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Takeovers will force companies to shape up, or ship out

As the country's stock markets move closer to the system in developed countries, it is time to ask why one of the more dynamic systems of the developed West cannot be implemented into India in a bigger way: The takeover.

The mention of 'takeover' carries a distinct connotation within the Indian context. In the 1980s, Swraj Paul launched an aggressive takeover bid of Escorts and DCM. His logic was based on the argument that these companies were being run like fiefdoms in which the management had a low stake and this acted as an incentive for these managements to siphon funds. The footnote to this story is that Paul, who expected the then prime minister Indira Gandhi's blessings in the takeover attempt, suddenly ran out of patronage and the general conclusion to the story was that existing managements should not be destabilised.

This 'destabilise' argument has run effectively until today. Any company under a hostile takeover threat immediately raises the bogey of the outsider wanting to disrupt established systems and is out to ruin the company. As a result, the general impression that hostile takeovers are bad, ill-advised, and anti-social has left a lasting impression on the investing public in this country. Any agency launching a hostile bid has been immediately dismissed as a trouble-maker.

Sadly, we have history to blame. In the 1980s, Paul's only 'fault' was that he was far ahead his times. For as the years progressed, the feeling gained ground that no management could run his company like a fiefdom and that anyone running it with a wafer-thin stake had no business being part of the management. But despite this increasing realisation, if still nothing transpired in making hostile takeovers popular or receiving tacit investor approval, it was because of certain traders-turned-industrialists who launched hostile takeovers, succeeded in gaining a majority, and then stripped the blue-chip companies en route to turning them into basket cases. Result: all those who agreed with the takeover concept within the Indian environment now developed reservations.

However, like it or not, the time has come for the takeover concept -- hostile or not -- to be aggressively absorbed within the Indian system. For years, we have looked upon takeovers as a subject in which an outsider comes in, takes control of a company he has played no part in setting up. We have also had a typically feudal way of looking at corporates. We often refer to companies as "X's company" whereas in actual fact X, even though he may have played a role in setting up the company, is now only a manager with a majority stake. If a more powerful entity comes along who can move the company faster than others, then so be it. This thinking is not only a part of the globalisation of the country. It makes economic sense to permit those who have stronger financial resources or better brand equity to take over companies with weaker muscle and permit the latter to be turned into powerful entities.

Look at the benefits of takeovers -- hostile or otherwise -- within the Indian context:

* Pressure on managements to be more responsive to the needs of shareowners: This is the first thing that comes to my mind. I can immediately think of a Delhi-based company with a fully-diluted equity of Rs 200 million reporting cash flow of Rs 500 million for 1996-97 and announcing a dividend of Rs 1.20 per share only. The company argued that it wanted to conserve cash! If this company were taken over and the incoming management not only maintained the profitability of the company (a worst-case assumption) but increased the dividend outgo to 25 per cent, wouldn't shareholders be delighted ?

* Pressure on managements to give up their feudal attitude: The first instance that comes to mind is the diversification of the Birla group into tyres. Not only did Kesoram lose money heavily in the first few years of this diversification, it conveniently leased out the running of the tyres division to a group company. By this, the promoters alienated shareholders of two companies: of one for launching into an unviable business, and of the other who were made to pay for the sins of some other company's blunder. This was a complacent management. A management with the threat of being raided might have sold the tyre business, raised cash and ploughed it back into the company. If you extent this logic, you will find that a number of managements sitting on dead assets would be more inclined to raise cash rather than give their shareholders a bad deal.

* Why re-invent the wheel?: The Gujarat Ambuja-Modi Cement deal is what this country needs. One company with a battered balance sheet is rescued by another who is prudently managed. As a result, one doesn't need to create fresh assets at a time when the country has competitive assets badly managed. In such a scenario, the takeover makes economic sense. The stronger company unleashes the potential locked within the weaker one. The shareholders of the mismanaged company get an escape route, the shareholders of the stronger company get assets at cheap cost. Win-win!

* No time for gestation: The greenfield route is going out of fashion in a number of industries. There are a thousand variables to take care of before the plant can even produce a gram of output (in the Indian context this includes bargaining with the local authorities on the amount of workers that will be absorbed from within them and the amount that displaced and claiming-to-be-displaced villagers will be paid!). A simpler way is to launch a takeover. Probably cheaper as well. More importantly, it takes the gestation period out of the business which means that money invested into taking over the company can be used productively as soon as the company's management passed hands. The Whirlpool example comes to mind. No setting up of new factories. Go into business from day one.

* Existing network: In the coming years, takeovers might transpire not as much for industrial assets as for the brands and distribution network. Buy a company and immediately move into a groove which has been created and nursed for years. Saves new companies from re-inventing the wheel.

* Low P/E ratios: The time looks right as well. The country's broad p/e quotes at a ridiculous low. Should takeovers be initiated on a large scale, this would tend to strengthen equities and provide investors with a return that has not been forthcoming for the last few years. Besides, there are a number of companies with relatively small equity bases thoroughly undervalued. This creates a double-virtue: under-capitalised and undervalued. In a number of cases, the reason behind this is that the existing managements have failed to inspire investor confidence. Change the management and see the valuations change overnight.

* Natural evolution: As the country globalises, a number of companies are beginning to realise that they do not have the economies of scale with which to fight. Result : their cost structure is out of shape and considerably higher than the global level. In such a scenario, they would need to invest considerably in the assets and get them to a globally competitive level. But, as we are seeing, most Indian corporates do not have this kind of money. There are two alternatives here: one, let the assets perish and the company go down the sink. Two, sell the company to someone who is able to bring in money and turn the company around. The example of Sterlite taking over the sick Malco and turning it around comes immediately to mind.

* Insecurity factor: This is the most important benefit of takeovers (or the threat of). Sloppy managements who realise that they can be bought out and that they will lose the support of their shareholders in the event of a proxy war, will then start delivering transparent annual reports, communicate more professionally with their shareowners, and reward them better over the years.

My conclusion is that Indian shareholders have been fooled for far too long. If they are complacent it is because they do not know that they can be treated considerably better. As for the managements whose companies are taken over, spare no tear for them: they make a huge killing when their stake is bought over by the incoming management. Anybody putting this cash at a 13 per cent fixed deposit can generally have three generations of his living off that wealth !

The one company that comes to my mind as a potential takeover case is the Hyderabad-based Nagarjuna Fertilisers. The management has a stake of not more than 15 per cent. The assets are worth in excess of Rs 15 billion. The business is shockproof and returns are guaranteed by the government. The stock quotes at a p/e of not more than 4. The dividend yield is attractive.

What more can one want?