The Logic of M&As - Essay Example

Gopi Gopinathan Case Study Analysis 02 May 2007 Case Study Analysis of a Strategic Event The Logic of M&As. In olden days companies used to take over another company primarily as part of its empire building strategy or to establish monopoly in a selected field. Today the scenario has entirely changed. Organic growth of an entity is becoming extremely difficult because of the demand for a fast track economic growth. Also, size matters for an enterprise for its viability, scales of economy and better synergy. Bigger an enterprise more robust it will be with better chances of survival. That is where Mergers & Acquisitions becomes an economic imperative. A greenfield unit in a core sector will take anything up to 5 years for implementation and another few years for integration into the system. But if one can get an established unit in its chosen field the combined entity can take off within a couple of years after due integration. Adding a new dimension to the issue Paul Tiffany, adjunct professor of management at Wharton and senior lecturer at the University of California's Haas School of Business in Berkeley, says that the global steel consolidation has an unfamiliar ring, he notes "It's interesting that the consolidation in the steel industry is driven not by market opportunity but by the threat of the Gopi 2 industry going out of business," (Knowledge@Wharton) October 31, 2006, Pedal to the Metal: Challenges of Tata Steel's Corus Takeover (online) available from http://knowledge.wharton.upenn.edu/india/article.cfmarticleid=4109 (accessed on 02 May 2007) Factors Leading To The Event. The most dramatic change in Indian business in the past decade has been the surge in ambition. Take Ratan Tata, the Mumbai-based tycoon who won the race to buy Britain's Corus Group, beating his Brazilian rival Benjamin Steinbruch in a fiercely contested auction. British Steel and the Dutch group Hoogovens merged in 1999 to become the largest steel makers in Europe because they felt the necessity to out-grow their national geography. With the passage of time the same company felt that they need a global presence. As stated by Corus chief executive Jim Leng that Corus now felt it was "no longer sufficient to be European. This is a global industry," he said. "We have got to respond with passion, but with commercial passion. It's not about big companies and small companies, it's a matter of being globally commercial." (Knowledge@Wharton). "We want to expand into geographies where, as a group, we can have a meaningful presence. First, we have chosen countries where we felt we could make an impact and, secondly, where we are able to participate, as we have in India, in the development of that country. When you visit a country or examine Gopi 3 a particular company, I think you intuitively know if there's an opportunity, and then you flesh out that opportunity in one form or other. If we get to the stage of justifying assembly or manufacturing operations, we will seek either to contract them or to invest in facilities in that country." (Interview with Ratan Tata in India Today Magazine issue dated November 6, 2006). In takeover parlance big sharks swallow up the small sharks. But in this case a small shark has swallowed a shark almost five times its size. It is the biggest international acquisition so far by an Indian company, and it coincided with Tata Steel's 100th anniversary. It will also be the Tata Group's 22nd foreign acquisition in two years. The Corus takeover catapults Tata Steel from its 65th place among global steel producers to the No 5 spot in the hierarchy of steel makers with a combined capacity of 23.5 million tons. Others ahead of it are Arcelor-Mittal (110 million tons), Japan's Nippon Steel (32 million tons), South Korea's Posco (30.5 million tons) and JFE of Japan (29.9 million tons). Excluding Corus, Tata Steel has plans to raise its Indian capacity to 30 million tons by 2015 through Greenfield projects. Tata Steel managing director B. Muthuraman said in a statement after the January 31 deal that the purchase price puts Corus's enterprise value at $700-$710 a ton, which compares with today's costs of $1,200-$1,300 a ton (for a new plant), and would take five or six years to build. Gopi 4 Tata at their steel plants in India produces the cheapest raw steel in the world. With the acquisition of Corus Tata Steel's can use Corus's technology and plants to supply their low cost products to high-end customers in Europe. Tata Steel has the same strategy for their recently acquired Nat Steel in Singapore and Millennium Steel in Thailand. The Balance sheets of Tata Steel speak of their higher efficiency compared to that of Corus. Although its $5 billion revenues is only a quarter of that of Corus's $19.4 billion, Tata Steel generates $1.5 billion a year in operating profits on a capacity of 5 million tons, while Corus brings home a poor $1.9 billion on its 18 million tons. Therefore, to sustain in business Corus had to become commercially viable and growth is the panacea for such ills in