Cover Story: How To Add Value To M & A

The guns are booming. Empowered by the New Takeover Code, and emboldened by the emergence of vulnerable quarries in a troubled economy, corporate India's corner-room buccaneers have unleashed the country's third M&A Wave. The new legal framework governing M&A activity has opened the doors to hostile takeovers, setting out objective guidelines and allowing the predator and the prey to get on with their attack and defence manoeuvres without the Securities & Exchange Board of India's having to step in as arbitrator. Simultaneously, the market for corporate control has exploded, with M&A being accepted as a vital means for corporate restructuring and redirecting capital towards efficient managements. The on-going slowdown has depressed share prices to levels where acquisitions have become viable. And the political vaccuum has created the ideal opportunity to move in for the kill without the government's intervention. Adding to the ammunition, the financial institutions are signalling, for the first time ever, that they will no longer protect existing owners of companies from takeover bids. Thus, despite sharing the aggressive intent behind the first two waves--dating back to the mid-1980s and the early 1990s, respectively--the third M&A Wave is also dramatically different in terms of the extent of firepower it has armed both the battlers with.

M&A IS BECOMING EASIER...

Corporate restructuring is creating a market for both acquisition and disposal of business units.

Two years of economic slowdown are causing shakeouts in many sectors, forcing losers to exit.

Share prices are low enough to make acquisitions of large equity stakes feasible in terms of price.

A formal Takeover Code has laid out the mechanism for both hostile and negotiated takeovers.

The financial institutions are, for the first time, willing to help the M&A game by selling their holdings.

No wonder, then, that in the space of one blistering fortnight this past month, half-a-dozen M&A battles were initiated. The predator lurking within the Rs 8,342.75-crore Hindustan Lever resurfaced with the negotiated acquisition of the Rs 59.11-crore Lakmé from the Rs 35,000-crore Tata Group. A potent takeover Scud, targetting a 20 per cent stake, was fired at the Rs 1,162.78-crore Indian Aluminium by the Rs 1,146.72-crore Sterlite Industries. Alarmed by the prospects of consolidation in the aluminium industry, the Rs 1,457.15-crore Hindalco immediately launched a broadside against the Rs 162.28-crore Pennar Aluminium, bidding for a 13 per cent chunk of the company. Simultaneously, acquisitions resurfaced in the pharmaceuticals sector, with the Rs 400-crore Wockhardt snapping up the Rs 200-crore Merind. And the troubled cement industry saw a major restructuring bid as the Rs 832.49-crore India Cements mounted a raid on the Rs 349.64-crore Raasi Cement, aiming to increase its holdings from 18.03 per cent by another 26.78 per cent.

Loading your cannons to join the wars? Be warned. For, your acquisition gambit could backfire badly, foisting upon the acquirer myriad problems, as many of the participants in the M&A mega-binge of corporate US in the 1980s discovered. For, in their quest for what they fondly imagined as invincible proportions and market domination, they engendered crippling handicaps for themselves: directionless, diversified conglomerates instead of sharply-focused corporations. Unanticipated added costs instead of anticipated economies of scale. Paralysing cultural mismatch instead of energy-enhancing managerial synergy.

Of course, these are not inevitable outcomes of M&A. On the contrary, the benefits of a successful acquisition are powerful, offering as they do dominant marketshares, the strength of sheer size, and unique competitive advantages. But just how does the attacker know beforehand whether the acquisition he's targeting will be worth the price he has to pay? The swelling of the M&A wave has created a critical historical juncture, when this question must be answered if the entire process of restructuring through acquisitions and sell-outs is to generate real benefits for the participants. The need for an answer coincides happily with a research project--destined to culminate in a book--aimed at determining how to optimise the value generated by M&A moves. As the model it has constructed contends, the key issue is to weave M&A into your corporate strategy instead of pursuing it opportunistically. In other words, the acquisition must enable you to achieve the same objectives as you intended to with your strategies. Only then will your post-acquisition corporation go on to create more value than that of its parts. BT presents the acquirer's guide to making your M&A work for you.

Many managers were, apparently, overexposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toad's body by a kiss from the beautiful princess. Consequently, they are certain that the managerial kiss will do wonders for the profitability of the target company. Such optimism is essential. Absent that rosy view, why else should the shareholders of Company A want to own an interest in B at a takeover cost that is two times the market price they'd pay if they made direct purchases on their own? In other words, investors can always buy toads at the going price for toads. If investors, instead, bankroll princesses who wish to pay double for the right to kiss the toad, those kisses better pack some real dynamite. We've observed many kisses, but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses even after their corporate backyards are knee-deep in unresponsive toads.

