The world’s richest Indian recently lost an opportunity to get even richer. Lakshmi Mittal, who was in the race for Mitsui & Co.’s controlling stake in exporter Sesa Goa Ltd, was beaten by compatriot Anil Agarwal. Agarwal’s Vedanta Resources Plc. picked up Mitsui’s shares and said it would buy an additional 20% from the public. The total cost is $1.37 billion (Rs5,617 crore). Sesa Goa is an ore mining firm. ArcelorMittal’s steel plants could have used that stuff. Vedanta produces non-ferrous metals. Analysts speculated that Agarwal probably wanted to lower his commercial risk by adding iron ore to the copper and zinc businesses he already owns.
That’s probably true. Yet, Sesa Goa’s real appeal isn’t in the company’s mining projects, but in financial statements.
It’s virtually an automated teller machine (ATM). Take a crude measure of the firm’s surplus cash flow: the money it made from mining last year minus what it invested. Divide that by long-term borrowings. You get a figure of, hold your breath, 885. Only one company in the Standard & Poor’s 500 Index—The McGraw-Hill Companies—is more tempting, if you exclude those that have no debt and need to be judged by other investing yardsticks. Buyout firms, on the prowl for underleveraged firms, love targets that can service loans costing 150 basis points above the London interbank offered rate (Libor) with their own cash flows.
Company boards in Asia should pay attention to cash. Buyout funds are bound to come calling soon, if they haven’t already. If control is important, manager-owners should follow the lead of Malaysian billionaire T. Ananda Krishnan, who is buying out minority shareholders in Maxis Communications Bhd, the country’s biggest mobile-phone operator, possibly by raising funds in the bond market.
Among companies in Asia, excluding Japan, with at least $1 billion in market value and some long-term debt, Sesa Goa’s “LBO (leveraged buyout) attractiveness” is only exceeded by Taiwan’s Inventec Co., one of the world’s top manufacturers of notebook PCs, and Bursa Malaysia Berhad, operator of the country’s stock exchange.
Loans raised for Asian buyouts surged to $28 billion in 2006, from just $7.5 billion in the previous year. Almost 45% of the activity, however, was concentrated in Australia.
The base may now broaden. From a Taiwanese maker of golf-club heads to an Egyptian fertilizer company, all kinds of emerging-market assets are now in play.
Within Asia, Taiwan has an added advantage. Not only are its tech firms generating dollops of cash, stock-market valuations are cheap. The price-to-earnings ratio of Taiwanese stocks is about 19, compared with a 10-year average of 29.
Getting acquired is, of course, one of several options. The other is to go out and invest in new assets or return the excess cash to investors. J.T. Wang, chairman of Taipei-based PC maker Acer Inc., said in April that he would do both.
The companies that follow Sesa Goa closely on my “Asian ATM” list are PT Tambang Batubara Bukit Asam, a state-run Indonesian coal miner; and KT&G Corp., South Korea’s biggest tobacco company. Both are underleveraged: They can pay their long-term debt with the free cash they generate in half-a-day. Bukit Asam said last month it will use its growing pile of cash—and take loans—to acquire rivals.
KT&G ended up on investor Carl Icahn’s radar last year. Together with US hedge-fund manager Warren Lichtenstein, Icahn bought stock in the company and threatened a takeover unless shareholders got a better deal. Icahn and Lichtenstein ended their alliance after KT&G announced plans to buy back shares and pay higher dividends.
The strategy of Asian managements in the past few years has been to make the best possible use of existing assets. They have made the wheels of business turn faster.
In many instances, that strategy fetched ample returns for investors. But it hasn’t always worked. Hindustan Lever Ltd (HLL) has sold at least six businesses in the past five years and yet managed to boost both sales and return on equity even with pre-tax margins that are narrower than in 2002.
Cash is coming in by the truckload, and the company is returning more of it to shareholders than it is investing in its future. The markets are unimpressed. Shares of HLL have given a total return of 30% over the past five years even as the benchmark Sensex has returned 410%.
In December, Patrick Cescau, chief executive of parent Unilever Plc., said the Indian unit will seek new acquisitions locally. Investors are waiting.
Why are companies in the developing economies of Asia not investing more boldly? “This reluctance to invest may reflect some lingering cautiousness stemming from the excess capacity and overzealous investment of the late 1990s and the high hurdle rates used by companies in assessing new investments,” the International Monetary Fund noted in its latest Global Financial Stability Report.
With strong global economic growth and easy financing conditions, the corporate under-confidence is puzzling. It’s time Asian managements stopped gloating over their earnings graph and paid closer attention to cash. Too much of it can be as bad for shareholders as too little.