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Tomorrow, the World

How Indian companies are changing the character of cross-border M&A.
Tom Leander, CFO Asia
January 14, 2008

Editor's Note: This article, published in the December 2007 issue of CFO Asia magazine, incorrectly stated that Dr. Reddy's, the Indian pharmaceutical company, set up an institute in Germany to educate children about the dangers of drug addiction. In fact, the institute was established by Betapharm, a German drug maker, before Dr. Reddy's acquired that company in 2006. We apologize for the error.

There are no second acts in American life, F. Scott Fitzgerald sadly pronounced. But the American novelist's observation doesn't apply to Indians journeying to the United States to reignite faded glory.

In February 2007, Sanjay Dalmia walked to a rostrum at the New Jersey offices of a troubled US textile company. He had just bought Best Manufacturing, a supplier to hotels and hospitals, for US$35 million, one of a chain of recent acquisitions that he is seeking to stitch together as an integrated global business, using America as a springboard.

"We're here to build a business, not destroy one," he told the managers of Best, rallying them with a spirited call in support of free enterprise. The scene was incongruous. Dalmia, 63, has shoulder-length gray hair and a patrician face. In his lilting Indian accent, he addressed a roomful of skeptical managers in the state whose most famous fictional son is Tony Soprano. "If we cannot bring this concept of free enterprise to the global market from America," he said, "then some other enterprising part of the world will rightfully do so."

The irony, of course, is that this is exactly what Dalmia and his Indian company were doing. He hails from the family that financed Mahatma Gandhi's audacious bid to toss the British from the subcontinent. They made their money in cement in the early 20th century, but over the years the family fortune fell on hard times. Sanjay devoted his life to politics and charity, but tired of this and turned to running the coterie of businesses that were left to him. Observing the globalizing success of Infosys, the BPO provider, and Dr. Reddy's, the pharmaceutical company, he thought, "Why not my businesses, too?"

Three years and several acquisitions later — in the United States, Romania, and the UK — he found himself in Roswell using words similar to those Bill Clinton used to tout the North American Free Trade Agreement in 1992.

Unbounded Confidence
A surge of cross-border M&A confidence is running through Indian businesses and it has intoxicated managers across a whole range of companies. "There's a sense in Indian companies now that they can buy assets overseas and deliver value," says Sumant Sinha, president of Aditya Birla Retail, and former CFO of the Aditya Birla Group. "It's happening in firms of all sizes."

While this attitude is exhilarating, it amounts more to mood than method. Some experts caution that Indian acquirers are only now having their optimism tested by the rigors of post-merger integration — a discipline that Bain & Co. famously says more than 70 percent of companies never master.

"Investors' expectations in the first two years following an acquisition can be very difficult, especially if you're doing a large-scale acquisition," says Rajani Kesari, CFO of Dr. Reddy's European operations and the executive in charge of the company's acquisition of Betapharm Arzneimittel, which it bought for US$571 million in 2006. "I see it as if we're doing our own startup, where the main goal is internal growth rather than delivering on short-term investor expectations." She adds, "You can't lose sight of the strategic and financial goals."

As global acquisitions go, Indian firms have more than given China a run for its money in 2006 and 2007 (see chart, left) for big buyouts. The watershed was the 2006 buyout of Acelor by Mittal Steel, which is run by Lakshmi Mittal (although not officially an Indian deal, as Mittal was registered in London). This year has seen equally significant deals, starting with Tata Steel's US$15.9 billion purchase of British steelmaker Corus. AV Aluminum, a subsidiary of the Aditya Birla Group, bought a U.S. aluminum firm, Novelis, for US$5.8 billion, in a deal which closed in February and was negotiated for the Birlas partly by Sinha.

While the big deals have grabbed the headlines — and, in the case of the debt-laden Tata/Corus, met with some financing woes — what really characterizes Indian transactions is their modest size and great number. In 2006, Indian companies engaged in 223 acquisitions, versus 145 for China. In 2007, Indian companies so far have launched 234 deals, versus 200 from China. The Indian deals are smaller, though. M&A from China so far this year is worth US$26 billion versus US$22 billion for India.

"Indian managers are in a phase in which they think they can do anything," says A.V. Vedpuriswar, an analyst with UBS, who until recently was the dean of the Institute of Chartered Financial Analysts of India, Hyderabad, and is author of several books on risk management and M&A.

"The mindset is upbeat. And in some respects their experience is unique," says Vedpuriswar. "A global bank will add 1,000 employees to captive operations in India in a year. But Infosys has been adding 1,000 employees a month — and absorbing them as well." Youthful optimism plays into it, too, he says. "Many young people have worked now for five or more years and achieved unimaginable success."


