Bharti-MTN deal : Sniffer dogs at work ?

My experience with M&A deal structures tells me that the level of distrust between the parties can be gauged by the magnitude of its complexity. By complexity I mean insistence on back to back cross holdings, layered cash and share swaps and other exhaustive clauses in the share swap agreements relating to Board composition, management, operational checks and internal audit.

Going by that, I am not surprised why the stock markets gave a thumps down to the news of Bharti-MTN merger. The Bharti share fell 5.41 per cent to close at Rs 811.85 on the Bombay Stock Exchange, on a day the Sensex rose 26 points.

The deal is not just complex by size, it’s structure too is no less contorted. Sample this. Under the deal, MTN will issue new shares (they prefer to call it “economic interest” instead of plain “shares” – probably an indication of refusal to imply ceding of management control to pacify regulators) to Bharti. The Indian company will also acquire around 36 per cent of MTN’s current paid-up capital from its shareholders at $10.2 per share, entailing a cash outgo of $6.8 billion. The fresh share issue will eventually take Bharti’s shareholding in MTN to 49 per cent.

In return, Bharti will issue 0.5 GDRs for every MTN share it acquires. The Indian promoters will eventually see a dilution of their 45.30 per cent stake in Bharti.

Even if it is to avoid regulatory hurdles, anti-trust allusions or even triggering of open offer requirements to other minority shareholders that can drive up the price ( open offer is triggered when stake in excess of 15% is acquired in an Indian company with the exception for inter-promoter swap or cross holdings), the deal structure is far too complex for execution because the exhaustive approvals and information sharing between the parties called for will certainly limit operational flexibility to a large extent – a factor that has been instrumental for the rapid growth of Bharti (and possibly MTN too) in India.

I see more of mutual suspicion than synergies in this deal. Shall be glad if proved wrong.

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Press "Sell"

So, the stock market has shrugged off its sloth, at least for the time being. The election results that brought back a seemingly stable Congress government clearly turbo charged the markets. That woke up many a sleeping investor and money no longer waits on the sidelines. That bodes well for valuations and for most companies it is clearly up by 50% from October 2008 lows.

They say banks are now all the more willing to lend to enterprises. Rising valuations will recharge the primary markets for sure going by the steady stream for DRHP filings with SEBI.

If that indicates improvement in liquidity (even to Real Estate companies that are now busy taking the QIP routes), I am sure I-Bankers will be on their toes to do M&A deals. But that’s exactly where I come from. When valuations are rising, it’s time that a few Indian companies should be selling out, not acquiring. Imagine if Tata Steel sold out to Corus, Hindalco to Novelis and Tata Motors divesting instead of acquiring JLR during the previous bubble ? They could’ve even reacquired these companies now when valuations of those companies have plummeted and Indian markets see a surge in liquidity. May be this is wisdom in hindsight, but they also say history repeats itself.

So it’s a word of caution from yours truly. More because I am selling my large cap holdings and swapping them for good mid / small caps that return 30% in as much as a week. It’s not a sound parallel I know, but then who can stop a blogger from speaking his mind ?

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Ranbaxy open offer is biased

So many conjectures and assumptions surrounding impending Ranbaxy open offer.

As it exists today, if you acquire 15% or more of a target company, you have to make a compulsory open offer to other investors of the company to buyout further 20% stake from them – the idea is to give those investors an exit option at the same price. But there’s a catch. While promoters can exit their entire stake, the rest of the shareholders can only exit partially – if the acquirer does not want to buyout the entire outstanding shareholders.

In the Daiichi-Sankyo acquisition of Ranbaxy, the promoters are exiting completely at a price of Rs.737/-per share for their 35% holding. Now Daiichi-Sankyo (acquirer) has to make an open offer for another 20% at or about the same price - which is at a significant premium (Rs.194 or 35.72%) to the closing price of Ranbaxy share at Rs.543/- yesterday. So if the remaining holders of [entire 65% non-promoters] tender their shares in the open offer, only 30.7% shares offered will be accepted resulting in a rejection rate of 70%.

