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Asia-PacificJanuary 8 2007

Gung-ho push for global domination

Indian companies from Tata to Videocon are making full use of the proceeds from foreign currency convertible bond sales to notch up a slew of high-profile global M&A deals. Kala Rao explains.
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The $7.6bn bid by Tata Steel to acquire British steel major Corus – with its prospect of becoming the fifth largest steel company in the world – revealed how audacious Indian companies have become in advancing their global ambitions. Early last month, Tata was getting ready for a possible bidding war with CSN, the Brazilian steel maker, which has made a counter offer. Irrespective of the outcome of that battle, what has grabbed the attention of financial analysts is that the contending buyers belong to emerging economies and the target is a large UK-based company.

Indian companies went on a buying spree last year, snapping up leading brand names in Europe and the US. The total value of announced Indian outbound M&A deals in the year to October 2006, was more than $18bn compared with $8.8bn a year earlier, according to figures from Dealogic. Tata Tea paid $677m for a 30% stake in US-based Energy Brands in August and Indian Hotels, another Tata company, snapped up the Ritz Carlton in Boston for $170m in October. In November, Zee Telefilms announced the purchase of a 50% stake in Dubai-based Taj Television, which owns Ten Sports, for $57m.

Videocon Industries and Ripplewood, a private equity fund, are sizing up Korean company Daewoo’s consumer durables business in a purchase with a potential price tag of about $720m and auto company Mahindra & Mahindra is acquiring Schoeneweiss, a German auto components company, for about $400m. Other large acquisitions made by Indian companies last year include wind energy company Suzlon’s purchase of Eve Holding, the Belgian group, for $526m; and pharmaceuticals company Dr Reddy’s acquisition of Betapharm, the German group, for $570m.

Asian El Dorado

In the past six years since its first major global purchase of Tetley, Tata group companies have added names including Daewoo, Ritz-Carlton, Glaceau flavoured water, NatSteel and, if they are successful, Corus to its stable. That India is still rated non-investment grade does not appear to matter; foreign portfolio investors who are flooding into the Indian stock market seem to have found El Dorado in an economy that is growing at more than 8% for the fourth consecutive year. Leo Puri, director at McKinsey, India, says that the rising acquisitive ambitions “reflect a changing landscape where there is a greatly improved perception of Indian companies, which has made larger resources available to them from international private equity, hedge funds and international banks”.

That “improved perception”, particularly among international creditors, has put a rich war chest, filled with loans from banks and money from the sale of foreign currency convertible bonds (FCCBs), at the disposal of Indian companies to make acquisitions.

Of the $31bn in foreign commercial loans by end June 2006, comprising about 23% of India’s external debt, $18bn are loans from commercial banks and $12bn by way of FCCBs.

For the most part, Indian companies are financing their foreign purchases from foreign borrowings. Regulations currently do not allow Indian banks to directly finance Indian companies’ foreign acquisitions, although some banks have got around them by lending to Indian companies’ overseas subsidiaries or joint ventures through funds raised by their offshore branches.

Deals such as Tata-Corus are structured as buy-outs leveraged on the cash flows of the target company with no recourse to Tata Steel’s balance sheet. “In such cases, offshore lenders support the ability of Indian managements to turnaround the cash flows of the target company,” points out Ravi Menon, co-head of investment banking at HSBC in India. A bidding war for Corus will see the big banks arrayed on each side: ABN AMRO, Deutsche and Standard Chartered for Tata; and Barclays, Goldman Sachs and BNP Paribas for CSN.

Payment preference

The preferred instrument used by Indian companies to raise cash is foreign currency bonds. Amar Chintopanth, CFO at 3i Infotech, an Indian IT solutions company which has acquired four companies overseas in the past year, says his company chose to sell convertibles over other options because “it kept the immediate dilution of equity to the minimum”. 3i has used about $56m from the $70m it raised in two FCCB offerings last year to acquire overseas companies including a $12m purchase of Professional Access in the US and $32m for Rhyne Systems in the UK. For a relatively small company, the terms were attractive: the $50m FCCBs were issued at zero coupon convertible into shares after five years at a 33% premium to its current share price; translating into a yield to maturity of 6.8% per year.

In what could be an emerging trend, Indian companies are pulling in international private equity investors as co-investors to make acquisitions. Videocon, an Indian consumer durables and electronics company, and Ripplewood have together signed an agreement to buy Korean company Daewoo’s electronics business in a creditors’ sale. Videocon will own just over 50% in a special purpose vehicle (SPV) that is being set up to make the acquisition, while Ripplewood will own the remainder.

Videocon will have the first right of refusal to buy those shares when Ripplewood decides to exit, in three to five years’ time. The decision to partner with Ripplewood, explains Videocon chief financial officer SM Hegde, is part of a “value arbitrage” strategy in which both companies share the “upside” on assets jointly acquired at an attractive price.

Raising the cash

The money (about $720m) to pay for the Daewoo purchase is being raised in three ways: from Daewoo’s creditors who opt to continue as lenders to the company after the takeover; from loans raised by the SPV; and from the acquiring companies’ own funds. Mr Hegde, who expected to close the deal by December, says his company will pay about $50m in equity for the purchase and he expects the foreign currency loans to cost 150 to 250 basis points over the three-month Libor.

Contrast this ‘de-risked’ strategy to the one Videocon used in early 2005 when it paid €240m to purchase Thomson’s colour picture tubes business with 100% equity and, as one investment banker points out, you see how far Indian companies have come in devising an acquisition strategy.

