India Inc in bind over billion-dollar buys

'Bull Market Blunders' Pull Down Parent Cos' Profitability, Result In High-Cost Debt

Mumbai: When Reliance Industries chairman Mukesh Ambani acquired German textile manufacturer Trevira in 2004, elevating him as the world's largest polyester fibre and yarn producer, little did he know that the firm will have to file for bankruptcy within five years. This may not have been a big-ticket acquisition but a sizeable majority of all billion-dollar acquisitions that India Inc indulged in during the mid 2000s have so far yielded little by way of returns. 

    At a time when India Inc says that it finds it easier to invest abroad because of a combination of issues in India — including high interest rates, policy paralysis and delay in clearances — it sounds paradoxical. A TOISMC Global Securities study reveals that most of India's billion-dollar-plus acquisitions in the last five years are still not making money and has dragged down the profitability of the parent company due to the monies involved in servicing the high-cost debt. 
    The exception is Tata Motor's acquisition of Jaguar Land Rover (JLR) and 
the takeover of Novellis by the AV Birla group. 
    In the case of Tata Motors, JLR enjoyed breakeven during 2009-10 and now contributes around 80% of the parent's profits. 
    Within months of Tata acquiring Corus for $13 billion in 2007, the Aditya Birla Group flagship Hindalco acquired Novelis for $6 billion, making the combined entity the world's largest rolled-aluminium producer. Debu Bhattacharya, MD of Hindalco and VC of Novelis, describes Novelis as a paying asset. "We are spending more to produce as operational costs have gone up significantly and at the same time we are getting less from selling as the LME (London Metal Exchange) has dropped to 1970 levels," Bhattacharya said, commenting on Hindalco's falling bottom line. 
    The study took into account only acquisitions worth over a billion dollars and not asset acquisitions since analysis became difficult in the absence of numbers reported by companies in this regard. "As fund availability was quite easy, Indian companies chased deals with huge enthusiasm in 2007. However, as the economy slowed from 2008 and liquidity dried up, many of the billion-dollar acquisitions have proved to be bull market blunders," Jagannadham Thunuguntla, strategist & head of research at SMC Global Securities, said. 
    Returns on equity (ROE) as well as on investment (ROI), both measures of a company's profitability, are depressed (see table). While ROE is the profit that a company generates through shareholders' money, ROI is the measure of profitability of an investment. 
    Typically, if the return on equity is anything less than 12%, it's nothing great because you get 10% on bank fixed deposits. Assuming you borrow at 6% to fund global acquisitions, an ROE in the 15-30% range is considered good. On a consolidated basis, the profitability of Tata Steel, Bharti Airtel, United Spirits and Reliance Industries was lower in 2011-12 compared to their standalone results, analysts said. 
    Tulsi Tanti-owned Suzlon Energy has not been lucky. Suzlon's ROE from German wind turbine maker REpower, which it acquired in 2007 for 1.3 billion euros, has been less than 4% with an ROI of around 7% in the last two years. It therefore did not come as a surprise when Tanti tried to sell the German firm to pare debt, but the deal collapsed on valuation issues. Suzlon, 
however, has kept its chin up. "We see our investment in REpower not just from the standpoint of financial returns, but rather in the context of our strategic objectives," a Suzlon spokesman said, describing the acquisition as a success. 
    Later in 2009, ONGC — through its overseas arm OVL — acquired UK-based Imperial Energy Corporation for over $2.1 billion. Last quarter, OVL had to make a provision of $408 million, or a fifth of what it paid, because of its poor performance, hurting OVL profits. A provision for impairment of Rs 1,953 crore ($408 million) has been made in respect of subsidiary, Jarpeno, as the asset is performing lower than estimates and the 'value in use' computed for the asset as on March 31, 2012, was lower than its carrying value, said an OVL statement in May. 
    Bharti Group's $10.7-billion acquisition of Zain's Africa business in 2010, the second-largest deal involving an Indian company, shares a similar fate. The ROI on the Zain acquisition has been just 2% in 2011 while the ROE is pegged at 6.5%. An email sent to the company in this regard went unanswered. 
    If analysts are to be believed, UB Group's acquisition of the Scottish distiller Whyte and Mackay in May 2007 for $1.1 billion through United Spirits (USL) has not worked wonders either. UB Group does not show ROI and ROE from Whyte and Mackay in its books of accounts. It, too, did not respond to TOI's queries on the issue. 
    It's no different for the Ruias-led Essar Group either, which acquired Canadian steel firm Algoma for $1.7 billion in 2007 with more than $1 billion of debt. Essar Steel Algoma clocked revenues of C$2.5 billion and EBITDA of C$453 million in FY09. Revenues fell to C$2.1 billion and EBITDA almost halved to C$282 million in FY12. The company is reportedly evaluating plans to sell stake in the firm or list it to raise funds. "Essar Steel Algoma has performed operationally and financially as per Essar Group's expectations and is now well integrated…with potential for further value addition and improvements," an Essar spokesman said. 
    Among billion-dollar asset acquisitions, the last big one was RIL's $3.8-billion acquisition of shale gas fields in the US in 2010, which the company says turned profitable in the first year of operation. Other large asset acquisitions include the purchase of 
Link Energy's coal assets by Adani Group for $2.3 billion and GVK's purchase of Hancock Coal's assets for $1.26 billion. 
    Since they require further infrastructure creation, returns would come only after a gestation period of three to five years. 
    "If you look at ROI and ROE in global acquisitions, most of them are negative; in some cases they are positive but in single digits. Assuming the average cost of loans are 6%, then ROI in most acquisitions, which are highly leveraged, would turn negative. This can be seen from consolidated results as Indian firms are posting good results on a standalone basis. But these costly acquisitions are weighing down consolidated results," said investment advisor S P Tulsian. 
    Videocon group chairman V N Dhoot agrees that most large acquisitions by India Inc have not been profitable. Deepak Parekh, chairman of HDFC, however, said that it's a cyclical issue and should correct when the product cycle improves. 
    Experts suggest that the way out is cost-cutting, portfolio rationalization, debt reduction or to exit investments even if it's at a loss. It's therefore not surprising that while some companies are looking at debt restructuring, some are even evaluating sales to deleverage their balance sheet.