Mergers & Alliances: 26/06/09

 

COMPANIES OPT FOR COST REDUCTIONS & EFFICIENCY IMPROVEMENTS
Rajiv Memani
The Economic Times

With the global economy in the grip of a downturn, corporate decision-makers have shifted their attention to survival in a tough market. However, in doing so, they risk forgoing those growth opportunities which often present themselves during the times of a slowdown. As organic growth in revenues is difficult to come by and profit margins are constantly under pressure, companies have been busy with much-needed cost reductions and efficiency improvements.

But is this enough to gain real competitive advantage and find the opportunities in adversity? Clearly, given the fact that most people are in business for the long-term , there must be a balance between the fight for survival and the quest for growth. A carefully identified and structured Merger & Acquisition (M&A ) transaction can accelerate growth by providing access to new markets, customer segments, technologies, human resources and economies of scale.

The current M&A activity, or the lack of it, needs to be viewed in this context. According to Bloomberg estimates , Indian M&A volumes have dropped from USD 42bn in 2007 to USD 33 bn in 2008 and just USD3.7 bn in the first three months of 2009. This is a worldwide phenomenon. Global M&A volumes are down to USD 427.4 bn in Q12009 from USD 2498 bn in 2008 and USD 4058 bn in 2007.

The reasons range from a shift in focus from growth to survival, higher risk-aversion , poor or no availability of capital for financing acquisitions, reduced private equity appetite etc. However, this really is the time for corporate strategists to consider M&A , as valuations are modest and an increasing number of companies are looking to consolidate by divesting non-core or non-performing assets and businesses.

In a recent Ernst & Young survey of 121 finance professionals in India conducted during February, 2009, a leading 78 percent of respondents thought that companies are either correctly valued or undervalued. Specifically, the metals and mining and IT and ITeS sector respondents felt that current valuations are low, while real estate and hospitality sector valuations were perceived to be still high and the consumer goods sector dominated the response on correct valuations.

Some recent M&A transactions in India where companies appear to have cashed in on low valuations include American Tower Corporation's acquisition of Xcel Telecom; TCS buying the BPO division of Citigroup and Sodexho's acquisition of Radhakrishna Hospitality. But generally, these have been few and far between.

A majority (63 percent) of our respondents felt that the slowdown will result in a consolidation in their sectors. Interestingly, the majority (58 percent) of our respondents in the above-mentioned survey told us that they would consider M&A as a prudent strategic decision for business growth during the slowdown. Yet, M&A volumes hardly reflect this conviction.

Non-availability of capital has been the biggest challenge. While banks have been reeling under a global liquidity crunch, private equity investments have dried up. Also, the Indian M&A boom had been driven by crossborder transactions, which have become much fewer due to lack of capital and increased caution. Further, market uncertainty has resulted in a widening of the bid/ask spread, where bridging the gap between buyer and seller expectations has made deal closures difficult.

Consequently, we are beginning to see some significant changes in the way transactions are financed and executed . With lower leveraging opportunities , promoter contribution has become important and banks may require additional comfort from borrowers . This will significantly reduce highly leveraged buyouts. Maximum debt levels are likely to be between 2.5-3 X EBITDA (post acquisition) vis-à-vis levels of 4-5 X EBITDA, structured through multiple levels of senior , subordinate, quasi and unsecured debt instruments.

Some of the solutions which can be considered include cashless transactions via the share-swap and asset swap route, delayed payment schemes, "earn-out" strategies, upside sharing and minority sales. A large number of all-share mergers could happen. Also, sovereign wealth funds, who continue to be more optimistic, can be considered as an alternate source of finance. Generally, with acquisition financing a challenge, big-ticket transactions may be fewer.

The author is Country Managing Partner, Ernst & Young

 

 

HAS THE TEMPLATE FOR A SUCCESSFUL JV CHANGED?
Arati Menon Carrol
The Economic Times

A year and a half ago, against the backdrop of a thriving Indian economy and an automotive market on overdrive, the Hero group announced a Rs 4,400 crore joint venture partnership with Daimler Trucks, a division of Daimler AG, giving Hero the opportunity to enter the commercial vehicles segment in India. In April this year, however, the Munjals unexpectedly announced a pull-out. Speculation had it that financial constraints forced them to re-focus on their core business of motorcycles; Hero Corporate Services chairman Sunil Kant Munjal blamed crashing demand in the commercial vehicle segment.

News of failed JVs has been doing the rounds; Britannia-Fonterra, TVS Group-Wabco and UTI-Shinsei Bank are among those who are either reviewing or have called off partnerships. Larsen & Toubro (L&T )'s plans to enter the non-life insurance business through a JV with US-based Travelers Insurance have also reportedly fallen through and engineering and construction company Punj Lloyd is exiting its two-year real estate business JV; chairman Atul Punj has admitted that a bad real estate environment prompted this decision.

So has the global economic meltdown found its latest victim? Strangely enough, industry pundits say this is a false alarm; partners aren't necessarily pulling the plug on JVs just so they can shore up revenues or cut costs. "If JVs are not working out it's less a sign of the times and more a factor of partners going their separate ways over the inability of the Indian partner to match investment dollar for dollar or a mismatch in business strategy," says Akil Hirani, managing partner at top law firm Majmudar & Co.

Ranjan Biswas, partner and national director India, transactions advisory services at Ernst&Young says a weak global economy does put pressure on JVs but not necessarily enough to break large numbers of them, but adds that for a joint venture to stand up to the event, both parties need to have thrashed out the harder parts of their partnership right at the start.

Hirani actually believes the opposite might be true. "A lot of Western multinationals are looking to beat the blues in their jurisdictions by partnering with Indian companies to leverage existing manufacturing or distribution networks in India." He might be right—news of fresh JVs has started doing the rounds.

IT training solutions provider Aptech is betting big on the Latin American market by entering into a JV with the Falgo group to set up IT training centres in Brazil.

So global recession may not have played spoilsport on this front but what it is having a significant effect on, says experts, are the foundations upon which partnerships are built. "The global recession is actually a great leveler. Traditionally the Indian promoter has always had his eye on taking the lion's share of profits by putting in the least amount of money.

So, has the template for a successful JV changed? Everyone agrees that the transparency factor will be key. Bajaj offers his advice: "If you have the right balance between aggression and focus on profits and follow similar corporate governance standards you're on the right track." Everyone agrees that there's likely to be less tip-toeing around common irritants like management and financial control and exit strategies.

Crucial issues that were just left open in the hope that they would be solved later on will now likely be knocked around at the outset. At the end of the day though, says Biswas, every JV has a shelf life. "The average life expectancy of a US company is 32 years. Recession or not, it's unreasonable to imagine a JV will continue in perpetuity."