Moreover, "new age" (read BPO and biotech) Indian firms are thinking about the process of acquisitions very early in their development, Vedpuriswar notes. "They're looking at the building blocks, setting aside resources to run committees to explore the issues," he says. "How do I get the leads? What should be the next level of contact? When do I get my CEO to have dinner with their CEO? They're making M&A methodologies, much like GE made theirs, with both care and confidence."

Vedpuriswar says Indian companies have gone through several M&A cycles since India's market liberalization began in 1992. In the period between 1992 and 1997, Indian companies grabbed 'low hanging fruit' at discount prices in the domestic market without much regard to building value following the buyout. Between 1997 and 2002, acquisitions slowed in the wake of the Asian financial crisis. This afforded some Indian managers the time to observe how multinationals operating in India absorbed and extracted value from their targets. They started using these skills in the next phase of M&A — from 2002 until today — which has been characterized by a spectacular appreciation of shares on the Bombay Stock Exchange.

The resulting high purchase prices for domestic stock deals have forced strict attention to post-acquisition value creation. Furthermore, says Anish Tripathi, director of markets and chief knowledge officer of KPMG in Mumbai, doing small deals has helped refine manager's dealmaking skills. "The ticket sizes of the deals are much smaller than you see in China," says Tripathi. "They can be US$20 million, and there are very few advisors — from banks or finance firms — who want to take on deals that small." He adds, "Many have been forced to go through the process on their own, based on their own networking and research. They're driving a deal with their own people."

Tripathi, too, notes the confidence of Indian managers' approach to acquisitions. "Right now, they believe the world is their oyster," he says. One reason is that Indian companies appear to outperform Chinese companies in their return on capital employed (ROCE). A recent Business Week ranking, for example, cited 13 firms — five more than from China — among the top 100 high-growth companies in Asia, ranked by performance in sales and ROCE.

"In respect to return on capital employed, Indian companies are becoming increasingly efficient," says Tripathi. "The CFOs of these companies are confident they can put this efficiency to work in an overseas acquisition."

But confidence in dealmaking is not the same thing as competence in making acquisitions deliver value, Vedpuriswar warns. "At some point, this may turn out to be misplaced optimism, and it will have to give way to cold business logic," he says.

A Gentler Approach?
Deepak Natraj, who is the head of strategic initiatives and chief risk officer of Infosys, advocates business logic, but more deliberate than cold. Infosys has only two acquisitions under its belt, and those have been a long time coming. Natraj, a small, intense man with penetrating eyes and a precise way of talking, was the deals' architect. Ten years ago, the company formed a group to plot acquisition strategy; its members included co-founder N.R. Narayana Murthy, then-CFO Mohandas Pai, and Natraj. The managers accepted Infosys would have to acquire to expand. The company didn't invest in the stock market and it had been acquisition shy, but it was sitting on more than US$1 billion in cash, and was under pressure to return the money to shareholders — or else seek higher returns via M&A.

The company struck a US$23 million deal for Expert Information Services, another BPO firm, in Australia in 2003. This was followed by rumors that it was pursuing BPO provider Capgemini, but that deal never materialized. In July, it bought the BPO unit of Philips Electronics for US$28 million, a deal that garnered Infosys a new skill set in finance outsourcing and came with US$250 million in contracts. "When we talk about acquisitions — and this can be to investment bankers or to representatives of a local community — everyone assumes that we're going to slash and burn and send two-thirds of the people home," says Natraj. "This defies common sense. If you acquire a services company, you acquire a workforce and customers. By sending home the workforce what are you paying for then?"

The way to allay the fears of the local workforce, he says, is to sell the model and talk of expansion directly to the employees. "When I look to buy a company of, say, 100 people," says Natraj, "my target is to create an offshore ratio of 7:3 — with 70 jobs in India for every 30 in Australia. I'm not trying to reduce those 100 Australian jobs to 30. My goal is to boost those 100 jobs to 300 so I can create 700 jobs in India — or Mexico or China — and elevate the number of total jobs associated with the business to 1,000."

Natraj advises giving the same message to local governments as the transaction is developing, not after the deal is a fait accompli. "We try to make sure the local government is with us when we're doing the transaction," he says. He prefers to leave the local CEO in place, as well as the HR director. "They tend to have better skills for that marketplace," he says. But he replaces the jobs that link the company with its centralized processes, most importantly those in finance. And he installs a new CFO.