Only recently unfettered from the rigid shackles of government control and exposed to market forces, corporate India will now have to chalk out and carry through long-term corporate strategies to enhance competitiveness and sustainability. They will have to index internal ability, and react to changes in their industries-and in the overall economy-to best avail the opportunities available. With 40 years of over-regulation resulting in deep distortions in the economy, there is an acute need for business to embark on a pragmatic approach to restructuring. M&A offers an obvious strategy for correcting the flaws of decades of a command economy. The prime motives behind employing M&A for restructuring:

The use of M&A as corporate strategy raises important issues. On the positive side, M&A may be critical to the healthy expansion of businesses as they evolve through successive stages of growth and development. For, both internal and external growth may be compatible with the long-range evolution of a company. Successful entry into new geographic and product markets often requires the speed, accompanied by an existing infrastructural framework, that only M&A can give access to. For these, as well as other reasons, some economists argue that M&As increase value through efficiency gains, and move resources to their best users.

Others are more sceptical, however, and claim that M&As are frequently disruptive, rarely resulting in efficiency gains. At best, they allow a redistribution of wealth, but generate no real economic benefits. Further, at the macro level, they affect investment, R&D, and employment-generation adversely, often bringing financial ruin upon companies. There are innumerable examples of companies that have been unable to bear the high costs of M&A, and have been forced to close down. There is, therefore, a real fear that Indian companies will over-react to their new freedom, and indulge in speculative and harmful M&A.

Since there is little scope for companies to learn from experience as M&A is a sporadic and time-consuming process, how, then, can they tell the toads from the princes as they adopt M&A as their chosen means for restructuring? Importantly, how does a predator determine whether or not a planned acquisition will prove beneficial?

The solution: identify possible ways of improving future gains by carefully selecting the type of mergers, the target company, the anticipated efficiencies, and a management strategy that will maximise potential synergy. This method will allow managers to practise a more realistic pricing policy, counter assimilation problems, and benchmark synergy expectations-all of which will, ultimately, lead to more value-creating M&A.

The management challenge for any corporation is to optimise the allocation of scarce and expensive resources such as capital, labour, research, training, and time in order to increase productivity. This, in turn, will boost value. The CEO usually has several options, and must assess the viability of each route given the expected increase in value it can provide. As there is great uncertainty about the success of each strategy so far as long-term profitability is concerned, even well-intentioned moves do not often improve shareholder value. As with any form of restructuring, M&A too should be placed within the framework of long-range strategic planning.

Thus, the objective of buying or selling business units, and bringing in accompanying changes in management, should only be undertaken if M&A will yield value to the respective companies. The rule of thumb: ascertain whether there is likely to be any economic gain from the merger. Post-M&A economic gain, or synergy, will be generated only if the two companies are worth more together than apart. Here, the Discounted Cash Flows (DCF) capture all additional future value. The basic motive of M&A can then be understood as an attempt to create value. The equation:

Synergy = Combined Value Of Post-M&A
A&B minus (Value Of Company A plus Value Of Company B)

Only if the synergy is positive will there be an economic justification for the merger.

It must also be remembered that there are several costs to an M&A manoeuvre: the price, the opportunity the cost of the acquisition, and softer issues such as culture clashes, integration friction et al, all of which lead to a price having to be paid by the companies coming together. While it isn't easy to factor these in, the attempt should be to make a realistic assumption about such costs. Using these calculations, the acquirer can then work out what his real cost of acquisition is.

From this simple analysis, it is clear that mergers will fail if the expected synergy does not exceed the premium paid, thereby creating no value for the bidder. However, many companies do not realise that they need to work specifically towards achieving these synergies. It is, in fact, possible to boost the synergy--by carefully selecting the type of merger, the target, and an optimum management strategy. Thus, the acquirer should not only have a clear understanding of its motivation for the M&A move, but must also link a management strategy to the motivation for the acquisition. This will help CEOs improve their understanding of the correlation between strategy and value-creation, enabling them to index the possible gains from M&A, ensure realistic pricing, anticipate and counter problems, have realistic expectations, and, ultimately, judge the impact on value.