The real acid test for any acquisition is whether it eventually makes money for shareholders.
It is too soon to decide whether global acquisitions by Indian companies during the past few years will pass this test. They could prove to be either strategic masterstrokes or financial albatrosses.
But one thing is obvious: They were badly timed.
Hindalco Industries Ltd’s struggle to finance the leveraged purchase of Novelis Inc. is well known. Global credit markets shut down before a $3 billion bridge loan was comfortably refinanced, a collapse in equity prices ensured that money could be raised from shareholders only after huge dilution, and a collapse in commodity prices damaged the free cash flow of both the acquired company and its acquirer.
Illustration: Jayachandran / Mint
But that was not the end of the problems. Novelis said on Wednesday that it had written down its “goodwill” by $1.5 billion, part of a $1.8 billion third-quarter loss reported by the wholly owned Canadian subsidiary of Hindalco. Most of the drop in the value of goodwill is because of the high market cost of debt.
These problems would have scorched Hindalco’s profit and loss account when the losses in its 100% subsidiary got into the Indian aluminium maker’s consolidated finances later in the year. But the company has now decided to take a controversial way out. It has decided to reduce its net worth rather than net profits.
More specifically, Hindalco has created a special “business reconstruction reserve account” by taking money out of the securities premium account. The new reserve will be used to write off some of the losses from the Novelis acquisition, thus reducing Hindalco’s net worth by the same amount. The more normal option would have been to set off the Novelis losses against Hindalco’s profits, a move that would, in all probability, have led to a further tumble in Hindalco’s share price.
Tata Motors Ltd had done something similar during the previous recession: It used its securities premium account to amortize costs it incurred in developing the Indica.
Investors should expect similar problems in the case of other large global acquisitions. Irrespective of whether the losses in global subsidiaries are set off against profits or reserves, it is quite evident that the global credit crisis and recession will pinch Indian companies which have taken leveraged bets on the global economy through their acquisitions.
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