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Avoid acquisitive Indian cos, say analysts

Avoid acquisitive Indian cos, say analysts
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First Published: Fri, Apr 27 2007. 01 11 AM IST
Updated: Fri, Apr 27 2007. 01 11 AM IST
New Delhi: Watch for more Indian companies to go on global shopping sprees. And for many investors, that might be the best thing to do: Just watch.
Some market observers recommend steering clear of domestic companies with global merger-and-acquisition plans unless investors plan to hold the shares a long time. In the short term, the analysts say, such shares are likely to suffer.
To the observers, some corporate titans now in an acquisition mode may not be the best bets for investors looking to buy into India’s growth spurt.
Annual growth of more than 8%, easier access to funds and a desire to compete on the world stage have fuelled a global buying binge that analysts say is far from over.
In January and February, Indian companies concluded or arranged $21 billion (Rs86,100 crore) in foreign purchases as they sought production capacity, new technology and enhanced access to overseas markets. In all of 2006, by comparison, they spent only $9.9 billion, according to accounting firm Grant Thornton.
In the past two weeks, the Essar Group has unveiled two billion-dollar deals—to purchase ailing Algoma Steel of Canada for about $1.63 billion, and to invest $1.65 billion to buy privately owned Minnesota Steel Industries and build a new steel mill to be fed by its iron-ore assets. India’s biggest privately-owned power company, Tata Power Ltd, agreed to pay $1.3 billion for 30% stakes in coal companies owned by Indonesian miner Bumi Resources.
Many of the bigger deals were leveraged buyouts, meaning the Indian companies, using a mixture of equity and debt, have taken on financial burdens for the purchases. And while the deals could well make sense in the long term, many immediately dented the buyer’s share price.
“The investors have not been very happy for the near to medium term,” says Phani Sekhar, a fund manager at Mumbai-based Angel Broking.
Since Hindalco Industries Ltd’s $5.73 billion purchase of Atlanta-based aluminium company Novelis in February, its stock has underperformed the Bombay Stock Exchange’s 30-share Sensex. Hindalco’s share price has dropped 14% while the Sensex is off 2.2%. On 31 January, the day Tata Steel Ltd closed its $12.9 billion acquisition of Anglo-Dutch steelmaker Corus Group, the company’s stock price skidded 10.7%. Since that decline, and particularly this month, Tata Steel’s shares have recovered but mainly because of a positive global outlook for steel demand. Thursday, they closed at Rs560.45—about 10% higher than on 29 January, just before the 31 January plunge.
Shares of Indian wind-turbine maker Suzlon Energy Ltd have been under pressure since 9 February, when it unveiled a bid for German wind-energy company Repower Systems. Since then, Suzlon has been locked in a bidding war for the company with French nuclear-engineering concern Areva. Shares of Suzlon are 4.4% below where they were when the bid was unveiled. Investors have a number of worries about foreign purchases, including how the deals will be financed, whether they make strategic sense, and what they will mean for earnings—especially if the buys are too costly.
Big deals tend to load a company with debt or dilute shareholders’ equity through the issue of new stock. Tata Steel, for example, has said it plans to raise $4.1 billion through a rights issue and convertible preferred-share issue to partially fund its Corus deal. While Tata Steel hopes to cut $350 million in operating costs through the purchase, analysts are concerned about diluting shares to fund the purchase.
Crisil, the rating service majority owned by Standard & Poor’s, placed Hindalco and Tata Steel on a ratings watch with “negative implications” after they announced their foreign acquisitions.
“Tata Steel has overstretched itself. Hindalco has overstretched itself,” says Sekhar of Angel Broking. “Execution risk comes into play,” he says, expressing concern that Indian companies lack experience absorbing international businesses with different corporate cultures, employment rules and other complicating factors.
Big purchases can also hurt earnings in the short term. In February, Merrill Lynch downgraded its rating on Suzlon Energy to “neutral” on concerns that the company would get into a bidding war for Repower, which it did. Merrill also said dilution of Suzlon’s per-share earnings was inevitable. Even if the deal ultimately failed, the brokerage said costs associated with the bid would lower Suzlon’s earnings per share by 8.5% in the year ended 31 March. A successful bid would trim Suzlon’s earnings per share by 13% in fiscal 2008, Merrill predicted.
To be sure, not all foreign deals—or talk of them—have immediately hurt Indian companies’ shares. Shares of United Spirits, one of the world’s largest liquor marketers, have remained steady despite widespread speculation it will acquire Scottish whisky outfit Whyte & Mackay. When reports surfaced of a possible deal in August, United Spirits’ shares were under Rs600 each. The stock later rallied, helped by a good profit performance and rising alcohol consumption in India. Thursday, its shares fell 0.31% to close at Rs854.85. Amnish Aggarwal, an analyst at Motilal Oswal, rates the company a “buy” and has an 18-month target price of Rs930.
In the long term, analysts say overseas acquisitions can pay off, helping some Indian buyers become international giants. For patient investors, that could be good reason to buy and hold the shares.
“I think on a case-by-case basis some companies might be able to do justice to the large acquisitions that they’re making,” says Sunil Singhania, a senior fund manager with Reliance Mutual Fund, India’s biggest mutual fund. Deals that offer something new, like access to new technology, could be worth a hefty price, he says.
Still, many analysts advise caution. While there can be “an enormous amount” of long-term advantage from purchases, “in the short term, people are uncomfortable,” says Jigar Shah, head of research at the Mumbai-based K.R. Choksey Shares & Securities. “At the first sight of a large cross-border acquisition…the main originator company’s (stock) is going to start suffering.”
Abhrajit Gangopadhyay in Kolkata contributed to this story.
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First Published: Fri, Apr 27 2007. 01 11 AM IST
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