However, the preferential issue would also play an important role as it would change the acceptance ratio. If the preferential issue is made before the open offer then the capital base would be enhanced, affecting the acceptance ratio. Open offer on current base of 373.2 million share (would) result in buyback of 74.63 million shares (30.7% acceptance) and in case of an expanded base 419.3 million (adding preferential issue of 46.26 million), it comes to 83.85 million shares (34.5% acceptance).

I imagine a "what-if" scenario. If I hold 100 shares of Ranbaxy and tender it in the open offer, only 30 shares will be accepted by Daiichi-Sankyo at Rs.737. I will be left holding the remaining 70 shares and exposing myself to vagaries of price action post open offer, which will certainly be, down. But the promoters would have made a neat exit with full premium in their pockets. How fair is that? Well, they may explain it as “control premium” – for having stuck with the company for over 75 years and having not entered or exited like ordinary investors. Still it rankles.

Why not make the acquirers make a minimum open offer to public, as far as possible, equal to the percentage of shareholding acquired from the promoters – which is 35% in this case? That would restore a semblance of fairness. [Of course subject to Listing Agreement post offer minimum public holding criteria]

To buy 100 shares today, I have to invest Rs.54,300 @ Rs.543 a share. If I tender all these shares, only 30 shares will be accepted at Rs.737, fetching me Rs.22,110. Since this is an off-market trade, I will take a short term capital gains tax knock of 30% (+ cess) on the gain (Rs.194 x 30 shares), netting me just Rs.20,306. So my net investment on the residual holding of 70 shares will be (Rs.54,300 – Rs.20,306) Rs.33,994 or Rs.485 per share. Post offer, if Ranbaxy stock price falls below Rs.485/-, the holder is incurring a net erosion in value.

Now Ranbaxy has an EPS of Rs.17.50 giving it a P/E multiple of 31 at its current price of Rs.543. Will it be sustainable post open offer in these harried times of oil price surge, global inflation and waning sentiment in our markets? When the public offer euphoria dies down, the stock will end up quoting at an average P/E of let’s say 17, the price of the Ranbaxy share will be around Rs.290/- leaving me to stare at an erosion of 47.65% in my Ranbaxy holding.

Now you know why Ranbaxy stock price is not going anywhere even after the news of its acquisition by Daiichi-Sankyo… It’s a play on capitalism again. Loaded in favor of promoters. Remember – rich getting richer…?

Readers, what do you think?

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[Update : Thanks to reader Ratan for correcting me on the STCG error in the original post, that now stands revised.]

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Burning question : what will happen to Ranbaxy subs?

Japanese major Daiichi Sankyo is set to buy the promoters - Malvinder Singh and Shivinder Singh's 34.8% stake in India's largest drugmaker Ranbaxy Laboratories.

The Share Purchase and Share Subscription agreement has been unanimously approved by the Boards of Directors of both companies. Daiichi Sankyo is expected to acquire the majority equity stake in Ranbaxy by a combination of (i) purchase of shares held by the Sellers, (ii) preferential allotment of equity shares, (iii) an open offer to the public shareholders for 20% of Ranbaxy's shares, as per Indian regulations, and (iv) Daiichi Sankyo's exercise of a portion or all of the share warrants to be issued on a preferential basis. All the shares/warrants will be acquired/issued at a price of Rs.737 per share.

This purchase price represents a premium of 53.5% to Ranbaxy's average daily closing price on the National Stock Exchange for the three months ending on June 10, 2008 and 31.4% to such closing price on June 10, 2008.

Burning question – will there be open offers in its subs Zenotec, Jupiter Biosciences, Krebs Biochemicals and Orchid Chemicals?

