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Thursday, February 22, 2007

Mergers & Acquisitions in India 2007

by Envenkat: Mumbai

The Indian media, has found a new bandwagon – M&A. Corus, Vodafone – Hutchison India, Novelis, Daewoo Electronics, Sinvest, REPower have already been announced. More than USD 25bn would change hands if all the above are consummated, and the first quarter has not even ended! Who knows how many more are in the works ? This set me to thinking about what it is that has really changed in the IndianEconomy, why are we currently seeing so many more of these announcements?

Global flows of Capital into the Country

Pre 1990s, this type of inflow was largely represented by Multilateral and bi-lateral agencies (World Bank, IMF, ADB, JICA…). During the late 90s, with the stock market liberalization and the advent of electronic trading, the FII vehicle became a convenient and efficient channel for such flows. It is estimated there is now over USD 100b of FII money in Indian capital markets. With such a large positive investor experience, the FDI investors could not be far behind. In 2006, FDI in fact overtook FII as a source of funding. However in 2007 it is likely that Outward FDI become greater than Inward FDI.

To put this in another perspective the deals so far announced have a transaction value of more than USD 25 bn, and include around USD 20 bn in acquisition funding! This is close to the External Commercial Borrowing limit, of USD 22bn, set by RBI for the entire country in FY07. So global capital markets are willing to almost double the capital available to Indian Corporates for financing their global acquisitions.

This increase in capital availability is against a global backdrop of rising interest rates and a commodity outlook which is stable or trending downward. Not the kind of scenario in which Risk Managers would recommend increasing allocations for an Emerging Market. Or is it that, India is different this time ?

Investment Grade rating for India

S&P completed its review and in Jan 2007 upgraded India to Investment grade, and hence now all the major credit rating agencies, agree that India is investment Grade. So maybe the Acquisition Funding opportunities were able to capitalize on this very rapidly. We have started hearing about many non-banks wanting to increase their deployment into Indian opportunities.

In the INR/ USD outlook markets have started discussing the possibility of an appreciation. Many of the Indian Corporates have become Net Foreign Exchange Earners, and thus have a natural hedge, if the INR depreciates.

Maybe somethings have changed. But how has the fundamental risk profile of the Indian Corporate undertaking these kind of transactions changed ?

Risk Profile

FII’s, as a shareholder class, are now a significant group in both the Corporates listed on the Stock market, and in Private Equity Funds seeking to invest in unlisted sectors/entitites. FII’s don’t have voting rights in the listed entities, hence would typically walk in case their perceptions concerning a given business change. This has also led to the need to maintain a Quarter On Quarter (QoQ) performance view. Maybe this is making Corporates view M&A opportunities as another option by which to meet their QoQ expectations.

Regulatory Issues, too are contributing – Custom duties are now down to the teens, and the Government has even started talking about single digit custom duty levels. This is now coming close to global levels. If Indian Corporates have to survive and thrive they have to operate at global scale. And M&A is definitely a more rapid way to achieve this! Another development which has significant bearing is the USD 180 bn which is sitting in the country’s foreign exchange reserves. People are concerned about getting better returns than those available from US treasury . Hence the Government too is supportive about using the reserves for Outward FDI, and getting National Pride up into the bargain!

The Managerial profile too is changing – In the early 90s, promoter holding was low, and levels of Debt in the Company were high. With the good corporate performance we have seen in the last few years, debt levels in companies have significantly reduced, and the promoter holding in many companies has now gone up. There are many Companies where the promoter holding is in excess of 50%. This along with the comparatively low gearing, has put the Promoter back in the driving seat of the Corporate strategy.

Maybe that is why we are seeing a rash of M&A transactions in 2007.

What will be the impact of these M&A transactions on Corporate performance/ Strategy – watch out for my next post on this.