Cafe Economics | Niranjan Rajadhyaksha
The global acquisition bandwagon has stalled, ever since the international credit market stumbled into a crisis in August—a crisis that could worsen in the months ahead as estimates of loan losses mount. So, we now have nothing to match the headline-grabbing deals of early 2007: Tata Steel and Corus, Hindalco and Novelis, Suzlon Energy and Repower.
That’s not surprising. In July, Café Economics had asked whether it was time to end the leveraged buyout (LBO) revelry. “The entire LBO party has been fuelled by cheap money, because interest rates have been very low in recent years thanks to central banks across the world. In other words, LBOs have been an arbitrage between the credit markets and the market for corporate assets. You borrow from one to buy in another. The ground is now shifting below the feet of the party-goers, as borrowing costs in the credit markets have started inching up.”
The lack of easy money to fund overseas takeovers has had its expected effect. But this does not mean that Indian companies will have to stay away from global acquisitions till the loan party comes to life again.
Perhaps it is time to use another type of acquisition strategy—stock swaps, where an acquiring company uses its own shares as currency to take control of a target company. Each shareholder in the target is offered a certain amount of shares in the acquiring company in exchange for his original shares.
Here’s why this could work.
The past few months have seen a very significant shift in global valuations, as investors have come to believe that Asia is decoupling from the US. Emerging market stocks now attract better valuations than stocks in the rich countries, for perhaps the first time ever. A recent report in The Economic Times shows that the market valuation of ICICI Bank is now at par with that of Lehman Brothers, a Wall Street investment bank. State Bank of India has a higher value than Singapore’s DBS. In a few years, it is likely that many Indian companies will have market values that are more than their global competitors.
More generally, the MSCI index for emerging market stocks has a trailing price-earnings multiple that is 12% higher than that for developed markets. And this could widen. The Economist says that CLSA strategist Christopher Woods expects the forward price-earnings multiple of shares in emerging Asia to “peak at twice America’s”. Though the two sets of figures are not strictly comparable, you can get the general idea. Investors seem to be ready to pay far more for every dollar of profits in emerging markets, compared with what they will pay for American profits.
And given the fact that economic growth in our part of the world is most likely going to be far quicker than that in the US, Japan and Europe, it is not unrealistic to expect emerging market companies to play catch up with their rich-world peers. China has already caught up, though this is also because of its irrationally exuberant stock market. Petro China was briefly valued at a trillion dollars, making it the world’s most valuable company. And Industrial & Commercial Bank of China (ICBC) has a market value more than that of Bank of America.
It’s all about the price of acquisition currency. LBOs and cash deals had a good run over the past few years because of the low price of global credit. Stock swaps could be the next big thing because of the high price of emerging market shares. Companies that have higher valuations need to offer fewer of their shares in exchange during an acquisition. You get more for less.
But there is a problem. Business families control many emerging market groups. A stock swap will dilute their control, as the investor base widens. To the extent that control matters, business families in Asia (including India) have little incentive to go in for this variety of acquisitions.
Mittal Steel had used a combination of cash and stock offers to buy Arcelor in 2006. One reason this was possible is that the Mittal family owned 88% of Mittal Steel before the Arcelor acquisition. Their holding in ArcelorMittal, the new merged entity, is down to 49.4%, enough to maintain control.
There are undoubtedly many Indian companies where the controlling family owns a large chunk of the share capital—DLF, Wipro and TCS, for example. Then there are the cases such as ICICI Bank and HDFC, where ownership is widely distributed and the top management does not come from a “family”. But a majority of Indian companies do not fall into either of these categories, and will find it difficult to do large stock-swap mergers without putting management control under threat.
So how will Indian companies that have an acquisition opportunity respond—by going in for a stock-swap acquisition or preferring to maintain tight control? It’s an interesting choice.
Your comments are welcome at cafeeconomics@livemint.com
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