If the deal comes through, it would mean a complete exit of Ranbaxy promoters from the company. SEBI regulations mandate any acquisition in excess of 15% in a company will trigger open offer and the acquirers will have to buyout at least 20% from the other shareholders at the same price they paid the promoter or the price computed by SEBI formula, whichever is higher.

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I like the shift in trend. Long held family stakes are no longer looked upon as non-disposable heirloom by younger generation. If an acquirer comes along offering 3x sales or at an attractive premium, the owners are willing to exit. That means there's a lot going for dealmakers like me. Long live change agents like Malvinder Singh! Hope the deal goes thro smoothly and closes fast. We don’t want a repeat of Bharti-MTN-RCom conundrum…...!!!

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[Update : Open offer will be triggered in Zenotech]

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Smaller local deals - way to go in 2008

I am not surprised after reading this. Going by the frenetic acquisitions in the Indian pharmaceuticals space, buyout fatigue is but natural. The strain on the resources of the acquirer post event is phenomenal. The integration of two distant, culturally disparate organizations taxes even the most competent management. You’ve miles to go before the intended benefits of the acquisition – global footprint, larger scale and added market share etc., are realized. Some estimates put the success rate of M&A deals during the last 5 years as low as just 18% globally.

But I think it’s far easier to integrate businesses in the same geographies. You can safely discount the cultural diversity element that rocks many deals. They are relatively inexpensive and you can trust your judgments since you’ve been active in the same realm. You can easily upsell your existing products. It’s a win-win and a surer and safer bet than a big ticket, overseas acquisition, where any one of the brands could suffer a dent depending upon the perceptions that surround the deal. If there is one sure winner in a big ticket deal, it’s the I-bankers and the advisers to the deal. The buyer rarely wins in overseas buyouts.

But the record is so much better in strategies that advocate acquiring local brands and strategic domestic investments. I see that trend in Indian Pharma space now - changing their tactics to concentrate on brand acquisitions and strategic investments rather than risky big ticket cross-border acquisitions. Some of my friends in I-banking circles tell me it’s the best time to buy businesses in the US since Rupee is on a record high against the dollar. But I don’t buy that line. You should buy a business only if it’s a sure value add in the long term, because it’s a one-off, game changing stuff. Not just because you have a favorable exchange rate, as matters to the import of raw material / capital goods.

But then my friends are I-Bankers and it suits them well to take that line. They have to get by :)
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Getting the blend right

The proof of a robust M&A strategy is in its blending. Most acquisitions fail because integration of diverse cultures is never easy. Why not scout for companies with similar culture - you may go. Try that; you’ll never find one. Every company has a unique culture since it is made up of different individuals, their shared beliefs and practices that identify the company to which they belong.

Mike Rogers of PatchLink, has completed 10 acquisitions and two sales during his career and has this interesting Op-Ed in Venture Beat where he shares his magic mantra for a successful inorganic growth strategy. While Mike concedes that there is no such thing as the perfect deal, he goes that it all depends on a sound strategy. You can fix a bad deal structure, you can fix a bad integration, but you can’t fix a bad strategy.

Read it.

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Infosys-Capgemini...did we get it right?

Read it recently. But why Capgemini? The next sound I heard was the bam bam bam of my head banging against the wall.

May be the mongers got it wrong. The space getting too crowded, Rupee appreciation that shows no sign of relenting, Visa woes, wage inflation and attrition getting out of hand - for Infosys, there never was a better time for a sellout. Organic scale up plans and revenue growth would depend on faster recruitment of skilled engineers that is in severe short supply. May be an Accenture, IBM, EDS or even CG bid for Infosys makes a better sense…

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Infosys management has been assiduous all along and I trust them for their deliberative approach. They wouldn’t load up debt in their balance sheet for acquiring a CG that it cannot discipline. CG is way too big, imbibed a lot of bad habits and is diverse in culture. Founders using the revolving door, rumors of a senseless acquisition….it looks like a dry run to me before a more dramatic something at Infosys…?

Shall we call it a sellout dance…?

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