The Indian stock market has begun to rally of late and the rupee seems to have halted its free fall. Yet some say it’s too soon for investors and companies to heave a sigh of relief.
Investments into India could come from cash-rich companies in Japan and the U.S.
If 2011 was a tough year for companies across several industries, 2012 won’t be a whole lot better, industry insiders say.
In an attempt to curtail inflation, India’s central bank raised interest rates several times through most of 2010 and 2011. Apart from curbing inflation, the consecutive rate increases dampened the availability of credit across sectors. This has made several companies financially vulnerable –perfect targets for acquisitions.
Munesh Khanna, head of advisory and senior partner at Grant Thornton India, an accountancy and advisory firm which advises Indian businesses on their global strategies, says he expects several Indian companies to be financially stressed. This is because of a combination of reasons—a slowing economy, high interest costs, a surging dollar and increasing rates on the foreign currency convertible bonds. These are bonds issued by Indian multinational firms to raise money in the different currencies they operate with. One way to deal with these stresses is to join forces.
“A lot of Indian companies are beginning to see the value in consolidation,” he says.
The Wall Street Journal spoke with three firms to get their predictions for the M&A market for the year ahead. Here are some of the key trends.
Cross border investments
“There’s definitely a stress in the [Indian financial] system,” says Ashok Wadhwa, the group chief executive of Ambit Group, a Mumbai investment bank. Companies have been feeling the pinch and are in need of cash, he says.
Mr. Wadhwa says cross-border investments into India could come from cash-rich companies in Japan and the U.S. Japanese companies, across sectors, are typically prudent and have a lot of cash on their balance sheets. With limited opportunities for growth at home, and having already invested in the U.S. and China, India is the next frontier for these companies, he says.
On the American side, many of the large U.S. companies, like Apple Inc. and PepsiCo Inc., already get a good chunk of their revenues from outside the country and are eager to take part or expand their presence in the consumption-driven Indian economy.
Mr. Wadhwa also expects Indian companies to go overseas to make acquisitions, partly driven by a need to hedge themselves against the slowdown in the Indian economy as well as the policy paralysis in the government. The Indian government has been hit by a string of corruptions scandals for more than a year and critics have accused the government of not passing many major initiatives since it was elected to a second term in office in 2009.
Which sectors will see the next set of deals?
Mr. Wadhwa expects to see mergers between equals or acquisitions by bigger rivals in telecom, power and financial services. A common theme across these sectors is that there are too many players as a result of which margins to make profits are significantly thin.
He is also predicting a consolidation in the infrastructure side of media and entertainment including in direct-to-home satellite service and cable TV. These require a lot of capital, which has been generally tight because of high interest rates.
Apart from telecom, Grant Thornton’s Mr. Khanna expects to see some deals in steel and mining sectors, insurance and the airline sectors. All these areas are overcrowded with several unprofitable, small to medium sized players who will be bought out by larger players, he says.
Mr. Khanna is expecting a shakeout in the insurance sector as well as this is another sector with too many players.
Mr. Wadhwa agrees on the airline sector and has been predicting a change in legislation before the budget session to invite foreign direct investment. (Earlier today a panel of Indian ministers recommended allowing foreign airlines to invest in the aviation sector)
“I don’t see why global strategic companies should not be allowed to invest in Indian companies,” he said. Middle eastern airlines like Etihad, Emirates, Qatar, for instance, would have a strategic interest in investing in Indian firms as a significant number of Indians work in the region, he says.
What will be the role of public markets?
Grant Thornton’s Mr. Khanna says the domestic capital market is pretty shallow. Large parts of several of the big corporates that trade on the Indian indices are owned by the promoters of those companies and by financial institutional investors, leaving very few shares to freely float and be bought by retail investors. As a result, stock markets go up when foreign institutional investors and foreign funds come in but “that won’t be happening in a hurry” because of the political deadlock.
Apart from that, despite its recent gains, the stock market continues to be pretty choppy and many privately held companies are putting on hold their plans to go public because of which the IPO market will be tepid, at best. Companies that were hoping to go public to raise cash may instead fall back on the private equity firms.
Where, then, are private equity firms likely to invest their money?
Darius Pandole is a partner at New Silk Route Advisors Pvt. Ltd., an Asia-focused private equity firm that was co-founded by former McKinsey & Co. head Rajat Gupta that now has $1.4 billion under management.
The good news in the current gloomy economic environment, he says, is that valuations of companies are down anywhere from 15% to 25% from a year ago. This means promoters are willing to sell their companies at a lower price, making several companies a lot more attractive for investors like him.
However, he has no doubts that it will be a tough year and investors will have to tighten their belts and maintain an investment discipline. His advice is to look at well-managed growth companies that can deliver results through cycles.
“As we look for companies to invest in, we look for management teams that possess competence and integrity, business models that are scalable and sustainable through cycles,” says Mr. Pandole.
Another key criteria for Mr. Pandole as he makes any investments is the “visibility of exit options,” he says. Most private equity firms that made investments in India in the past five to six years haven’t had much success in exiting those investments. One typical exit route for firms like Mr. Pandole’s is to take the company public—a dim option for this year with a rocky stock market.
Some of the sectors that are high on his list of possible opportunities include infrastructure, consumer services (anything that has a play on India’s growing young and middle class), manufacturing in technically-oriented sectors like high-end pharmaceutical and auto ancillaries.
