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M&As: In the limelight - Views on News from Equitymaster
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  • Aug 27, 2008

    M&As: In the limelight

    Mergers and acquisitions (M&A) have considerably picked up pace in the recent times across the globe. For companies it is not just sufficient to produce quality products or offer better services but the need to grow and expand as to achieve economies of scale, spread risk (diversification can help spread risk), expand market share, gain access to new technology, strengthen distribution network and R&D capabilities and increase profits and therefore returns for shareholders.

    The acquisitions or tie ups made by the Indian corporations in the past two years are beyond the domestic market; competing for space in the global economy with the present occupants indicating their high ambitions to grow. The sectors which have witnessed a flurry of M&A activity are banking, pharmaceuticals, steel and cement among others. In India, the early mergers and acquisitions were carried out by government agencies or by financial institutions within the framework of a regulated regime and were also more national and regional in nature. However, post liberalisation and on account of opening up of economy, Indian companies became aggressive and in recent times are venturing overseas to strengthen their position internationally. Let us study in detail the rationale for merging with or acquiring companies.

    To gain scale of operation and market share:
    Let us take the example of the steel industry, which has witnessed consolidation activity in the recent past. Considering the nature of the industry where supply cannot be immediately controlled to influence the price, there is need for price stability for the steel producers to expand capacities. The steel prices have been quite volatile and the current phase of consolidation is expected to bring in stability. Further, the strategies behind merger and acquisition also depend upon the need to integrate or de-integrate the activities, apart from expanding scale of operations. The acquisition of Corus by Tata Steel was a move to de-integrate acitivities with the low cost upstream production being carried out in India and the high-end downstream processing facilities in end-user markets. Similar was the case with the Hindalco-Novelis deal. The deal marked Hindalco's foray into value-added aluminum products, transformed the company into the world's largest player in the downstream business of aluminum products and catapulted it to the fifth largest integrated aluminum player.

    To diversify revenues:
    Take the case of the pharma industry. Globally, the generics pharma industry is on a major consolidation mode on account of increased competition and margin pressure. Therefore the need to attain scale and widespread geographical presence has further given boost to M&A activity. Strong research expertise, well established marketing network, large product portfolio, desire to diversify geographically and consolidate market share has led to cross border deals in the recent past. Leading domestic players such as Ranbaxy and Dr.Reddy's made large acquisitions in Europe to augment revenues from this region and reduce dependence on the highly competitive US generics market.

    To rationalise costs:
    M&A lead to economies of scale with increases in size of operations apart from increasing penetration levels and stable pricing power. At times deals are stuck to integrate facilities and achieve cost synergies. The Reserve Bank of India (RBI's) decision to merge United Western Bank (UWB) with IDBI has benefited the latter in terms of rural penetration. Moreover, the cost of operations and NPAs (non performing assets) of WUB was on the lower side as compared to IDBI. Thus, the deal has not only helped IDBI increase market share and customer base but has also supported its declining margins.

  • IDBI's performance analysis of the first quarter ended June 2008.

    Strengthen product/service portfolio:
    This is another rationale for acquiring companies. A wider portfolio of offerings helps the company remain competitive and also leads to de-risking of revenues. The latest in line is the Infosys's move to acquire Axon highlights the software major's move to strengthen its IT consulting business, while de-risking revenues geographically.

    To gain access to technology:
    Many Indian companies do not have the technical know how of high standards as seen in developed countries. To develop the same requires considerable investments in terms of value and time. The acquisition route to some extent solves this issue by paying a little premium. Thus, some acquisitions are targeted to gain access to technology or domain knowledge or intellectual rights. Tata Motors' move to sign the Jaguar Land Rover (JLR) deal highlights the formers strategy to get hold of state of the art technology to be competitive in the auto industry.

  • Read our result analysis of the auto major for the 1QFY09.

    Not all are successful
    While there are numerous benefits for which the companies strike M&A deals, integrating the business of a newly acquired company is a difficult task. Not all the M&As turn out to be successful. Further, for M&A activities, some companies leverage their balance sheet or dilute stake as not all are funded through internal accruals. Meanwhile, the acquirer company has to witness cash outflows in terms of repayment of funds raised for the acquisition and if the cycle reverses resulting into lower realisations, it results into a drag on the company's profitability. Take the case of Tata Steel, which has leveraged its balance sheet to fund the Corus acquisition. Corus's performance has not been so heartening and if synergising the businesses takes time then the resultant cost savings will be deferred.

    On the other hand, Grasim's acquisition of L&T's cement division later rechristened Ultratech at the time of upturn in the cement cycle has not only resulted in improved logistics (as Grasim's markets, which were at a fair distance from its plants can now be served by Ultratech Cements' plants) but also benefits in terms of economies of scale.

    To conclude...
    In case of M&As it is not only important to achieve cost synergies but also to integrate employees and work cultures. More importantly, the valuations have to be reasonable for the acquiring company to create value from the acquired company. Only then will the shareholders of the acquiring company stand to benefit in the longer term.

  • Read the two most classical ways of disrupting a takeover threat.



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