In contrast to the marked hostility in the takeover of Arcelor by L N Mittal, the absence of rancour so far in the Corus takeover owes much to the Tatas’ reputation as “a friendly partner”. But, judging by other acquisitions made by Tata group companies, some shrewd financial engineering goes into structuring the deal.

Tata Motors, India’s leading truck maker, purchased a strategic 21% stake in Hispano Carrocera, a Spanish bus company, for €12m in 2005 with a call option to purchase the remaining 79% shares that may be exercised in the next five years.

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That purchase will be in the form of an earn-out, with payments made to the owner-managers at the technocrat-owned Hispano in the form of performance bonuses based on the actual performance of the company, explains Tata Motors’ chief financial officer P P Kadle.

 

The acquisition strategy for a particular purchase is determined after an examination of the target company’s profile, the business and financial objectives of the purchase, apart from a host of tax and corporate regulations, says Mr Kadle. “We may start off with a 50:50 debt-equity ratio when looking to finance a transaction, but the debt or equity component could rise once we’ve examined the future cash flows of the target company, its ability to service debt or the possibility of an IPO [initial public offering] in the future,” he points out.

Acquisitions by Tata Motors are made through a holding company subsidiary registered in Singapore, where the corporate tax rate structure is attractive (20% or lower). The company has made two other overseas purchases in recent years: Daewoo commercial vehicle, Korea’s second largest heavy truck maker, for $102m in 2004, and British design company Incat for $100m the following year.

The right price

So are Indian companies running the risk of over-paying for their purchases? Videocon says it uses a benchmark to assess the price it pays for an acquisition. “In general, we pay cash equivalent to the net working capital plus cash of the target company and take the assets at zero value,” says Mr Hegde.

A rigorous evaluation of the target company’s assets is undertaken in the due diligence. On occasion, Videocon has backed out from negotiations, as it did last November from a bid to acquire Thai television tube company CRT, when it was unconvinced about the worth of CRT’s assets, adds Mr Hegde. However, only time will tell if Indian companies are the value-buyers that eager investment bankers make them out to be.

Indian banks are starting to chafe at regulations that do not permit them to finance foreign purchases of Indian companies freely. At present, they may finance the acquisition of foreign assets by an offshore subsidiary or joint venture of an Indian company equal to twice the Indian company’s net worth.

Several mid-sized Indian companies have emerged as purchasers of foreign assets, and private Indian banks such as ICICI and UTI Bank, keen to edge into a market that is dominated by foreign banks, have raised foreign currency borrowings. In late November, ICICI, India’s second largest commercial bank, said it would raise $1bn in a yen-denominated syndicated loan from 14 international banks – in part to fund Indian companies in foreign currency loans.

UTI Bank, which principally finances mid-size Indian companies, lead-managed Aban Loyd’s purchase of a strategic 33.7% stake in Norwegian company Sinvest ASA for $460m last June. UTI Bank’s senior vice-president Rajesh Tiwari says that as a long-time creditor to Aban, his bank knew that the next “logical step forward” for the company, which is a market leader in the offshore drilling market in India, was an overseas acquisition. “We will support companies whose managements have a proven track record,” Mr Tiwari says.

The bank has underwritten $120m of the debt and, as lead manager to the deal, brought other Indian banks into the deal – Bank of Baroda, Bank of India and Export-Import Bank of India. The debt is being raised by Aban’s Singapore-based SPV, and a part of that debt will be converted into equity at a later date. By picking future global leaders such as Aban Loyd, companies that “are likely to switch orbits” in the next five years, UTI Bank hopes to join the big league, too.

Red tape persists

Still, cutting through the maze of exchange control regulations can prove to be cumbersome, particularly as the size of acquisitions grows large or, as in the case of the Corus acquisition, Indian companies have to bid up the offer price in an overseas takeover. The figures involved in the Corus acquisition illustrate this all too clearly. Tata Steel UK, a subsidiary of the Indian company, will raise $5.6bn in leveraged finance to pay for the purchase, of which about $3bn will be senior debt, $2.6bn high yield debt and $69m a revolving credit facility. Tata Sons, a holding company that owns about 23% of Tata Steel, must raise $3.5bn to fund the Corus acquisition but has few options open to it. As an Indian non-bank finance company, regulations do not allow Tata Sons to raise foreign currency loans.

Tata Sons must therefore sell the shares it owns in other Tata group companies, such as Tata Consulting Services (TCS), India’s largest software services company. It owns almost 80% of TCS and market reports said that about 5% of TCS shares could be on the block. In mid-November, Tata Sons sold 1% of TCS shares for about $200m.

“If Tata Sons could sell exchangeable bonds, or bonds that may later be converted into shares of another group company [TCS in this case], there would be no pressure to sell TCS shares right away,” says V Anantharaman, who heads investment banking at Credit Suisse First Boston, India.

Borrowing limits

In its mid-term credit policy review in October, the Indian central bank raised the ceiling on foreign currency borrowings of an Indian company from $500m to $750m a year.

Then again, an Indian company may use the money borrowed overseas to make foreign acquisitions but not local ones. The convoluted logic behind this regulation is not very clear but can be traced to the Indian government’s pathological aversion to foreign debt. So long as the money is raised abroad by an overseas SPV or joint venture of an Indian company, the government seems to have no problem. “Funding a large local acquisition through local borrowings can be difficult, particularly since the local bond markets are not deep enough,” says Tata’s Mr Kadle.

However obstructive they may be, those regulations have not yet proved to be a show-stopper and that perhaps is a measure of how far Indian companies have advanced.

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