Deal-making is now being characterized by complex and creative financial structures. But all of this complexity can be risky from an execution standpoint. In a Facebook Live interview with Mint under its program ‘Deals Hub’, Ajay Arora, who leads the M&A practice for EY in India says that the execution intensity in deal making has increased exponentially. Arora also talks about the forces that will shape the mergers and acquisition market. Edited excerpts:
What are the forces shaping the M&A (mergers and acquisitions) market?
If you rewind the last five years, we were range bound between $25-30 billion in terms of cumulative M&A on a year-on-year basis. Last year was a big shift where the deal value almost doubled.
There was two big drivers. First, domestic consolidation, where we saw large assets being bought by big business houses like Aditya Birla Group and Adani. Second, spike in inbound M&A, where we clearly saw big ticket transactions happening in oil and gas and across sectors.
We have not seen that before Indian businesses going on shopping like this. What changed?
Post 2010, its been a cautious environment in deal making. Prior to that, it was largely outbound that was driving the Indian M&A. Most of the Indian companies have now become very cautious acquirers of assets globally and hence that has softened. Domestic M&A was quiet but it picked up as capital became available, and there was quality assets available at right price. The key factors were quantum of leverage on which some big business houses were sitting and the pressure from banks. When these two came together, that is banks influencing the decision making and driving some of these corporates to sell non-core or underperforming assets. You clearly saw big triggers sitting there, either global buyers or domestic, lapping up some of these assets.
We also saw transactions in cements in the last 12-18 months. The larger ones being Jaypee assets being acquired by UltraTech, Lafarge assets being acquired by Nirma, and Reliance cement assets being acquired by Birla Corp.
Do we see more deals as a result of deleveraging?
This is probably expected to ramp up further because there are two factors acting as catalysts. Primarily it’s the intent of the government, the banking and the financial institutions, to ensure that some of these accounts gets regularised. Second, a lot of Indian corporates are focusing in core verticals and as they tend to do that, they will divest some of these non-core assets to improve liquidity in their balance sheet.
Valuations look high. Give us a sense of on how valuations are impacting deal making?
This is a very important driver for deal making. Valuations over the last one year have increased quite a bit and this is because of clear momentum that we are seeing in the capital market. Capital market, which are used as a benchmark for valuing other transactions are at a peak right now and I don’t see them softening. If you evaluate deal structures, you will notice that they have become little more innovative and complex. These are effectively being used to mitigate and address the valuation challenge.
Along with deal making becoming complex, there are execution challenges. We see lot of deals getting undone. What are the concerns that investment bankers have to be cognizant of?
The execution intensity in the last 24-36 months have probably multiplied exponentially. There are three reasons for that. One, deal sizes are increasing. Second, innovative structures are being explored and they have to pass the litmus test with the regulators. These litmus tests are the key factors that some of the deals were undone. Third, the amount of work that some of these buyers have to do on the diligence sides have intensified.
What is the intent of the government in facilitating large M&A deals?
If you look at the initiatives such as promoting ease of doing business, abolishment of FIPB (Foreign Investment Promotion Board); the intent of the government is clearly pro-business. For some of the complex deals, approval process do take time. The government is following a rigorous process in terms of evaluating complex transactions, looking at merits and demerits of the transactions, and looking at the extent of deviation.
Which sectors will drive the M&A going forward?
There is going to be significant deal activity in four to five sectors. Technology continues to be significant deal driver. Financial services will continue to see lot of PE (private equity) activities. Insurance sector will see lot of consolidation. Pharma and healthcare will see lot of activities in terms of strategic M&A and PE exits. Infrastructure in road and power which is largely M&A driven and especially PE funds in the renewable energy space will also see lot of activities. Manufacturing in automobiles and chemicals will witness significant amount of inbound M&A.
What is driving M&A transactions in oil and gas sector?
Oil and gas, historically, have witnessed fewer but mega deals. Traditionally, in the last decade or so we have seen state-owned companies going into foreign jurisdictions to acquire E&P (exploration and production) assets with the objective of energy security for the country and that is going to continue its trend. You will see ONGC, Oil India, IOCL and BPCL cutting big cheques to acquire assets abroad like Russia, CIS (Commonwealth of Independent States), Africa and Latin America. The second side of the activity will see consolidation in the domestic E&P space. The third is on PSU (public sector units) mergers that is done largely to create Indian majors at par with global majors, which is a step in the right direction. ONGC and HPCL coming together brings the upstream strength of ONGC with the downstream strength of HPCL.
Do we see big ticket M&A deals in the rest of 2017?
From the rest of 2017, large bucket would be driven by the restructuring cases which are currently under IBC (Insolvency and Bankruptcy Code) proceedings. Second would be timing of big ticket PE exits. Third could be inbound M&A where some of the big majors from Japan would be looking across the manufacturing space.
Would we continue to see succession driven deal making at family businesses?
This is a big shift that has happened in this decade, where family businesses are more amenable to the idea of exits. Part of it is due to succession. Secondly, they want to monetize as there are good prices available and also good global buyers available. Some of these global buyers are proactively engaging with them and convincing them to sell. They feel that they can exit their current business and invest in sunrise sectors where next generations are more interested.