This is important, he says, because, "we have a very centralized function, an SAP backbone, and when you join the company the processes are set until the day you leave." From an integration point of view, he says, the CFO is the executive who works most closely with the home office and the integration team. The object is to put the controls in place as soon as possible, but in a way that doesn't disturb the company's style of doing business.

KPMG's Tripathi says that Indian companies in Europe, and operating outside of the BPOsector, are following a similar path. Referring to autoparts maker Bharat Forge's 2004 purchase of CDP, a German forging company, Tripathi says, "Bharat didn't mess with the structure, leaving most of the existing people to run the show." On the pattern of Infosys, finance ran the integration and transformation and supervised the export of low-value jobs back to India while retaining the higher- value positions in Germany. This strategy has met with success in Germany because high labor and commodity costs are crippling the country's mid-size business segment. Says Tripathi, "The value proposition offered to the local community can be: 'We can save the business with our model, and at the same time improve social welfare.'"

Hyderabad on Line Two
Stepping into a limo on her way to Ausberg, Germany — literally translated as "foreign mountain" — where she is ready to go to an offsite meeting of managers, Rajani Kesari reflects on the distance between her Hyderabad home and this corner of northern Europe, with its clear Teutonic air. "It's swirling snow, and the air is bone-chilling — it's a long way from Hyderabad," she says.

Kesari might be called an accounting and finance prodigy. She started her career as a chartered and cost accountant in the pressure cooker of India, worked for PwC and KPMG overseas, and then joined Dr. Reddy's back in Hyderabad, working for the audit committee chairman for the first implementation of Sarbanes- Oxley. It allowed her, she says, to become completely involved in all of Dr. Reddy's businesses — and the company completed the project a full year ahead of schedule. The success of the project won her the recognition that got her to Germany, where she served on the audit committee looking into the acquisition, and as tax advisor on the Betapharm deal. "Operating businesses is a lot more exciting," she says, and her job now includes risk management and strategic planning, as well as finance, across Europe.

Kesari faces epic struggles in making the Betapharm acquisition work. Almost from the start, when it looked like a sweetheart deal, the purchase was hobbled by problems beyond Dr. Reddy's control. Just months after the purchase closed last year, German regulators enacted a law that led to a drop in product prices. Sales revenues from Germany fell by 12 percent in the company's second quarter, compared to the year-earlier period. Due in part to the fall off of revenue from Germany, Dr. Reddy's underperformed against analysts' EBITDA projections by 13 percent in the same quarter, and reported lower profits. The company is attempting to make up the loss by shifting production of six products back to India and launching eight new products in Germany to realign Betapharm's product mix with the realities of the German market.

Then there was the sub-prime debacle. When the Betapharm deal closed, it brought Dr. Reddy's consolidated group debt to US$700 million. The company launched an American depositary receipt (ADR) earlier this year that helped wipe away half of that debt. But Kesari says that the higher financing costs applied to the remainder of the debt are affecting the P&L of Betapharm. The company turned to inter-company loans in late summer to mitigate the impact.

These financial difficulties had to affect the integration — no easy matter in labor-conscious Germany. "Because of the significantly reduced prices and the new competitive landscape in the German market for pharmaceuticals — the largest in Europe — working with the new staff required a lot of attention and care," says Kesari. Part of the job was building a case to demonstrate that the character of sales opportunities had changed in the market and backing that up with numbers.

She also faced difficult weekly questions from the company's labor council. All but the smallest German companies have a council of workers to review changes that affect the workforce. Kesari says the process of meeting the council was daunting, but she was eventually able to get their approval for the restructuring plan.

She believes that the attention devoted to cultural matters has made the acquisition more likely to succeed. "We went in thinking it would be best to try to make [the Germans] part of the Dr. Reddy's family," says Kesari. Like Infosys, Dr. Reddy's decided to retain most of the acquired company's key employees, including the CEO, and controlled the integration through finance, with Kesari as the new CFO. "We made it a point to make everyone know they were on the same page," she says. This meant flying in managers from Hyderabad for meetings with local managers when setting goals and discussing strategy.

In India, Dr. Reddy's has pioneered corporate social responsibility programs. The company drew on its CSR organization to set up an independent institute in Germany to educate children about the dangers of drug addiction. The program attracted the attention of the German government, which agreed to provide funding. Its success showed Dr. Reddy's commitment to public health in a market that might otherwise be leery of the intentions of an Indian drug maker.


Watch Out, Wal-Mart
Long hair flowing, relaxed in a high-back chair before a picture window at the family's landmark residence in New Delhi, Sanjay Dalmia hardly looks the part of an M&A mogul. But business is his destiny, he will tell you. His alert eyes and surfeit of enthusiasm confirm that he has caught the acquisitive bug.

