End of the Indian outbound story?

October 2006: Tata Steel offers to buy British steelmaker Corus Group for $8.1 billion. November 2006: Brazilian rival CSN makes a counter bid of $8.4 billion. January 2007: Tata Steel outbids CSN and bags Corus for $11.3 billion.

February 2007: Suzlon Energy makes a $1.33 billion counter bid for Germany-based REpower Systems AG. Areva T&D of France increases its initial bid by bettering Suzlon’s initial bid. April 2007: Suzlon ups its bid, allowing it to get control of REpower for around $1.55 billion.

September 2008: Infosys makes a bid for acquiring consulting major Axon of the UK for $748 million. Days later, domestic rival HCL Technologies gets into the fray with a counter offer that’s 8 per cent higher. Days later, Infosys backs out from the race for Axon.

May 2008: Vedanta Group’s Sterlite Industries initiates talks to acquire American copper mining firm Asarco LLC for a proposed $2.6 billion. October 2008: Sterlite scales down its bid to $2.1 billion. Negotiations are still under way as Business Today goes to press.

It’s a remarkable turnaround— in sentiment, confidence and fortunes. Until last year, Indian companies were willing to pay virtually any price to buy assets or companies abroad. Promoters expressed their ambitions to “globalise” and become Indian multinationals, investment bankers made hay whilst the sun shone, and the media— both local and international— saluted these soldiers of fortune who were determined to break down domestic barriers and march boldly into uncharted territories.

It’s a slightly different story in these days of credit crunches and battered equities. Billion-dollar transactions, till recently par for the course for Indian promoters, have all but dried up. Even smaller deals are few and far between, despite assets being available at fire-sale prices. Robin Banerjee, CFO and Director (Finance), Essar Steel Holdings, sums up the situation succinctly: “Target companies are certainly cheaper now. But given the turmoil in the credit markets, it makes sense to conserve cash rather than go for an acquisition at this point of time.” The lack of action in outbound mergers & acquisitions (M&A) is evident in the slump in the numbers in 2008.

For those who’ve already cut those mega deals, which include India’s biggest conglomerates like the Tatas and the Aditya Birla Group, now is the time to rustle up those billions in prepayments and repayments on loans taken to bankroll the M&A spree. And that task is proving no walk in the park. Consider: Tata Motors had planned a Rs 4,145-crore rights issue to repay a bridge loan taken to finance the $2.3 billion acquisition of Jaguar Land Rover. The stock market crash made the rights issue at Rs 340 per ordinary share (and Rs 305 per share with lower voting rights) unattractive, as the price in the market dipped way below the offer price at the time of issue. Investors obviously chose to ignore the issue. Result? The company along with the merchant banker to the issue, JM Financial, had to subscribe to 60 per cent of the issue. Whilst this might have given the Tatas an opportunity to increase their stake in the automobile giant cost-effectively— from 33 per cent to 42 per cent—it still involved an outgo of around Rs 3,000 crore.

The Aditya Birla-owned Hindalco Industries found itself in a similar predicament, when its stock price fell below its rights issue price of Rs 96 per share. The aluminium major had floated the Rs 5,047 crore issue to repay a $3 billion bridge loan taken last year to fund the $5.7 billion acquisition of Novelis Inc. of Canada. With investors refusing to bite, the five bankers to the issue subscribed to 40 per cent of the issue, with the promoters mopping up to 50 per cent. Hindalco has managed to raise $982 million from a syndicate of 11 global banks at 3.15 per cent above the Libor (London Interbank Offered Rate), and hopes to repay the rest of the loan through internal accruals and by liquidating treasury holdings.

Whilst the Tatas and Birla were able to see their issues through, another cross-border mover, Tulsi Tanti of Suzlon Energy, wasn’t so lucky. Suzlon had little option but to scrap a Rs 1,800-crore rights issue due to lack of investor appetite. The company was raising money to increase its stake in REpower Systems, in which it had in June 2007 acquired a 34 per cent stake; Suzlon has hiked it to 90 per cent in 2008. It now needs to arrange an equivalent amount through other sources.

If the big boys are burning midnight oil to get their financing act together, medium-size enterprises have little option but hit the brakes in their quest for growth. For instance, the Pune-based Sanghvi Movers, a Rs 250 crore crane manufacturing company, has put on hold its plans to spend $2 billion on overseas acquisitions. Then there’s the Kolkata-headquartered Stone India Ltd., a manufacturer and supplier of railway equipments, which has been scouting for a European company in a similar business since September. Amitava Mondal, MD & CEO, Stone India, says those ambitions have been put on the backburner for now.

While the sharp drop in market valuations makes a case for acquisitions, it comes at a time when a global credit crunch has made banks pull back their lending activity, thereby affecting the financing of acquisition deals. Kishore Srinivasan, Executive Director (Structured Finance), Avendus Advisors, says a lot of deals are stuck because the cost of funding has gone up significantly. “Earlier banks were willing to lend at a mark-up of 3-3.5 per cent over Libor, which has now gone up to 6-6.50 per cent. Banks now want higher collaterals and stringent covenants for lending for an acquisition,” adds Srinivasan. Bridge finance, under which companies take a short-term loan to finance an acquisition and replace it with a mix of long-term loans and equity at the end of tenure, is clearly out of favour now.In such circumstances, cash, and companies sitting on cash, is king. “Companies that have a cash chest are clearly of the opinion that this is the best time to buy assets,” says S. Subramaniam, Head of Investment Banking, Enam Securities Pvt. Ltd. A senior executive at a foreign bank, on condition of anonymity, reveals that that he is advising only cash-rich companies to undertake an overseas acquisition. Companies that had lined up brownfield and greenfield expansion plans are now contemplating a buyout, which could be cheaper than putting up a new project, adds the executive.

