India Inc.'s M&A Spree Will Outlast the Recession

There was a time when Westerners assumed that an Indian in the head office of a multinational or Western company was either an accountant or a computer nerd. Nowadays, as Indian companies have been buying up businesses in the U.S., Britain, and elsewhere, that person is just as likely to be the boss. Many Indian companies are on a quest to be globally competitive, leading a growing number to scale up outside India. This is especially true for those that operate in the global industries of aluminum, automobiles, and steel such as Hindalco, Tata Motors (TTM), and Tata Steel.

As late as 2001, Indian outward investment was less than $1 billion. Instead, India—like all developing countries—was actively courting foreign investment into the country. By 2006, India had reached the tipping point. For the first time, Indian outward investment of $10 billion had outstripped foreign investment into India. The spending spree continued unabated in 2007. Indian companies arranged or concluded $21 billion in 40 foreign investment deals in January and February of 2007 alone. Moreover, Indian foreign investment in the financial year closing Mar. 31, 2007, exceeded the cumulative total foreign investment by Indian companies in the 58 years between its independence in 1947 and 2005.

Because of the financial crisis, the days when acquirers could use the assets, and sometimes even the cash flow, of the target company as collateral seem to be over. The impetus for many of the acquisitions was not that the Indian companies were particularly globally dominant in their industry or rich; rather, one of the primary facilitators was the easy liquidity prevailing in the markets. Big deals based on easy liquidity, however, tend to load a company with debt or dilute shareholder equity through the needed issuance of new stock. Ratings agencies put Tata Steel and Hindalco on credit-rating watch after they announced large foreign acquisitions.

Back to Lending Basics

Since today there is no such thing as easy liquidity for most Indian companies, they are now back to traditional conservative practices, with lending institutions asking for the core assets of the acquiring company, at 50% to 90% of actual valuation, as the collateral. This will slow down the cross-border merger-and-acquisition activity that we have seen from Indian firms between 2001 and 2007. Still, even as Indian companies pause because of the economic crisis, there's no denying their M&A transactions have transformed India Inc. and its global footprint. It was unimaginable even a decade ago that any Indian company could pull off a multibillion-dollar acquisition of a company in the developed world or buy a prestigious luxury brand such as Jaguar. But today, Indians have emerged as second only to Americans as foreign employers of Britons.

While for many Indian companies the economic slowdown has put the brakes on overseas acquisitions, others are still shopping. The IT outsourcing arm of the Tata Group, Tata Consultancy Services, picked up Citigroup Global Services (the North American bank's India-based outsourcing division) for $505 million in October. Another Indian technology company, HCL, bought Britain's Axon Group for $672 million in December. And Sterlite put in a bid to buy bankrupt copper miner Arasco for $1.7 billion last month.

The acquisitions reflect the rapid growth of the Indian economy since 1991. When combined with the restructuring efficiencies wrought by Indian companies over the past 15 years, this growth resulted in average profit margins of around 10%, more than twice the global average, until the onset of the economic crisis. By one estimate, before the crisis hit, 60% of India's 200 leading companies were looking to spend their newfound wealth on foreign acquisitions and investments. While Indian appetite for overseas deals now has surely diminished, a World Economic Forum survey in January found Indian CEOs to be the most optimistic compared with any other country.

Some of India Inc.'s purchases may have looked too expensive to outside observers. A potential acquisition target firm in the developed market, burdened with high operating costs and focused on a declining domestic market, may not seem attractive to a Western or Japanese suitor. But to an Indian company, the target can appear different as it may have brands, customers, or technology that an aspiring Indian multinational covets. The current high operating costs of the target company do not deter Indian firms, because their vision is different.

Newfound Confidence

The Indian global powerhouses have been large domestic players in the Indian market for some time; however, until recently they never had the confidence or the ability to be on the world stage. Forged in India's harsh environment, these companies are now increasingly seeking to secure the best of both worlds—access to the lucrative high-margin markets of the developed world by owning companies in Europe and the U.S. while maintaining their low-cost bases at home. Today, many Indian firms aspire to go global, and they are extraordinarily confident about acquiring foreign firms and integrating them with their companies in India.

As I have observed during my teachings at London Business School, Indian firms have brought three unique traits to succeed in their acquisition spree. First, many are part of a group of companies such as Aditya Birla or Tata groups. They can leverage group assets to complete deals that would be difficult for any individual company. One or more in a group can lend or take an equity position in the company that is attempting to make the acquisition, or the entire group's assets can be offered to raise debt funds.

Second, Indian companies have historically had very high debt-to-equity ratios. This means Indian entrepreneurs can live with debt levels that many Western companies would find uncomfortable. Whether this is wise under the new debt regime is open to debate. Previously, Indian firms borrowed from nationalized banks whose mandate was to support India's economic development. As such they were unlikely to be aggressive with respect to interest rates, debt collection, or valuation and revaluation of collateral. Now Indian firms are tapping global financial markets to fund their deals, and these lenders are going to be more exacting. High leverage increases risk. Nevertheless, the historical attitude toward debt has facilitated these acquisitions.

Finally, Indian firms, despite being public, are often controlled by powerful families and individual shareholders, who have considerable management leeway. Such a shareholder can swiftly decide to make an acquisition, knowing that the stock price may dip in the short run. This would be impossible for more conservatively managed companies run by professionals, whose compensation is significantly tied to increases in stock price. Furthermore, Indian controlling shareholders have considerable flexibility in negotiating postmerger autonomy issues with the managers of the acquired firms.

The academic research is pretty unambiguous on the success of mergers and acquisitions. Approximately half of all M&A deals fail, and the casualty rate increases with the size of the deal as well as for cross-border deals vs. domestic deals. The foreign acquisition experience of other Asian countries, such as Japan and China, also indicates a high failure rate. Therefore, there is no reason to believe India's success rate will be significantly different. While it is only to be expected that some of these Indian acquirers will stumble because they have either paid too much or taken on large amounts of debt, the overall trend remains unaffected. For the developed world and its companies, the era of India as a major overseas investor is here. The question is not how to stop this trend but how to deal with it.

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