How Can India Inc. Reduce Transaction Costs of Acquisitions? Ans: BIMBOs

The number of cross border M&A deals initiated by Indian firms have risen exponentially in the past couple of years. However, if the attempted Tata-Corus deal is a pointer to the future then India Inc. have some teething issues to sort out - exaggerated valuations, higher transaction costs, elongated due diligence phases and excessive use of corporate espionage and intelligence tactics. The answer lies in framing innovative deal structures that keep all the stakeholders honest and motivated.

Millions of children in our country who are painstakingly taught Indian History will always remember the treachery of a character named Mir Jafar. His betrayal of Siraj ud dowlah's army to Rober Clive's Britishers in the infamous Battle of Plassey fought on the fertile plains of Bengal was at that time an insignificant piece of trivia. Little did Jafar know that it would resign India to 400 years of colonial rule. Even after independance, the "short selling mentality" continues to plague the minds of young Indian managers. We continue to be good at making short term profits and in exploiting fleeting opportunities at the expense of a greater benefit to the country. The phenomenon is manifesting its ugly head again - this time in the acquisitions and buyouts that India Inc. has been making for the past 2-3 years.

The primary premise upon which most of these deals are based is the arbitrage opportunity based on a cheaper cost of funds in foreign countries. There is also gains in terms of technology, management expertise, access to order books (made famous by Bharat Forge) and better marketing & branding. Let me explain the concept of arbitrage - the cost of funds, whether it is equity or debt is indirectly related to the GDP growth rate. This growth rate is proxied by the risk free interest rate in each country. India and china naturally have a higher cost of funds and hence our firms have to provide higher returns to the shareholders through either capital gains or dividends. Their counterparts in the western world however cannot be as demanding. Thus, they settle for the high premiums that Indian firms pay. Lawyers and investment banks are also paid a very high fee for their services and thus transaction charges go through the roof. Since the interested parties do not have a sustained incentive structure, it is anyone's guess as to how long they remain committed to the deal.

Apart from the issue of unnecessarily higher premiums and transaction costs of Indian aquisitions, there is also the larger issue of who owns this arbitrage in risk free rates. I feel that a high GDP growth rate is a "public good" as it is the citizens of the country who pay for the heated economy either through inflation or through the social costs of development and lifestyle changes. It is this public good that is being exploited by firms to pursue their ambitions of becoming a global company. Companies are even getting innovative at exploiting this resource to its fullest - notable among them are Tata Tea's acquisition of Tetley - a company almost 3 times its size via the LBO route and the Betapharm deal using Foreign Currency Convertible Bonds (FCCB). India's improved sovereign rating by both Moody's and S&P also contributes to this business tactic. But there is an underlying flaw behind the entire logic - an arbitrage opportunity is always a short term one and is not enough to motivate the upper management to make a long term success of a deal. The solution to this puzzle lies in coming up with innovative deal structures - notably BIMBOs. No... not the blonde buxom ones, I mean Buy In Management Buy Outs - an increasingly popular mechanism to undertake big ticket aquisitions. It ensures the seperation of ownership and management and at the same time leaves enough incentive for all the stakeholders to ensure that synergies are exploited and no flight of talent ensues after the deal is done. And the evidence is there - two leading PE firms Actis and ICICI Ventures have already executed more than three BIMBOs respectively and both of them promise that more are in the pipeline. The biggest gain for these firms are what they save on due diligence costs paid to I-banking firms and lawyers. Something for the old economy behemoths like Tatas and Birlas to think about!

Empirical evidence shows that more than 70% of acquisitions fail to improve shareholder wealth over a horizon of greater than 5 years. Indians have been particularly bad and i think it has something to do with the fact that we are a more docile lot as evidenced by our historians who keep trumpeting the fact that we have never attacked a country in our 5000 year record (may not be entirely true as the Chola dynasty at its prime extended upto Java in Indonesia). Given this fact and the ever shrinking arbitrage in interest rates, my bet is you'll be seeing a lot more of BIMBOs - pun intended:)