Signs of bad times Companies’ fund-raising plans have been hit. Tata Motors along with merchant bankers JM Financial had to subscribe to 60 per cent of a Rs 4,145-crore rights issue, the proceeds of which are to be used to repay a bridge loan taken for the Jaguar-Land Rover acquisition. Hindalco’s rights issue to repay a $3 billion bridge loan taken to fund the acquisition of Novelis, too, was undersubscribed after the stock price fell below the issue price of Rs 96 per share. Five banks ubscribed to 40 per cent of the Rs 5,047 crore issue and promoters picked up 50 per cent. Suzlon Energy had to scrap its Rs 1,800 crore rights issue due to lack of investor appetite. The company was raising those funds to increase its stake in REpower Systems. Sanghvi Movers, a Rs 250-crore crane manufacturer, had plans to spend $2 bn on overseas acquisitions. Those plans have now been put on hold. Stone India, a supplier of railway equipment, had been scouting for a European company in a similar business, but has deferred negotiations.

For companies that have made the big buyouts, financing may not be the only concern. They’ve also got to worry about recessionary conditions that prevail in markets they have entered, and the sector in which they’ve made the acquisition. Reduced demand would mean lower production, which in turn will mean lower cash flows, thereby upsetting plans to retire debt through operations. In the steel sector, for example, in which Tata Steel acquired Corus of the UK, prices have dropped as demand has come off sharply. Result? Corus recently announced plans to cut production by 1 million tonnes over the next three months. Back home, Essar Steel, which acquired US-based Algoma Steel Inc. and a mining company Minnesota Steel LLC in 2007, is planning to adjust its production capacity in line with demand; the Ruia-owned group has put employees in Algoma Steel under notice in accordance with the terms of the Employment Standards Act in Canada. The Essar Group is in no hurry to make further acquisitions. Earlier during the year, the Ruias had made attempts to acquire the US-based Esmark for $668 million, but subsequently backed out after the transaction became too expensive.

Automobiles players face a similar conundrum as the sector is hit by slackening demand. When announcing Tata Motors’ results for the second quarter of 2008-09 last fortnight, Ravi Kant, MD, hinted that the commercial vehicle major has more than enough on its plate. “We are yet to complete the acquisition of Land Rover and Jaguar and will focus on it. We are not looking at another acquisition globally despite attractive valuations,” says Kant. Another Tata Group company, Tata Chemicals, which acquired US-based General Chemical Industrial Products Inc. for around $1 billion in January, says it has put restrictions on capital expenditure. “Liquidity is absolutely important now. Maintaining a high cash reserve is the best way to insulate oneself in the current market,” says P.K. Ghose, Executive VP and CFO at Tata Chemicals.

Investment bankers point out that the appetite for outbound M&A won’t go away. What will change, however, is the structuring of such deals. In the bull market, companies could go ahead and sign a deal even before tying up the finances, but now they want to ensure that money is tied-up well in advance, observes Subramaniam of Enam.

“The fundamental, strategic reasons for which Indian companies consider M&A have not changed. So, we haven’t seen waning of interest among potential buyers thus far,” says Sameer Nath, Head (M&A) at Citi India. Vishal Kapoor, Head (Acquisition Financing), Citi India, adds: “With the change in the market conditions, deal structures are likely to be more conservative with lower leverage and tighter covenants as compared to deals done during 2005 to the first half of 2007, when liquidity in the markets was abundant.” The burning question, however, is what happens if a buyer defaults on loan repayments—will the bank get recourse to the target asset? The Indian outbound brigade will be hoping it doesn’t get in a position to answer that question.

Tata Motors C. Ramakrishnan CFO

Acquisition made: Jaguar and Land Rover in March 2008. Cost: $2.3 billion. Mode of financing: Bridge loan of $3 billion to be repaid in June 2009. Raised Rs 4,145 crore through a rights issue. Has dropped plans to raise $600mn through ADR/GDR. Funds that still need to be tied up: $600 mn. CFO-speak: “We have time till June 2009 and at that time we will think of raising funds through equity-linked instruments”

Hindalco Industries Debu Bhattacharya Managing Director

Acquisition made: Novelis Inc. in February 2007. Cost: $5.7 billion. Mode of financing: Bridge loan of $3 billion to be repaid by November 2008. Raised Rs 5,000 crore from a rights issue, $1billion from treasury and around $1billion through a syndicated loan. Funds that still need to be tied up: Just raised around $1 billion, from a syndicate of global banks. MD-speak: “We have an efficient capital structure that will allow us to take further leverage. The interest outgo for the bridge loan will be lower now”

Suzlon Energy Tulsi Tanti CMD

Acquisition made: Increased stake in REpower Systems from 34 per cent in Feb 2007 to 90 per cent in 2008. Cost: Around $1.3 billion. Mode of financing: A seven-year loan, which in turn is to be financed through a convertible bond issue and a follow-on equity offering. A rights issue of Rs 1,800 crore has been scrapped. Funds that still need to be tied up: Rs 1,800 crore to acquire an additional 23 per cent stake in REpower. CMD-speak: “We are quite comfortable with the repayment requirement of our acquisition and capex debts”

Tata Chemicals P.K. Ghose Executive VP & CFO

Acquisition made: General Chemical Industrial Products Inc. Cost: $1 billion. Mode of financing: $500 million through an ECB, $350 million bridge loan for six months and $180 million through internal accruals and stake sale in group companies. Funds that still need to be tied up: Arranging for $350 million bridge loan to repay bridge loan in November. CFO-speak: “We have put restrictions on capital expansion. It’s important to preserve cash at this point of time”