industry. Corus will benefit from access to Indian iron-ore reserves as well as its market for steel. India's per capita steel consumption is still about 35 kilograms a year, which is about one-tenth of a developed-country. What Ratan Tata is buying for $12 billion is the opportunity to be among the global leaders in a business that will probably become more profitable and less volatile in the years to come. The cost of not buying this leadership position when it is available would have in posterity proved fatal. In reply to a question on the sharp fall in Tata steels stock immediately after the takeover was announced, Ratan Tata said "The market is looking at it on a short-term basis, Hopefully, in the future somebody will look back and say we did the right thing." Gopi 5 What lies ahead The combined entity of Tata Steel, which is the most profitable steel company in the world and Corus the second largest steel producer in Europe, now has tremendous growth opportunities and also faces significant challenges. Maintaining its low-cost advantages by securing captive raw materials as it expands capacity is one; another is the euphoria on the current high steel prices which has the prospect of softening over time. Imminent consolidation in China and the rise of new rivals as a result of consolidation and cartelization among the top producers are transforming the global steel business. The company that was recognised as the world's best steel producer by World Steel Dynamics in 2005 instills confidence in the share holders that it will successfully surmount such eventualities as and when it comes. Tata Steel cannot bank wholly on steel prices remaining strong, says Tiffany. "If Tata wants to invest billions of dollars to build steel mills in India to supply Europe, it is a huge bet. How long will the price be high And for how long will India's costs be low" he asks. He points out that in China's Guangdong province -- its industrial heartland -- "inflation is going wild" and the country is losing investment to Vietnam because of rising prices. "That's going to happen in India too." (Knowledge@Wharton) "The Tata-Corus deal is different because it links low-cost Indian production and raw materials and growth markets to high-margin markets and Gopi 6 high technology in the West," says Phanish Puranam, professor of strategic and international management at the London Business School, who is also associated with the school's Aditya Birla India Center. He adds that the cost advantage of operating from India can be leveraged in Western markets, and "differentiation based on better technology from Corus can work in the Asian markets." (Knowledge@Wharton) Peter Fish, managing director at MEPS (International), a steel consulting firm in Sheffield, U.K., is a long-time Corus watcher. He predicts that a decline in steel prices could benefit Tata-Corus. "Prices in the U.S. are already on the way down. In Europe, they will turn down by the end of the year. They could fall by more than 10% during the year," he says. "When prices drop, obviously the companies that will survive the best will be those that are most competitive. If you have cheap raw materials available, you have a better opportunity to survive the difficult times" ((Knowledge@Wharton). This merger is also not without pain. Corus will have to shut down some of its plants in the U.K. and the two parties will have to work together to obtain absolute synergy. What works in favor of Tata-Corus is the friendly nature of the deal, and the strong Anglo-Indian link. Many Tata Steel managers have been trained in the U.K. Gopi 7 An Assessment of the Persona, Ratan Tata. Cool and reserved Mr. Ratan Tata took over the reigns of Tata Sons, the salt-to-software conglomerate and the holding company of Tata Steel, in 1991 from the flamboyant JRD Tata. This was not the first time that markets thought Ratan Tata was being reckless. On Jan 15, 1998, Tata unveiled to a crowd in New Delhi the first model of his indigenously built dream car costing only Rupees 1 lakh (approximately US $ 2350). The financial press was indifferent to Tata sinking about $450 million on a car designed and built in India just when the protected auto market has been opened up and the big-bulge Japanese, U.S. and South Korean carmakers have landed in the country. Though Tata is still confident of bringing out the car by the 2008 deadline. However, today Tata controls about one-sixth of the fast-growing Indian passenger-car market with his other indigenous models. Those who bought Tata Motors shares in October 1998 has earned an annualized 30 percent return in U.S. dollar terms till date. Tata group has a lion's share in the struggling Indian tea industry. The large tracts of land needed heavy investments to rejuvenate. The tea business was facing heavy competition from other tea-producing countries. Also militancy was taking its toll in the North Eastern parts of India, which has large areas under tea plantation. The business strategies needed to be revamped. He reduced the direct land holdings and strategized