Sanjay Bhandarkar, managing director, NM Rothschild, tells Shobhana Subramanian that M&A activity in the near term could be stymied by the fact that not too many corporates are sitting on cash and the fact that confidence levels right now are low. Bhandarkar believes that, going ahead, foreign companies would be eyeing buyouts in India and, given that several smaller promoters are looking to sell, the number of in-bound acquisitions is set to rise.
2011 hasn?t seen any big deals yet, just the several deals in the natural resources space.
It?s a mix of sentiment and also the fact that the last few years have seen some really large outbound deals. Almost every big group which had the ability to do so did acquisitions of a size that take time to absorb both managerially and technically.
Moreover, these are uncertain times and people are focused on making acquisitions work but the
limited evidence of the last few years shows us that Indian companies have done very well in the way they have cut costs or improved profitability. We also find that some players want to sell to foreign players, rather than a domestic player, because the perception is that they would get a premium. Also, even though there is a slowdown, promoters are hopeful and are willing to wait it out.
We?ve seen several inbound acquisitions, especially in the pharmaceuticals space, the latest being Abott-Piramal.
The inbound theme, in general, is going to be a much bigger theme going ahead and that?s because, despite all the gloom in financial markets overseas, both European and US corporates are sitting on a lot of cash. Generally top companies are net cash; that?s the only bright spot. When things settle down, they would want a bigger share of the high- growth developing markets; to my mind that?s a natural corollary. Also, there are promoters who do want to sell out. I?m not saying that the big groups will do so but, in the mid-corporate space, we are seeing such a trend. That trend will get accelerated because, partly, capital needs have increased and in times of volatility not too many people are able to raise the capital. Also, there are strings attached to that capital and, in some cases, smaller players are apprehensive of competition from the big boys.
What do you make of the 26% mandatory open offer to minority shareholders as stipulated in the new takeover code?
I think the code is a good one and, in the absence of acquisition financing in India, the scales are tilted in favour of foreign buyers. Therefore, the 26% buyout of minority shares is sensible for now and I would think offering to buy out 100% of minority shareholders is the longer-term objective. The increase in the threshold for an open offer to 25%, from 15% earlier, is sensible since it allows promoters to raise money from other sources like PE funds or even a strategic investor. On the flip side, 25% is effectively like giving 26% in a listed company context, but that should make promoters focus on the company?s performance and ensure that it?s not a deeply undervalued company.
Promoters today are selling businesses rather than companies, thereby depriving the minority shareholders of an exit.
I don?t see how the code could have addressed that because in most cases promoters would have been able to out-vote the smaller shareholders, since they do own fairly large stakes. But, at the end of the day, it?s not as though the cash is going directly to the promoter and the minority shareholder is not seeing any of it; the cash is going to the company.
In India, it is somewhat different since in most other parts of the world, the concept of a promoter doesn?t really exist.
Do you see a change in the mindset of Indian promoters who no longer see it as a failure if they choose to sell out?
That mindset has clearly changed and is one of the main factors leading to more in-bound acquisitions. The younger generation has different interests and multiple options. One saw a lot of this happening in the 1990s in Germany where many of the mid-sized entrepreneurs sold out. Today, very often, the second generation is not always interested in the business and at times businesses owned by 7-8 family members where each one doesn?t have enough of an economic interest.
We don?t see too many LBOs in India.
We don?t have access to local debt financing and there?s a limit to how much can come from foreign banks in India too, even if they leverage their global balance sheets. So, if I?m borrowing in a holding company overseas, which then owns 100% of an Indian operation, the only access I have to cash flows to meet that obligation is dividend payments from India where I have paid corporate tax and dividend distribution tax. If I had that debt on the books of the operating company, I could have used the operating cash flows of that company to service the debt plus I would have had a tax shield on it. So raising money overseas is not a very efficient way of raising debt, it increases the size of the cost and raises cost.
The PEs haven?t done too much either.
There has been a pick up in PE activity this year. But it?s still not that easy to do deals in India.
The larger players don?t want to compromise their investing style too much, so they don?t want to get into classical growth investing which is applicable in India. They don?t mind not being in control but they want to have a significant level of influence. They know India is an important market, but they?re in no hurry and that?s good because patience is very important in India. It?s better to wait and get good deals. Some like KKR do structured finance, high yielding debt like preference capital. That gives the promoter also greater flexibility because it?s a substitute for equity but at the same time allows him not to dilute; it allows him to leverage the equity.
In this market, is cash more valuable or equity?
That depends on how the buyer views his equity at the time of the purchase. In a depressed market, it would be rare for an acquirer to use its own equity if cash is an option. In a frothy market, you would see more equity deals as it provides the acquirer some hedge against future fall in the market.
How leveraged are corporate balance sheets today compared with 2008?
At a broad level, it might seem like corporate India is less leveraged but if you look closer you see that there aren?t too many people who are comfortably sitting on cash. That?s the sense I get. If you leave aside some of the consumer companies, most other sectors don?t really have the cash to go out and do something aggressive. Also, operating cash flows could be under pressure if the global recovery is delayed. So there will be a period of listlessness for some time as far as M&A is concerned and action will be sporadic. M&A is all about animal spirits and confidence, right now that?s not too high.