Back in 2008, chief economic adviser Arvind Subramanian co-authored a paper showing that India had overtaken China in outward FDI as a proportion of GDP. Typically, FDI flows from rich to poor countries, and many Indian economists warned in 1991 that Indian industry would be decimated by multinationals if India opened up. Subramanian showed that Indian companies not only held their own, but invested aggressively overseas. Result: India’s outward FDI was 0.9% of GDP, higher than China’s 0.6%.
Many cheered this development. But today, outward FDI reveals more follies than blessings. This should be a warning to many acquisitions in the pipeline. Indian companies must reassess the risks and gains of investing abroad. History shows that most acquisitions and mergers reduce, rather than add, value. When economies are booming, profits are high and borrowing easy. So, companies use plentiful cash and credit for acquisitions. It seems an easy way of increasing sales and profits.
But in a boom buy, prices are high, and future profit projections tend to be over-optimistic. Aggressive bidding often results in sky-high prices that nobody would bid in more normal times. This is sometimes called the winner’s curse. When the boom ends, as all booms do, sales and profits fall way beyond expectations. Acquirers suffer huge losses that have to be written down, above all in countries with depreciating currencies.
Thanks to luck or good management, some acquisitions do succeed. Tata’s acquisition of Jaguar Land Rover (JLR) was a fabulous success. The huge losses of Tata Motors at home have more than been offset by JLR’s profits abroad. But the same group’s acquisition of British steel company Corus has been a disaster.
Tata has sold some of Corus’ assets and written down $1.6 billion to reflect its subsidiary’s woes. This is probably not enough: if auctioned today, Corus might fetch barely half the $13 billion Tata paid for it.
Kumar Mangalam Birla’s $6-billion acquisition of Novelis has proved indifferent, if not erroneous. His flagship company Hindalco took an impairment hit of Rs 1,380 crore on its Australian arm, Aditya Birla Minerals, where it had to stop copper production due to a sinkhole incident.
Crompton Greaves and Suzlon have lost heavily on foreign acquisitions. Naveen Jindal went for an iron ore mine in Bolivia, but had to quit after substantial losses.
Reliance has become India’s biggest company, but its foreign ventures have fared poorly. It acquired Hoechst’s polyester plant in Germany but had to shut that after big losses. It took up oil exploration in seven countries, but failed to find any worthwhile deposits. It invested heavily in shale gas/oil companies in the US, and this initially looked an excellent bet, but that’s no longer so after the sharp fall in the price of oil and gas.
Most Indians were delighted when Lakshmi Mittal acquired France’s Arcelor, to make ArcelorMittal the biggest steel company in the world. But its share price today has slumped to €9.70, against the acquisition price of $40.37.
Steel a Steal
Mittal started his global empire by buying up bankrupt public sector steel plants at throwaway prices, sometimes close to zero. He was able to turn these around in country after country. That was truly a winning strategy. But when he changed his strategy and went for a big-time buy at a high price, he suffered badly.
All major Indian pharmaceutical companies have become multinationals. Many of their foreign acquisitions yielded poor or negative returns for years. Today, many of their foreign operations have started looking good. The companies concerned say these were long-term bets that have finally paid off. Most of India’s top pharma companies now have higher sales abroad than at home.
A highly successful acquirer has been Motherson Sumi, an auto parts company unheard of 20 years ago that has become one of the world’s biggest, with 75% of its sales outside India. Bharat Forge and Amtek Auto have also made many foreign acquisitions, but with a mixed record.
The commodity boom of 2003-11 induced many Indian companies to invest in established coal companies or new mines in Indonesia and Mozambique, with disastrous results. GVK, Lanco and Adani aim to invest billions of dollars in Australian coal mines deep inland that require new rail lines and ports. The projects look very risky at today’s low coal prices.
Climate change worries may slash global power capacity based on coal, worsening the coal glut and attendant prices. Surely, a better strategy will be to wait for coal companies in some countries to go bust and then acquire those cheaply.
Opportunism will always beat gigantism in foreign acquisitions. Lakshmi Mittal fared brilliantly when he took over bust companies and turned them around. JLR had lost money for years under Ford and BMW, so Tata got it relatively cheap.
Cheapness alone is not enough: many cheap buys have flopped. The trick lies in discerning hidden value in depressed stock. That should be the guiding principle of future buys.