Merger - It's the most talked about term today creating lot of excitement and speculative activity in the markets. With the turmoil in the equity markets, 'takeovers', 'open offers', 'buybacks' and 'acquisitions' are some of the terms, which are making the noise in the markets. But before Mergers & Acquisitions (M&A) activity speeds up, it has to actually pass through a long chain of procedures (both legal and financial), which at times delays the deal.
With the liberalization of the Indian economy in 1991, restrictions on M&As have been lowered. The numbers of M&As have increased many times in the last decade compared to the slack period of 1970-80s when legal hurdles trimmed the M&A growth. To put things in perspective, from 15 mergers in 1998, the number crossed to over 280 in FY01. With a downturn in the capital markets, valuations have come down to historic lows. It's high time that the consolidation game speeds up.
What is merger and why it happens? In simple terms, a merger means blending of two or more existing undertakings into one, consequent to which each undertaking would lose their separate identity. The most common reasons for mergers are, operating synergies, market expansion, diversification, growth, consolidation of production capacities and tax savings. However, these are just some of the illustrations and not the exhaustive benefits.
However, before the idea of M&A crystallizes, the firm needs to understand its own capabilities and industry position. It also needs to know the same about the other firms it seeks to tie up with, to get a real benefit from a merger.
Globalization has increased the competitive pressure in the markets. In a highly challenging environment a strong reason for M&A is a desire to survive. Thus apart from growth, the survival factor has off late, spurred the M&A activity worldwide.
Take retail finance for instance. With corporate banking becoming an unprofitable business for banks due to high risk of asset quality, banks including financial institutions are tapping the retail finance segment. ICICI's acquisition of Anagram Finance from Lalbhai group, HDFC Bank's merger with Times Bank and ICICI Bank's merger with Bank of Madura are some of the latest examples of consolidation in the banking sector. We could see the similar trend perking up in other sectors.
Valuations: Any understanding on M&A is incomplete without a discussion on valuation. During the course of a merger procedure, normally a Chartered Accountant or a category-I Merchant Banker is appointed to work out the value of shares of companies involved in the merger. Based on the values so computed the exchange ratio is worked out. It is the value at which a buyer and seller would make a deal. There are certain basic factors, which determine the value of a company's share. As these are very subjective factors, valuations generally vary from case to case depending on assumptions and future projections. Some such factors are listed below:
- The company's business prospects and nature of its business
- The prospects for industry in which the company operates
- Management reputation
- Goodwill and brand value
- Marketing network
- Technology level
- Efficiency level in terms of employees
- Financial performance
- Future earnings
- The legal implications
- Government policy in general and in particular for that industry
- Current valuations of shares in stock markets
Factors affecting M&As in India
Indian corporates are largely promoter controlled. As a result, it is difficult for either of the two promoters to voluntarily relinquish management control in favour of the other in case of merger between two companies.
Merger deals often require prior negotiations and concurrence of banks and financial institutions apart from SEBI's rules and regulations. Reluctance of these entities sometimes keeps the entire process on hold. In August 2001, SEBI barred a number of promoters and their associate companies from accessing the capital markets for non-compliance with takeover regulations. Mr. Arun Bajoria and his associates are one of them. Similarly Hindujas, Videocon International and Sterlite Industries were disqualified for bidding for the government's stake for disinvestment transactions.
Valuation factor also sometimes delays the deal. Absence of efficient capital market system makes market capitalization of companies' unattractive. A number of deals announced in earlier months were called off due to dismal state of capital markets affecting companies' valuations. Take for instance, the downturn in the IT sector and low valuations for IT stocks prompted Maars Software International to call off its merger with Mascon Global.
Any M&A decision is a commercial decision. It should not only be beneficial to both transferor and transferee companies, but it should also be in the interest of members and creditors of both transferor and transferee companies and also in public interest.
The latest example is open offer by Zydus Cadila to acquire German Remedies for Rs 650 per share. Reportedly, two other bidders had submitted much higher bids for the stake in German Remedies to Asta Medica and Heller AG (the two foreign promoters who were selling their stake). However, the Zydus Cadila group also offered to acquire the rights to five pharma brands held by Asta Medica apart from acquiring a stake in the company. Consequently, this Rs 526 m deal at price of Rs 650 per share, was clinched in Zydus Cadila group's favour. Since the shareholders of German Remedies would not benefit from the sale of these five brands, they filed a complaint against this deal with SEBI in April '01.
