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Markets: Pressing the 'A'button! - Views on News from Equitymaster
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  • Jul 3, 2006

    Markets: Pressing the 'A'button!

    There has been frenzied activity on the mergers and acquisitions (M&A) front across sectors in the past couple of years and the noticeable trend witnessed is the rise in the number of cross border deals made. These were in the form of acquiring either the entire business, or technical know-how or a product portfolio depending upon companies' strategy. In this write-up, we shall try to highlight the rationale for Indian companies making these global acquisitions and the challenges that these (Indian players) face with respect to the same.

    Rationale for inorganic growth...
    Acquiring scale: Gaining in 'size and scale' is one of the primary reasons that has prompted Indian companies to go globetrotting for acquiring companies. This is especially more pronounced in industries, which are highly fragmented and competitive. For instance, in the pharma sector, companies are looking to consolidate due to severe pricing pressures witnessed in the global generics industry and the step up in the pace of the acquisition activity is expected to edge out smaller and uncompetitive firms in the long term.

    Increasing geographical reach: Acquisitions also provide a faster way to establish foothold in a market where a company has virtually no presence as against starting operations in a particular geography right from scratch (the latter would take a relatively longer time to scale up). To put things in perspective, in the European market, Indian majors have chosen to establish a presence 'the inorganic way'. Bharat Forge's acquisition of the Swedish company Imarta Kilsta, along with the previous ones viz., CDP and Aluminiumtechnik of Germany and Federal Forge in US, means that the company has 'dual shore capability' for all of its core products like crankshafts, beams, knuckles and pistons. Another case in point is Tata Steel's acquisition of NatSteel, which will enable the former to get a presence in the lucrative Chinese market, which currently controls nearly 25% of the world's steel production.

    Backward integration: Backward integration in terms of securing raw material is also another rationale behind an acquisition even in the international markets. For instance, BILT recently acquired the Malaysian company Sabah Forest Industries (SFI), primarily for the purpose of securing pulp. This is because SFI has access to 289,000 hectares of forestland, which will enable BILT to meet its fibre requirements. It must be noted that raw material shortage continues to plague the Indian paper sector, which is further compounded by the fact that these companies are not allowed to have captive wood plantations.

    Bridging product and technology gap: The fourth criterion for an acquisition is augmenting the product portfolio i.e., typically to gain access to value added or technically complex products. For instance, Biocon recently bought out the intellectual property (IP) assets of the US-based company Nobex. Nobex has the technical know-how for the oral delivery of protein, peptide and small molecule drugs currently available only by injection. This is a niche area and will enable Biocon to complement its biotech portfolio.

    Challenges 'acquired'...
    Integration: Integrating two businesses is always the most difficult and challenging part of M&A and is more pronounced for deals across borders. First and foremost, integration requires effective interaction and coordination between the merging firms to realise the strategic potential of the deal with a special focus on human resource related issues. In cross border deals, the stark difference in people and cultures and management style is brought to the fore and integrating these factors along with the business processes becomes critical. This also entails having a good knowledge about the country in question and its regulations. This means that cross border M&A deals have to be planned right from the day the acquiring company has identified the company that it wants to acquire. At the end of the day, the success or failure of an M&A deal depends upon how well the integration process has been handled.

    Impact on profitability: Acquisitions generally tend to hamper operations margins and profitability in the medium term as the restructuring process gets underway. Some companies adopt the strategy of acquiring stressed assets with the objective of turning them around and adding value to their existing business. While the price paid is relatively lower, what gains paramount importance is the extent of management depth to turn the company around. For example, Sun Pharma, over the years, has managed to turn around the loss making companies that it has acquired, the notable case in point being Caraco. Similarly, Nicholas Piramal's acquisition of the European CMO Avecia had pressurised the margins of the company in FY06. Investors should also note that acquisitions could take a longer time (sometimes more time than what even the management had anticipated) in adding value to the company.

    To sum up...
    The crux of the matter is whether the acquisition is worth the price paid. Thus, valuations assume significant importance. For instance, in the global generics space, US-based Watson acquired Andrx Corporation for a total consideration of US$ 1.9 bn, which translated into an obscene EV/EBIDTA multiple of 45 times! Similarly, the M&A deal between Holcim and Gujarat Ambuja, valued at over US$ 200 per tonne is touted amongst the most expensive deal in the history of the global cement industry, which will mean that Holcim will be under pressure to perform consistently well to justify the high valuation.

    Thus, investors need to tread with caution and not get carried away with the market euphoria that generally surrounds the news of any acquisition. Certainly, it should not form the only basis for investing in a particular stock. While there are definitely positives, at the end of the day, a company needs to be well researched and the acquisition deal evaluated as thoroughly as possible (based on available details) before reaching a conclusion on the potential value that is likely to accrue from such an acquisition.



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