Mergers and acquisitions (M&As) have become an integral part of India’s corporate landscape. Scarcely a week passes without news of an Indian company buying a firm abroad. This is part and parcel of globalization. In an increasingly integrated global economy, it makes sense to have a global footprint.
The reaction to this process has been very positive, and not just from the corporate sector. The media has largely played the role of cheerleader, egging on their champions in a rather bizarre display of corporate jingoism. Unfortunately, the positive spin given to acquisitions, and the hype and excitement surrounding them, has often obscured the risks involved.
There are some indications, however, that a more mature approach to M&A activity is slowly emerging. Equity investors, for instance, have become far more sceptical about the benefits of takeovers, almost invariably punishing them with lower valuations. Recent high-profile cases in point have been Tata Steel’s takeover of Corus and Hindalco’s acquisition of Novelis. This is hardly unusual—the “winner’s curse”, which lowers the stock prices of acquiring companies, has long been a feature of mature markets.
It has also long been known that two-thirds of all acquisitions fail to achieve the benefits planned while making the bids. These concerns have recently been highlighted by rating agency Crisil. In a research note, the agency has said that the spate of M&As runs the risk of impairing the credit ratings of acquirers.
Tata Steel and Hindalco have already seen their ratings take a hit. The Crisil note argues that the reason why the spate of M&As has so far failed to stretch corporate India’s balance sheets is because they were so healthy in the first place. The restructuring of the 1990s and the lack of capital expenditure had led to companies having a lot of cash on their balance sheets, very low debt to equity ratios and fat cash flows. Those benign conditions, says Crisil, are changing. The tendency towards larger deals, for instance, has led to companies increasingly taking on debt, either on their own balance sheets or against the assets they have acquired. In either case, provision has to be made for servicing the debt.
Even if the debt is on the books of the acquired company, the onus is ultimately on the acquirer, since it has to protect the value of its acquisition. Corporate India’s capacity expansion, funded in large part by external commercial borrowings, has led to higher debt-equity ratios. Moreover, a four-year stockmarket boom has raised valuations and the risk of overpaying for acquisitions is currently very high. The risks of acquisition have increased.
One of the reasons why acquisitions are often made at too high a price is the hubris of chief executives. Inflated egos all too often are more concerned with leaving their mark on the company, rather than creating shareholder value. Peer pressure adds fuel to the fire, a fire fanned assiduously by a horde of M&A specialists and investment bankers eager to bag big deals and fat fees.
That doesn’t mean that M&A activity should slow down or stop. Rather, as a recent Mint study underlined, there is vast scope for consolidation in most industries, which will enable companies to achieve greater economies of scale and pricing power. In many industries, Indian companies are only a fraction of the size of their global competitors and there is an urgent need to scale up. And the success of a company such as Mittal Steel is a shining example of the value of inorganic growth. The challenge, of course, is to ensure that good targets are acquired cheaply, can be integrated easily and without straining the acquiring company’s balance sheet. In these times of easy money and sky-high valuations, that’s easier said than done.
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