The sudden burst of overseas acquisitions has left a lot of people in a bright mood—corporate bosses who have leapfrogged into the global big league, bankers who are counting their fees and uninvited cheerleaders who have been busy tooting the success of others.
That leaves the shareholders. What should they make of the megabuck deals that are being struck on their behalf?
The recent sharp fall in the share prices of Tata Steel, Hindalco and Suzlon shows that they are worried. Do they have good reason to worry? Some clarity on how overseas deals have been structured is a useful first step towards an answer. The Reserve Bank of India (RBI) says that the total value of direct foreign investment abroad in 2005-06 was $2.7 billion. That number is way below the more than $20 billion of global deals done by Indian companies last year.
The huge gap between the actual capital outflow from Indian balance-sheets and the total value of overseas deals tells us a lot about how the M&A game is being played. “Many acquisitions are taking place through an overseas SPV set to raise finances from the international market and such transactions are not captured in the overseas investment statistics,” RBI deputy governor Shyamala Gopinath said in a speech she gave in Mumbai in January.
It works something like this. The Indian company invests in the equity of an overseas subsidiary that has been set up to raise money for global acquisitions. The subsidiary then borrows from international investors. This money is passed on to yet another subsidiary, which does its own borrowing. And so on. In effect, the initial money put in by the Indian parent is leveraged several times over. Most global acquisitions are being built on a mountain of high-cost debt.
Are Indian companies taking too many risks in the LBO hunt? “It is too early to give a generic answer to that question. A lot depends on what the financial structure of the deal is. There are no common patterns in these LBOs,” R. Ravimohan, managing director of credit rating agency Crisil, told me. He says that his agency is comfortable with most overseas acquisitions as long as two conditions are met—the equity component of the deal is large enough and the debt matures between one and 15 years.
Indian companies are not taking on too much short-term debt. Credit rating agency Moody’s is worried that many Chinese, Korean and Indonesian companies are depending heavily on short-term debt to fund both growth and acquisitions.
But why borrow? Why not swap shares?
Last year, for example, L.N. Mittal took control of Arcelor by offering to swap shares. He offered Arcelor shareholders 11.10 euros of cash and one Mittal Steel share for every one Arcelor share held by them. There were other variants of this offer, including a pure cash deal of 37.74 euros per share. The point is that one of the alternatives that were offered to Arcelor shareholders was to trade their shares for Mittal Steel shares. Companies can offer (and have offered) to swap shares during takeovers over the years. But such deals seem to be racing into the list of endangered financial animals. Why?
I am reminded of a typically acerbic comment made by financial writer Michael Lewis in 1988, when LBOs crashed into America’s economy. “Management-led LBOs, in which a company’s managers use borrowed money to buy the company from its shareholders, have become the easiest way for people not born with $100 million to ensure that their children don’t similarly suffer.” Lewis was writing about a different type of LBO, in a different country and a different age.
Yet, his core observation stands the test of time: LBOs are about corporate ambition and control. Indian managements do not use stock swaps to buy large companies partly because the resulting equity dilution will be so severe that they’ll lose control of “their” companies. Hence, cash is king.
Fair enough—as long as corporate ambition is not being pursued at the cost of long-term shareholder wealth.
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