates. Also, if the cash flows of two combining firms are not perfectly correlated the combined firm has a much lower risk of insolvency.

Another dimension of the synergy argument is expansion.

Firms desirous of expanding in a specific geographic area or venturing into a new area of operations often acquire firms in that geographic location or field of operations since such an expansion is quicker than internal growth. Acquiring a firm immediately grants possession over the target’s operations, marketing, distribution network, market presence etc that would otherwise have taken years for the acquiring firm to build on its own.

3) Managerial motivations – This stems from lack of alignment between shareholders’ and management’s interests i.e. agency problem. Management might pursue goals like more perks and perquisites, lesser work effort etc rather than profit maximisation. This works detrimental to shareholders’ interests but the costs of detection far outweigh the costs of agency problem. Since management’s salary and rewards often depend on the size of the enterprise, management is motivated to acquire firms or businesses with no proper strategic or financial rationale. Some of the prominent conglomerate mergers in the U.S. were driven by this ‘empire-building’ motive of the management.

4) Capacity Reduction – The desire to reduce capacity, as during the recession of early 1980s, is one of the primary motives for M&A especially in economies undergoing restructuring for rationalising traditional industries. Capacity reductions aid cost reduction strategies and help firms in cutting wasteful scale of operations, workforce, marketing etc.

5) Acquisition of growth – Sustenance of growth also pushes firms towards M&A. The target maybe in a growth sector making it attractive to the acquirer. In specific cases, it is cheaper to acquire growth than to develop in new areas. At times, it may be appropriate to acquire a company in a growth sector at a premium rather than investing in assets to achieve growth.

6) Acquisition of specific assets – Acquisition of or access to a specific asset is quite a compelling reason for M&A. These assets can be tangible like prime real estate locations, manufacturing abilities, financial muscle or intangible like technological know-how, skilled personnel, R&D resources, innovative culture etc. An acquirer could find it perfectly logical to buy these assets even at a premium more so in case of a rapid product or market expansion and relatively scarce expertise.

7) Tax considerations – A firm may be motivated to acquire another firm for tax reasons. For instance, the acquirer may preserve the net operating loss and other tax attributes of the target thereby gaining a significant tax liability reduction. If the two firms are operating in different geographic areas with different tax rates applicable such differences can be exploited for an advantage. Asset acquisition can spark VAT and other business tax issues but a merger helps avoid these.

Some firms have constraints on their ability to use their tax benefits and it is seen that mergers can help lift these constraints.

8) Diversification – This could be diversification in geography, product portfolio, cash flows, operations etc. With diversification, a firm can even out the rough/risky aspects of its operations and thus ensure a stable, healthy firm. Different geographies or cash flows can have a cross-subsidising effect with the stronger part of a firm making up for the weaker part of operations. However, this cross-subsidising argument is criticised heavily by some who believe that it makes firms inefficient and is claimed to be one of the main reasons for failure of conglomerates.

9) Cross-selling – This is mostly one of the prominent reasons for deals between firms in different sectors and/or different geographies. Through this, both firms can leverage each other’s selling points and in the process gain access to a previously undiscovered market. It guarantees enhanced market presence to each of the partner firms.

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