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Status: Offline Posts: 3 Management Paradise Rupees.: 531 Join Date: Oct 2008 | Does M&A always create value? -
October 3rd, 2008
M&A Analysis
The April 2004 HBS paper ( Should we brace ourselves for another era of M&A value destruction?) states , “ In the end, M&A is a flawed process, invented by brokers, lawyers and CEOs with super-sized egos!” MarkSirower , author of the famous book Synergy Trap , shows that, on the average, 2/3rd of all deals end up destroying shareholder value. Let us see some examples before attempting the three case studies.
Vodafone:
The year 2000 Vodafone-Mannesmann merger was proclaimed to be the single largest deal in the history of mankind. Sir Christopher Gent, then CEO, Vodafone, paid a huge $ 190 bn for Germany’s Mannesmann AG, making Vodafone the biggest operator in Europe. The combined entity was valued at $365 bn, making it the world’s fourth largest company overnight. If Gent’s strategy was suicidal to the company’s financial, Arun Sarin , who was on Vodafone board since June 1999, and took over from Gent in april 2000, redefined how much shareholder value could ever be destroyed from a company. Eight years since the deal, the value of Vodafone in terms of market cap stands at $161.4 bn, down by a huge $203.6 bn, a fall of 53%. Vodafone suffered a loss of $86 bn in last eight years. Both Arun Sarin and Christopher Gent , retired multi-millionaires, a far cry from thousands of shareholders across countries, who retired as paupers.
Similar shareholder wealth destruction are exemplified by CEO Gary Foresee’s Sprint Nextel merger , resulting in erosion of common stock from $ 26.9 pre merger to $ 8.30 post merger; by CEO Patricia Russo’s Alcatel Lucent merger which resulted in the common stock tumbling from $ 15.4 pre-merger to $ 6.09 post-merger; and again CEO Meg Whitman’s eBay acquisition of Skype resulting in eBay stock price falling from $40 to $25.
Case Study 1 : Hindalco –Novelis
Last year, Hindalco acquired Novelis for a staggering $ 5.76 billion. Few anticipated Kumaramangalam Birla to be the man to rescue Novelis.
Novelis , on a net worth of $ 322 million, had a debt of $ 2.33 billion ( that is DER of 7.23 :1 !)
The valuations paid by Hindalco were steep, considering Novelis worked only on conversion model and was a loss making company. Moreover, with $3.03 billion bridge loan that it took for Novelis acquisition , Hindalco is already on a rough road. With the debt market tightening , the metal maker is left with no choice but to dilute its equity through a 1:3 rights issue.
Given the state of equity market, Hindalco may have to price the rights issue at a fairly huge discount. Further, high interest costs, which rose by over 490% ( from Rs 3.13 billion in FY 07 to Rs 18.49 billion in FY 08) have already dented Hindalco’s EPS in FY08 to Rs 15.76, from Rs 26.73 in FY07, a fall of 41% !
With high equity dilutions at 33%,EPS estimations of Hindalco may be revised by as much as 17%. With Novelis having posted a pre tax loss of $62million in FY08, the Hindalco stock is unlikely to find any takers.
The question is, who will rescue Hindalco now?
Deal Value: $ 5.76 bn
Share Price: Pre merger- Rs 146.65; post deal- Rs 147.25
Premium paid per share: 37.27%
PE ratio: pre merger- 5.10, now- 7.52
Combined market cap: Rs 18 bn.
Case Study 2: Tata Motors- JLR
To succeed and thrive in a competitive environment you can no longer choose to remain a domestic player. In a bid of the fittest, it is the never ending quest for new horizons and opportunities that has been the bedrock of transformation for companies across the globe. With a number of acquisitions, subsidiaries, associate companies series and strategic tie ups , Tata Motors Ltd exemplify this . Jaguar and Land Rover ( JLR) , two of the iconic brands are now a part of the Tata kitty. With this , Tata Motors has catapulted itself into the premium global car market. However, there is another side to this.
The $2.3 bn deal has many analysts skeptical about the luxury brand fitment into the Tata stable. Add to this, the concerns over the global recession , which raises questions as to whether opting for debt in order to pay for the deal justifies the logic behind brand Tata’s global ambitions. The share prices have been continually heading southwards ever since the deal was announced and has plummeted by a huge 39.37% till date.
Further analysts are skeptical as to whether the synergy from the deal will eventually increase the brand value or not. Many suggest that the revenue synergy is limited in the medium term ( 2 – 3 years ). It is estimated that the pro forma profit before tax will come down by 5-10% in FY09. The analysts predict that the consolidated profit could move down by 9% and 12% respectively in FY09 and FY10 on account of sluggish outlook for commercial vehicles. So, it was only in the long term that JLR would have delivered some good. But, now due to the economic downturn in the US, that ‘long term’ is set to get stretched further, which means very soon Tata Motors will start repenting for the debt that they have taken to fund the deal.
But then, it is nothing new for the Tata’s. They are just good at making a mistake and then again repeating it to perfection. If in the Corus deal they jeopardized the stakeholder’s wealth by paying an exorbitant amount, in case of JLR they are set to destroy it for their irrational exuberance.
Deal Value: $ 2.3bn
Share Price: pre-merger- Rs 679.95, post deal- Rs 655.20
PE ratio: pre merger- 8.43, current- 12.9
Combined market cap- $ 3.78 bn
Case Study 3: United Spirits and W&M
Good times really seems to be a distant dream for this ‘King of Good Times’ these days. Be cricket or aviation, Vijay Mallya happens to be on a rough road. However, when it comes to alcoholic beverages, there is no stopping for him.
In 2007, FMCG, F&B accounted for just 1% of total M&A deals in India. Interestingly, what contributed most to this was the mega acquisition of Scottish whisky firm Whyte $ Mackay ( W & M ) by Mallya owned United spirits Ltd ( USL ) for a whopping $1.17 bn. In fact , USL paid 25% premium ( over its 20 days average share price at the time of the deal ) to take control of W&M. The acquisition not only plugged a missing link in USL’s product portfolio by giving it a strong presence in the Scotch whiskey market, but also pushed the company’s consolidated sales up to 75 million cases annually helping it to become the second largest liquor company in the world ( in terms of of total sales ), behind Diageo Plc of UK.
No doubt at a time when global Scotch whisky is expected to be extremely buoyant, W&M’s bulk scotch inventories of 115 million litres have not only proved valuable but have also allowed USL the opportunity to meet their own growing requirements for their brands in India. However, financed through ICICI bank ( $ 325 million ) and Citibank ( $310 million ), the deal now seems to be denting USL’s financials. Though USL has posted a 20% increase in EBITDA for the Q1FY08, its margins have been declined by about 90 basis points. Even the EPS is expected to come down to Rs 32.05 as on July 24,2008 from Rs 52.57 reported at the end of FY07. Moreover, with the slated entry of big players like Heineken, Anheuser-Busch & Carlsberg , who plan to enter India soon, the dent just might broaden.
Certainly, in the coming years we will see more JVs and acquisitions in the Indian liquor industry , which is growing at a staggering pace of about 10%. This will definitely make USL’s sailing a little rough.
Deal Value: $ 1.17 bn
Share Price: pre-merger- Rs 837.60, post-deal- Rs 1292
Premium paid per share: 25%
PE ratio: Pre-merger- 15.85, current – 36.91
Combined market cap: Rs 131.22 bn |
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