At first glance, Dalmia's acquisitions appear to have an improvised quality. Via a soda ash company he owned, dubbed Gujarat Heavy Chemicals, or GHCL, the Sanjay Dalmia Group purchased a small call center business in upstate New York in 2005. A year later, the United States lifted manufacturing quotas on Indian textiles, and Dalmia switched gears entirely, buying bankrupt US$250 million- a-year textile manufacturer Dan River for US$54 million in 2006. The company had three plants and 3,000 employees, which Dalmia quickly reduced to zero plants and just 210 workers. The Indian head of BPO operation, who had proved successful at managing the call center, was transferred to the textiles operation in Danville, North Carolina.

The idea was to make Dan River a launch pad for an integrated textile supply chain that would sell in America and, eventually, around the world. GHCL owns a sourcing operation in India, through which Dan River now sources all its production from India, Pakistan, and China. But Dalmia says that the labor savings from such an acquisition are not the objective. "Manufacturing in India is not the goal — you can gain savings of up to US$100 million by doing that, but we're looking for a lot more than that," Dalmia says. His vision is to secure profits by owning the most significant components of the textile value chain, while sourcing the manufacturing in lower cost markets.

GHCL has made several significant steps toward this goal. Last year, it bought a UK home textiles retailer called Roseby's for US$50 million, a deal which added US$210 million to its turnover. This was followed by the purchase of Best Manufacturing, a bankrupt textile firm based in Roswell, Georgia, which sells directly to hotels and hospitals, and which Dalmia regards as a business-to-business enterprise. It contributed US$160 million in turnover to GHCL. Dan River has since acquired another Chapter 11 textile firm, called H.W. Baker Lenin Co., for US$6.75 million.

The point of buying these busted firms is to link them into a single value chain for a global business in two parts of the textiles business — selling to consumers through retail outlets like Rosebys, and selling to the hotel and hospital industry through suppliers like Best Textiles. The latter has tremendous demand, says Dalmia, and tends to still do most of its sourcing in the United States. "My strength is sourcing," says Dalmia, "and I want to be the dominant player in supplying to hotels and hospitals in North America. Then I want to replicate the whole thing in Europe and Asia."

Along the way, Dalmia has traveled to the United States several times to encourage his new employees. He cuts an odd figure as an industrialist, having devoted much of his earlier years to charity and to socialist politics in India. Still, the match seems palatable in the Simpsonesque, Springfield-style towns where these once bankrupt companies reside. "The employees rarely fight us," says Vinod Madhok, CFO of the Sanjay Dalmia Group. "They're glad to be working and to have a chance to grow the company at last." Dalmia, in contrast to Infosys and Dr. Reddy's, keeps the CFOs of his acquired companies on staff.

As for Dalmia, he says he had a revelation as he witnessed how Indian companies were grasping globalization. "I realized that I could change more lives for the better in business today, with all its possibilities, than in charity or politics."

In the end, the confidence on display among Indian acquirers seems out of step with the common view of businesses as a rapacious mission for profits. A component of Indian confidence is a sense of innocence — a feeling that business can both make money and do good. That attitude may yet be put to a severe test. But how ironic would it be if this softer approach turned out to be M&A's killer app?

Tom Leander is editor-in-chief of CFO Asia.


M&A, the Indian Way

Step 1. Cultivate local political and community leaders, and emphasize that your aim is to create higher-value jobs for the local economy. Hire a representative who is already connected to political and labor leaders.

Step 2. Rally the rank-and-file of the acquired firm by presenting your business model as the best way to retain global competitiveness. Build the case that free enterprise is a global phenomenon and that hiding from it is useless.

Step 3. Retain as many important operating and functional business leaders in the local company as possible. Leaving the company in the hands of the former CEO, if competent, is desirable. Keeping local HR leaders is important: they know the ins and outs of the local market better than anyone.


Step 4. Put in place a new CFO from the home office. The process of integration is best run by the finance department, whose job it is to apply uniform reporting and performance measurement standards throughout the global company, and to introduce these into the acquisition. Because of this, finance is the best liaison between the managers at home and those guiding the acquisition locally.

Step 5. Leverage corporate social responsibility programs to build trust and confidence in the local market. Dr. Reddy's overcame German skeptics at Betapharm via its introduction of an innovative teaching program to make children aware of the dangers of addiction.


To see a list of the top ten cross-border Indian transactions to date, click here.


Indian versus Chinese cross-border M&A transactions since 2004, in terms of total deal value.
GHCL's buyouts are aimed at securing an end-to-end global value chain in textiles, 1998 - 2007.


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