Critical issues in acquisitions

Why are companies, especially auto component manufacturers, on an acquisition drive, buying up companies abroad? What is the benefit? What is the driver of business efficiency of excellence or value creation that is happening through this route?

Let me just start with an example of creation of value through an M&A. The most widely spoken about M&A in the component industry is the one done by Bharat Forge of CDP which was carried out a year and a half ago. It was an acquisition of a company in Germany which made Bharat Forge the second largest forging entity in the world.

This acquisition also meant 120 million Euros of turnover. It was a profitable company and continues to be profitable. The total acquisition cost was 29 million euros. The interesting part is that when you look at this deal from a financial angle, the Bharat Forge balance sheet exposure stood at six million euros. So by adding a cost of around Rs 30 crore to its balance sheet it was able to increase its turnover by around Rs 1000 crore. That is the value of what an M&A does.

The ripple effect on the way the stock markets react, the way the balance sheets change and the way it can use the currency to go out and raise further funds (which it has actually done) and go out and look for more foreign acquisitions is a classic case of what is happening in the industry. Amtek is another company that started out similarly and has been more aggressive than Bharat Forge. They have created a lot of value in the company and have got out and raised $150 million of FCCB in the last couple of months. It is an interesting concept that different companies have used. So what is the driver behind it? Clearly, it is increased access to markets and customers which is perhaps the number one point. Access to a good production base is also very important.

Many companies think you go out there and shut down plants and come back here. But it does not work so easily. You have to be there, the customers want you at the doorstep. Bharat Forge had sent out a press release in which it mentions dual shoring instead of off shoring where it said it would be using complementary facilities in both sides of the world, in the expensive as well as low cost countries. Product portfolio is also enhanced as a result of M&A and you can look at some significant cost synergies. I think technology cost is one of the largest saving a company can have. A lot of cost savings in terms of testing, validation, research and development etc can also be made.

One of the key things driving M&As is easier availability of funds. Most of the mid-cap companies in India are getting a valuation of three to five times their EV/EBITDA. This most commonly used global metric of enterprise value by EBITDA (earning before interest, taxes, depreciation and amortisation) is 10 to 12 times internationally. So you are taking a currency of stock that is quoted 10 to 12 times EV/ EBITDA, raising funds against that, using financial leverage to double and triple that amount of money. The result is that you end up with a fantastic value creation. That is what is happening with all companies.

One must remember that for every successful CDP that is successful, there are 10 others that do not happen. You generally do not read about them but people like us get into that and understand that not everything happens successfully. So the more you evaluate, the more you plan, the less the pains at the time of closing a deal. Post-integration, there are a host of financial issues which are not unmanageable, there are legal issues and also a hot of challenges before any company.

So, if you are able to work with a strong information technology system you are able to sort things out better. I think the proof of the pudding is in the eating and one must talk to companies that have done M&As successfully, the Bharat Forges, the Amteks and the rest who have done it again and again.

Today more and more companies are considering M&As. It is an extremely viable of option available with most companies. If it is structured and financed carefully it is not as expensive as they are to be. You necessarily do not have to be a Bharat Forge to do that.