the business into a brand by acquiring Tetley and emerged as the second largest tea company in the world. Gopi 8 Later on he acquired a 30 per cent stake in the US beverages giant Glaceau for $677 million, which not only de-risked it from the commodity cycle of tea but also set a new benchmark for growth. The Road Ahead "The world is witnessing a change in the demography of consumption". stated the Indian Commerce Minister Kamal Nath, "The economic gravity of the world has shifted from the Atlantic to the Indian Ocean. Like in the 1980s when the Japanese went and bought assets abroad such as the Rockefeller Center and the Pebbles Beach, and then the Koreans in the 1990s, the world is looking at India through the prism of high growth potential," Tata Steel, too, may have found it difficult to penetrate the lucrative construction, packaging and automobile markets in Europe without help from Corus. Saikat Chaudhuri, Wharton professor of management, says "opportunities are plenty for steel companies that meet quality standards, especially since many of them have faced difficulties in getting access to the arena, which is dominated by the IBMs and the Accentures of the world; many others don't have the pedigree. If Tata steel meets the technical specifications of customers and at a slightly lower cost, it can break into that market more easily with Corus in tow". Gopi 9 Historical Perspectives. Jamsetji Nusserwanji Tata (1839-1904), the founder of Tata Group ranks among the greatest visionaries of Industrial enterprises of all time. Gifted with the most extraordinary imagination and prescience, he laid the foundations of Indian industry, contributed to its consolidation, and became a key figure in India's industrial renaissance. In the 1890s when J N Tata wanted money to set up the steel plant, the British Government had refused him permission to raise funds in England. He had then raised the funds at home from Indians including Motilal Nehru and Mohammed Ali Jinnah (the super- rich lawyers and leaders of India's freedom struggle) to set up Tata Steel. Less than a century later Tata Steel proved the point once again when it bought over Europe's second largest steel company Corus with British roots and catapulted it from 65th position to 5th position. Other less obvious links also exist. In his biography of J. R. D. Tata in Vohuman.org, a publication of the Zoroastrian Educational Institute in Palo Alto, Calif., Meher D. Amalsad recalls that in 1912, the London School of Economics established the Ratan Tata Department (J. R. D. Tata's father). The following year, that department sought applications for a lecturer's job, for which two people applied. "One was a young man called Clement Atlee, who, after careful consideration, was selected for this position," writes Amalsad. "About 32 years later, Atlee became the Prime Minister of Britain." It was under Gopi 10 Atlee's government that India was granted independence in 1947.(Site details) http://knowledge.wharton.upenn.edu/india/article.cfmarticleid=4109# Ratan Tata has said he is confident the two companies have "a cultural fit and similar work practices." Nearly 30 years ago, J. R. D. Tata had lured away a young engineer from Corus's predecessor company, British Steel, to work at Tata Steel. That young Sheffield-educated engineer -- Sir Jamshed J. Irani (knighted by the Queen) -- was Tata Steel's managing director until six years ago. (India Knowledge@Wharton Sponsors) Site http://knowledge.wharton.upenn.edu/india/article.cfmarticleid=4158 (accessed on 2nd May 2007) Conclusion Is the purchase of a company from a developing nation a sign of the future There has been growing evidence of a shift in global business power, with foreign investment from developing countries now becoming a major factor in the world economy. The United Nations Conference on Trade and Development (UNCTAD) has confirmed the trend - with foreign direct investment from developing countries and transition economies, such as Russia and the former Soviet Union, rising 5% to $133bn (70bn) in 2005. (UNCTAD Investment Brief #4, 2006) can be accessed from www.unctad.org/wir (accessed on 2 May 2007) Gopi 11 In a study conducted in 2000 by Lehman Brothers, it was found that, on an average, large M&A deals cause the domestic currency of the target corporation to appreciate by 1% relative to the acquirer's. For every $1-billion deal, the currency of the target corporation increased in value by 0.5%. More specifically, the report found that in the period immediately after the deal is announced, there is generally a strong upward movement in the target corporation's domestic currency (relative to the acquirer's currency). Fifty days after the announcement, the target currency is then, on average, 1% stronger. (From Wikipedia - Mergers and Acquisitions) Ratan Tata is a highly capable individual, and he has done remarkable things with the Tata Group in the years after 1991, the year he took control of the group from the legendary J. R. D. Tata. According to him there is a strategic value for an asset, which