There is little doubt that Indian companies have come of age in the world market for M&A (mergers and acquisitions). In justifying a price for an acquisition, acquirers often cite as reasons — opportunities to buy out a major competitor, obtain access to new markets or ownership of a famous brand. In focusing on these reasons, however, Indian companies may simply miss out on the most obvious opportunity of all:The ability to bring value through the important but far less dramatic act of bringing better management processes to a less well run company.
The popular perception of acquisitions has been created from fiction such as the book, Barbarians at the Gate, which suggest an aggressive management approach usually involving the imposition of dramatic change. Things have changed since then. Several studies since that book was released indicate that turnover of senior management of the company being acquired is often negatively correlated with performance. At the same time, there is now a lot of evidence that, effective post merger integration is the largest value creator in the M&A process. It is, therefore, now well accepted that how you manage your acquisition is perhaps more important than what you buy.
This new finding is particularly relevant to Indian companies which often have superior systems of governance, better trained employees and exposure to more modern capital investment that their targets. This can seem counterintuitive if one visualizes all acquisition candidates as well established and financially strong Fortune 1,000 companies. In fact, the vast majority of less heralded acquisitions involve a well managed, usually listed Indian company buying mid-sized organizations in Europe or the US. This difference in governance quality and exposure to best practice can be further reinforced — several acquiree firms also have constraints on capital, may have stopped hiring, and could well suffer from low-employee morale.
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This gap in governance, really represents value left on the table, by the seller. In the following paragraphs, I try to describe some of the most common ways by which companies can add value to the acquisition even without other dramatic changes to the business structure.
Firstly, most large Indian acquirers are subject to a variety of governance checks, particularly if they are listed on stock exchanges. While these balances certainly exist in the developed world, they are typically likely to be applied with much less zeal to a company which is off the radar of management, as would be the case with a company for sale. These balances, when brought to the new acquiree, can reduce the incentives of managements to waste resources, bring in greater financial discipline and increase shareholder value in the long run. Greater levels of board engagement is a cheap and effective way to add value.
Secondly, even low-growth businesses do have many opportunities for positive NPV (net present value) projects with relatively low payback periods. Companies which are up for sale tend to become the victims of resource constraints. In several acquisitions that I have participated in, both in the UK and the US, many attractive projects simply fell by the wayside for want of funding once the sellers chose to defocus on the business. As new buyers, the Tata group was prepared to take a very different view of the market from that taken by the erstwhile owners and it did not hesitate to invest in several positive NPV projects that had been turned down before. These could often be relatively straightforward capital investments such as the installation of SAP to improve performance, upgrade of tea packeting machinery to reduce costs, or investment in new software to route voice traffic more efficiently. Almost always, we found that these investments paid for themselves within 18 months, but were eschewed by previous owners who had made up their minds to exit.
A preparedness to make the necessary intelligent capital investment in a newly acquired business is an effective way to build employee morale. As a CFO, I personally found the morale-boosting effect of the capital investment process one of the most rewarding parts of my role. During the acquisition of Teleglobe in Montreal by VSNL ( now Tata Communications), VSNL’s willingness to invest in necessary capital expenditure shortly after the closure of the transaction spoke far more eloquently of our commitment to the new business than any rhetoric could have done. Furthermore, in the same transaction, the fact that the boards and senior management of the organization both in Mumbai and in North America spent large amounts of time engaging with employees and communicating a longer-term vision resulted in greater employee commitment.
In addition to the above, Indian companies are now among the largest spenders on a variety of capital goods, giving them a procurement clout in excess of their size. This is particularly true in areas such as information technology (IT) and telecom where our markets are growing much faster than others. And thanks, perhaps, to India’s ability to leapfrog technology and processes, there are now many businesses where Indian companies are at the forefront of innovation. In the application of IT, in the proliferation of value-added telecom services, and in marketing to low-income consumers, best practices now originate in India.
One buys a company not only because of what it is, but what one can make of it.
Govind Sankaranarayanan is CFO, Tata Capital Ltd. He writes on issues related to governance. The views expressed in this column are personal. Write to him at email@example.com