The most common factor, which generally delays any M&A process, is the legal regulations. In India, the M&A activity is required to pass through several laws including Companies Act, Income Tax Act, Foreign Exchange Management Act, SEBI Act and Industries (Development and Regulation) Act. Many M&A deals announced in earlier months have been stalled, pending hearing by the courts and regulatory authorities. These include open offers for Castrol India, German Remedies and Foseco India.
These factors many times results in a cancellation of a potential M&A deal. The disinvestment of Air India received a major setback due to some of these factors. On September 1, 2001, Singapore Airlines withdrew from the disinvestment process, leaving the Tata group as a sole bidder for the government's 40% stake. The Tata group is now evaluating the induction of other international airline majors to bid for the government stake. However, the September 11 incidents have stunned the world airline industry and thus the disinvestment of Air India is unlikely to get through in the near future. The government's own complicated rules and regulations have resulted in it losing significant revenues (through delay in the disinvestment process).
As a result, the government has introduced various measures to facilitate speedy clearance of M&A deals. The Competition Bill, cleared by the cabinet on June '01 is one such action from the Centre. The Bill has exempted all companies from informing the government about any M&A deal. It would now be optional for companies to pre-notify M&A deals to the statutory body, the Competition Commission of India. This body would review only those M&A cases, which would result in post merger turnover of over Rs 30 bn and an asset base of over Rs 10 bn.
At the same time, this Bill would also track any M&A deal, which would create a monopoly or would lead to market dominance in the Indian industry. If the merged entity is found to be anti-competitive, it would be asked to split.
The relaxation of FDI policy (in May '01) is another step in the right direction. Increasing FDI limit in pharma, telecom, civil aviation, real estate and banking sector would now attract foreign investment in the country. Out of the 73 acquisition deals announced in August '01, over 50% of the acquirers were foreign companies, constituting an estimated 60% of the total consideration of Rs 16 bn.
The largest deal in August '01 was by British Gas Plc who proposed to take over the Pipavav LNG project for Rs 3.8 bn (US$ 850 m). The British energy major would invest this amount to increase the annual LNG handling capacity to 10 million metric tonnes from the earlier planned 5.3 million metric tonnes per annum. The LNG project envisages construction of an LNG terminal for importing, storing and supplying LNG to various companies in Gujarat. However, the Dabhol-Enron controversy could to an extent make Indian companies unattractive for investment purpose.
M&A loosing sheen...
But these were some of the few measures, to boost M&As in India. The government is yet to make laws more clear to stimulate M&A activity. During the first five months of FY02, 502 M&A deals, worth Rs 123 bn were struck. However, these were lower than the deals announced in the previous year. While there was an 18% drop in acquisition deals, mergers were 34% lower than those reported in the first five months of FY01.
|Merger (Rs bn)
Some of the major deals announced in the past few months
Acquisition of PSI Data by the Aditya Birla group for a total consideration of Rs 992 m was one of the largest IT deals in India. The acquisition was routed through group company Indian Rayon.
The Birla-Tata-AT&T combine and BPL Communications announced the merger of their cellular operations to create a combined entity of Rs 99 bn. The new entity would become the largest cellular operator in the industry with a subscriber base of 0.9 m and 24% market share of the mobile market in India.
Bharti Group another telecom giant, also consolidated its presence in the cellular industry through its acquisition of BK Modi-promoted Spice Cell for Rs 4.1 bn (US$ 90 m). It was the largest deal for the month of July. Bharti Group now has the largest presence in the cellular service industry with licences to operate in 15 out of the 21 telecom circles. This includes the eight new licences obtained in the bidding for the fourth cellular operator.
Pharma sector witnessed highest consolidation activity during the past 6 months of the fiscal year. Beginning with the merger of Nicholas Piramal with Rhone-Poulenc (India), followed by Pfizer with Parke Davis and Glaxo with SmithKline Pharma.
The M&A game in the Indian context has already made a healthy start. However, the structural and legal problems are adversely affecting the growth rates. Although, the government has realized this fact, it is yet to become proactive. With the entry of multinationals into the Indian markets, consolidation would be the best way to survive and to gain market share.