India leapfrogged 30 places in the recently-published Ease of Doing Business index brought out by the World Bank. This is a singular feat any country can aspire for.
India leapfrogged 30 places in the recently-published Ease of Doing Business index brought out by the World Bank. This is a singular feat any country can aspire for. One key factor commentators have missed while remarking on this is India emerging as an investment hotspot, leading to a spike in mergers and acquisitions (M&As). An important point to note here is that foreign capital’s appetite to be part of the India Growth Story has been sector-agnostic. The spate of M&As that the country has witnessed despite global headwinds and domestic disruptions—though these were transient—cut across sectors and themes. There are a host of positives that are playing out in India’s favour, including macro-economic outlook and a fast-changing regulatory eco-system—and both are central to the current M&A outlook. The Indian economy has stayed resilient over the past several quarters, mainly because of a stable fisc, easing credit conditions with manageable inflation and continued progress in reforms.
The government has distinguished itself by going with both incremental or granular reform measures and top-gear reforms. The reforms race that the government seems to be in is no sprint event, but a marathon. This has spurred M&A activity—both cross-border and consolidation within—and a key indicator of this were the big-ticket announcements that drove total deal value to a record level, compared to the ticket size of the deals struck during the past five years or so.
Despite the fiscal slippage and downward revision of the GDP growth forecast, the economy can now count on the support of three solid pillars: exports, stepping up of capital expenditure by the public sector—especially in the infrastructure space, which has the maximum forward and backward linkages—and consumption growth. Economic growth will gain traction with all these three themes taking central stage going forward.
Rising growth and limited capacity additions imply that capacity utilisation cycle will only head upwards from here. The long lead time for creating new capacity means that most sectors will experience higher pricing power as utilisation rates rise. The companies that were keeping their businesses a going concern with borrowed money have realised that such models no longer work after banks started taking the IBC route. This has left debt-heavy companies with little headroom but to put assets on block.
There is another factor that keeps the party going in the Deal Street. It is simple business logic that instead of setting up a greenfield project or going for a brownfield expansion, a better option is to go for buy-outs at lower level of valuations. It brings down the lead time for the acquirer looking to consolidate business or foray into newer verticals. It is a proven fact that for most of the capital-intensive sectors, it takes 3-4 years to set up new capacity. Hence, acquisition is a faster way to build capacity at the turn of each growth cycle.
It should also be noted that lower capital expenditure doesn’t always stem from the lack of finances. In fact, many big business enterprises have been sitting on huge cash piles. With the opportunities for expansion through the ‘inorganic’ route, with the added advantages of lower valuation levels and reduced lead-time, many companies will start buying existing capacities at bargain prices.
For the past 12-18 months, cash-rich companies have been rewarding shareholders through higher payouts or buy-backs for better capital allocation. However, with the growth cycle looking up, firms are sure to use their cash reserves to add capacity, keeping the M&A pot on the boil. The big-bang recapitalisation plan of PSBs announced by the government is expected to free locked-in capital of banks and make it available for corporates with good financial track-record, abetting the M&A action.
As already said, the foreign demand for quality Indian assets is also high. This is reflected in a quantum leap in foreign direct investment (FDI) contribution to GDP numbers. The market’s positive take on the India Growth Story, brushing aside the overheating thesis, is also a positive for M&As.
Further, equity valuations are currently trending in the middle range, which is a major positive for deal making. So, a sweet spot in the win-win combination of ability to buy and willingness to sell making 2018 the beginning of a new M&A cycle is indeed foreseeable.
The author is founder & MD, Singhi Advisors