must be kept in mind during M&As. Tata's worst critics concede today that the gamble on cars and tea have paid off, with some help, of course, from unprecedented economic growth in the country in the past three years. Can Tata prove his critics wrong again with Corus Gopi 12 Appendix A INTERVIEW | RATAN TATA "Skepticism about Indian companies declining" Tata Sons Chairman Ratan Tata responded to questions on acquisitions, the way the world is looking at India and his quest to make the Tatas a truly international group. Q. The acquisition of Corus takes you to a new level with a group size of over $40 billion. What next A. We will continue to focus on enhancing the competitiveness of our Group companies in an increasingly globalising world. We want to expand markets for our existing products overseas. While in India, we are trying to break new ground in addressing the needs of the mass market. Q. You once said Indian companies can't afford not to export. Have we now reached a point where Indian companies must acquire to get scale and exponential growth A. I would not make such a definitive statement. Scale and growth need to be linked with a company's need to remain competitive. Acquisitions for the sake of acquisitions will not necessarily yield the desired results. Q. What is driving the spree of acquisitions Need for exponential growth or acquisition of capacity A. As I said, acquisitions for the sake of acquisitions will often not yield the Gopi 13 necessary results. We need to link each acquisition with the industry in which a company is operating, and the strategic context of that industry. The ultimate objective is to leverage opportunities and resources, wherever in the world they may be resident, to improve the competitiveness of our companies. Q. Do you have a personal benchmark for the group in terms of size, turnover and profits A. Not really. Around a decade back, we tabled some numbers, but those were primarily to illustrate what might be possible to our managers. Then a few years back, we set some targets for revenue and profitability growth for our companies; these, however, did not fully capture the issues some companies might face in their quest for growth. I feel what should drive each company is the need to constantly improve their ability to compete. In a measured way, they should seek to achieve market leadership in India and where relevant, establish a market presence and ability to compete effectively overseas. Q. Is there a blueprint that the group is following in terms of strategy for its acquisitions A. We want to expand into geographies where, as a group, we can have a meaningful presence. First, we have chosen countries where we felt we could make an impact and, secondly, where we are able to participate, as we have in India, in the development of that country. When you visit a country or examine a particular company, I think you intuitively know if there's an opportunity, and then you flesh out that Gopi 14 opportunity in one form or other. If we get to the stage of justifying assembly or manufacturing operations, we will seek either to contract them or to invest in facilities in that country. Q. Would you call the acquisition of Corus among your major achievements A. Our offer to acquire Corus has resulted after a long period of evaluation of the opportunity and discussion between the two organizations and the proposed union has been built on a global strategy and the prospects of the combined entity look promising. Q. Have things become easier for Indian companies since your acquisition of Tetley in 2001 A. Things have definitely changed for the better. Managements of Indian companies are more prepared to take risk. Global finance is available to them and skepticism about their ability to manage global enterprises is declining. Q. Where do you see Tatas, say, at the end of the decade A. We will be a group that probably has an equal division of businesses within India and overseas. With a large multinational workforce, our outlook as a Group will hopefully be truly international, so that wherever we may establish operations in overseas markets; we would come to be regarded as a local enterprise that merely happens to be owned by an Indian corporation. Gopi 15 Appendix B Share Holding Pattern Tata Steel As On 31 March 2007 Gopi 16 Works Cited 1. From Wikipedia - Mergers and Acquisitions. 2. UNCTAD Investment Brief #4 2006 can be accessed from www.unctad.org/wir (accessed on 2nd May 2007). 3. Knowledge@Wharton October 31, 2006, Pedal to the Metal: Challenges of Tata Steel's Corus Takeover (online) available from Sponsors Site http://knowledge.wharton.upenn.edu/india/article.cfmarticleid=4158 (accessed on 02nd May 2007). 4. Knowledge@Wharton October 31, 2006, Pedal to the Metal: Challenges of Tata Steel's Corus Takeover (online) available from http://knowledge.wharton.upenn.edu/india/article.cfmarticleid=4109 (accessed on 02nd May 2007). 5. Interview with Ratan Tata by India Today Magazine issue dated November 6, 2006. "Skepticism about Indian Companies Declining" Read More