Within infrastructure, Mr. Pandole says he will be focused on construction companies, renewable energy, ports and logistics.
Investments into India could come from cash-rich companies in Japan and the U.S.
If 2011 was a tough year for companies across several industries, 2012 won’t be a whole lot better, industry insiders say.
In an attempt to curtail inflation, India’s central bank raised interest rates several times through most of 2010 and 2011. Apart from curbing inflation, the consecutive rate increases dampened the availability of credit across sectors. This has made several companies financially vulnerable –perfect targets for acquisitions.
Munesh Khanna, head of advisory and senior partner at Grant Thornton India, an accountancy and advisory firm which advises Indian businesses on their global strategies, says he expects several Indian companies to be financially stressed. This is because of a combination of reasons—a slowing economy, high interest costs, a surging dollar and increasing rates on the foreign currency convertible bonds. These are bonds issued by Indian multinational firms to raise money in the different currencies they operate with. One way to deal with these stresses is to join forces.
“A lot of Indian companies are beginning to see the value in consolidation,” he says.
The Wall Street Journal spoke with three firms to get their predictions for the M&A market for the year ahead. Here are some of the key trends.
Cross border investments
“There’s definitely a stress in the [Indian financial] system,” says Ashok Wadhwa, the group chief executive of Ambit Group, a Mumbai investment bank. Companies have been feeling the pinch and are in need of cash, he says.
Mr. Wadhwa says cross-border investments into India could come from cash-rich companies in Japan and the U.S. Japanese companies, across sectors, are typically prudent and have a lot of cash on their balance sheets. With limited opportunities for growth at home, and having already invested in the U.S. and China, India is the next frontier for these companies, he says.
On the American side, many of the large U.S. companies, like Apple Inc. and PepsiCo Inc., already get a good chunk of their revenues from outside the country and are eager to take part or expand their presence in the consumption-driven Indian economy.
Mr. Wadhwa also expects Indian companies to go overseas to make acquisitions, partly driven by a need to hedge themselves against the slowdown in the Indian economy as well as the policy paralysis in the government. The Indian government has been hit by a string of corruptions scandals for more than a year and critics have accused the government of not passing many major initiatives since it was elected to a second term in office in 2009.
Which sectors will see the next set of deals?
Mr. Wadhwa expects to see mergers between equals or acquisitions by bigger rivals in telecom, power and financial services. A common theme across these sectors is that there are too many players as a result of which margins to make profits are significantly thin.
He is also predicting a consolidation in the infrastructure side of media and entertainment including in direct-to-home satellite service and cable TV. These require a lot of capital, which has been generally tight because of high interest rates.
Apart from telecom, Grant Thornton’s Mr. Khanna expects to see some deals in steel and mining sectors, insurance and the airline sectors. All these areas are overcrowded with several unprofitable, small to medium sized players who will be bought out by larger players, he says.
Mr. Khanna is expecting a shakeout in the insurance sector as well as this is another sector with too many players.
Mr. Wadhwa agrees on the airline sector and has been predicting a change in legislation before the budget session to invite foreign direct investment. (Earlier today a panel of Indian ministers recommended allowing foreign airlines to invest in the aviation sector)
“I don’t see why global strategic companies should not be allowed to invest in Indian companies,” he said. Middle eastern airlines like Etihad, Emirates, Qatar, for instance, would have a strategic interest in investing in Indian firms as a significant number of Indians work in the region, he says.
What will be the role of public markets?
Grant Thornton’s Mr. Khanna says the domestic capital market is pretty shallow. Large parts of several of the big corporates that trade on the Indian indices are owned by the promoters of those companies and by financial institutional investors, leaving very few shares to freely float and be bought by retail investors. As a result, stock markets go up when foreign institutional investors and foreign funds come in but “that won’t be happening in a hurry” because of the political deadlock.
Apart from that, despite its recent gains, the stock market continues to be pretty choppy and many privately held companies are putting on hold their plans to go public because of which the IPO market will be tepid, at best. Companies that were hoping to go public to raise cash may instead fall back on the private equity firms.
Where, then, are private equity firms likely to invest their money?
Darius Pandole is a partner at New Silk Route Advisors Pvt. Ltd., an Asia-focused private equity firm that was co-founded by former McKinsey & Co. head Rajat Gupta that now has $1.4 billion under management.
The good news in the current gloomy economic environment, he says, is that valuations of companies are down anywhere from 15% to 25% from a year ago. This means promoters are willing to sell their companies at a lower price, making several companies a lot more attractive for investors like him.
However, he has no doubts that it will be a tough year and investors will have to tighten their belts and maintain an investment discipline. His advice is to look at well-managed growth companies that can deliver results through cycles.
“As we look for companies to invest in, we look for management teams that possess competence and integrity, business models that are scalable and sustainable through cycles,” says Mr. Pandole.
Another key criteria for Mr. Pandole as he makes any investments is the “visibility of exit options,” he says. Most private equity firms that made investments in India in the past five to six years haven’t had much success in exiting those investments. One typical exit route for firms like Mr. Pandole’s is to take the company public—a dim option for this year with a rocky stock market.
Some of the sectors that are high on his list of possible opportunities include infrastructure, consumer services (anything that has a play on India’s growing young and middle class), manufacturing in technically-oriented sectors like high-end pharmaceutical and auto ancillaries.
Within infrastructure, Mr. Pandole says he will be focused on construction companies, renewable energy, ports and logistics.
