The Indian media gleefully called last year the "Great Indian Takeaway". Starting with Tata Steel's US$11 billion (Dh40.37bn) buyout of Corus, the Anglo-Dutch steel maker, in January of that year, Indian companies went on to snap up international firms worth more than $31.4bn. That was four times higher than the 2006 figure. This year, the acquisition spree has continued, but now that recession is starting to sweep through the US and UK markets, the wisdom of these deals is likely to be put to the test.
Back in March, when the Indian car manufacturer Tata Motors bought the iconic British brands Jaguar and Land Rover, there were already questioning voices. In the weeks leading up to the $2.3bn deal, the Wall Street investment bank Bear Stearns had collapsed and been bought out by JPMorgan Chase. "There may be some pressures in some geographies today," said Ravi Kant, the Tata Motors chairman, when announcing the deal. "[But] we feel that we have done a wise thing by going in for these two brands."
Six months later, Mr Kant cannot afford to be so sanguine. "At the time that we did the deal, none of these things were foreseen," he said as Tata Motors's results were announced recently. "It's unfortunate that today all of us, not just Jaguar and Land Rover, are in this situation of economic turmoil." Others are certainly in the same boat. Most of the international firms that Indian companies have bought in the past two years have had long histories of loss-making. They were often larger than the Indian companies buying them, and the international expansion was often made possible by easy borrowing.
That cheap and easy money is now gone. The Indian wind turbine maker Suzlon last week dropped the $360 million rights issue it needed to buy an additional stake in the German wind power company REpower Systems. Tata Motors has abandoned its plan to raise $500m to pay off the bridge loan for its Jaguar-Land Rover deal through an issue of international equity, citing "the unprecedented and challenging times". It only managed to raise the $840m domestic portion of its rights issue because its parent group bought $608m of the shares.
The refinancing for Hindalco's acquisition of the Canadian aluminium roller Novelis has also run into problems. Investors only bought 17 per cent of Hindalco Industries's $1bn rights issue, again leaving the controlling Birla family and the underwriting banks to pick up the slack. Last week, Hindalco - a maker of aluminium and copper products - succeeded in raising a $1bn loan from a consortium of 11 international banks. But it still needs to find a further $1bn internally to repay the $3.03bn loan.
It only takes a cursory look at the financial histories of most of the companies that Indian firms have acquired to see the scale of the risk. Novelis, the world's largest flat-rolled aluminium maker, was already haemorrhaging cash when India's Hindalco bought it in February last year. At the heart of Corus, which Tata Steel bought for £6.2bn (Dh33.9bn) at the end of January last year, is British Steel. The company only turned a profit in two of its 10 years of independent life, and then continued to make heavy losses after it merged with the Dutch steel maker Koninklijke Hoogovens to form Corus in 1999.
Ford is thought to have absorbed losses of more than $10bn in the years that it owned Jaguar and Land Rover. And the list goes on. REpower, which Suzlon bought a major stake in last year, made heavy losses in 2004 and 2005. The international power company Intergen, which India's GMR Infrastructure took a 50 per cent stake in for $1.1bn in July, made heavy losses in 2002. The story is broadly the same for most of the smaller car parts manufacturers or pharmaceuticals groups that Indian companies have bought.
And this vulnerability to losses has been made still worse by the debt that Indian companies have tended to load onto their balance sheets. Tata Tea set the trend for India's international acquisitions when it bought Tetley Tea in 2000. The leveraged buyout-type structure it used - with most of the debt loaded on to a UK-based acquisition vehicle - has been copied, not least by Tata Steel with its Corus acquisition.
Tata Steel paid for almost half of the Corus deal by loading $6.14bn of bank debt onto the acquisition vehicle, Tata Steel UK. Hindalco did something similar with Novelis. TV Raghunath, the head of mergers and acquisitions at Kotak Mahindra Capital, said: "Not many of them have recourse to the parent, or not a big portion, so consequently the Indian acquirer is pretty much insulated." But their new subsidiaries are, as a consequence, exposed. Last month, ratings agencies Moody's and Standard & Poor's both downgraded the outlooks on Tata Steel UK. Moody's said it feared that Tata Steel UK could end up holding debt worth more than four times its underlying earnings if the slump in the steel price continued.
Fitch has also put Tata Steel on watch for a downgrade, saying it was now less certain of parent Tata Group's ability to support its companies. Other companies have funded their deals at the parent level with foreign currency convertible bonds (FCCBs), which now look vulnerable to currency fluctuations. The $500m worth of FCCBs that Suzlon issued to fund the REpower acquisition led it to post losses of $26m as it adjusted the liability to reflect the rupee's fall to a record low against the dollar.
. The recession has begun to show its effects on the companies acquired by Indian firms. Tata Motors announced recently that the number of cars the two brands sold between July and September had slumped by more than 11 per cent compared to the same period last year. Sales of Land Rover, traditionally seen as the strongest brand of the two, dropped nearly 20 per cent. Corus is also starting to put Tata Steel under pressure. The first year of Corus ownership was better than Tata Steel could possibly have hoped for.
"There was a huge margin expansion because raw materials prices did not got as high as the steel price," said Rakesh Arora, a steel analyst at Macquarie Bank. When steel prices were at their peak earlier this year, Corus was making $120 for every tonne it produced. In the first six months of this year, Corus would have earned about $2bn. This is much more than Tata Steel could have expected at the time of the acquisition, said Mr Arora.
But now the slump in steel demand and prices could easily push Corus back into making losses. Merrill Lynch estimates that Tata Steel is more sensitive to a fall in the steel price than its Indian peers - for every 1 per cent change in the steel price, the company's earnings per share for next year fall 15 per cent. Tata has already been taking bold short-term measures to keep its new acquisitions in the black. Ratan Tata, the chairman of Tata Group, has issued a directive to all of the chief executives of Tata companies, putting a moratorium on further acquisitions and asking them to cut back on acquisition plans.
Last Friday, Tata Steel moved to cut production from 20 per cent to 30 per cent, and said it would lay off 400 workers at Corus plants in Europe. Tata Motors is planning to cut 600 jobs from Jaguar and Land Rover's UK manufacturing plants, and is offering workers three-month sabbaticals on 80 per cent of their pay. Some plants are only working four days a week. Aditya Sanghi, the head of investment banking at Yes Bank, which advised Suzlon on its REpower deal, said it would take the next few years to reveal which acquisitions were well judged and which were not.
"There is no broad-brush answer. It all depends on individual synergies," he said. "You need to look at what the rationale of the acquisition was. I don't think if a deal is strategic, a short-term downturn should take away the strategic merits of it." firstname.lastname@example.org