India Economy

Large deals, small returns

Shyam Pattabiraman | Updated on February 02, 2013 Published on January 26, 2013

The logos of carmakers Tata Motors of India (L), Jaguar and Land Rover (bottom R) are seen on the first media day of the 78th Geneva Car Show, in this file combination picture from March 4, 2008. Chinese demand for its luxury Jaguar Land Rover (JLR) models propelled fourth-quarter net profit at Tata Motors, capping a bumper year in 2011 for the Indian automaker. REUTERS/Denis Balibouse/Arnd Wiegmann/Files (SWITZERLAND - Tags: TRANSPORT BUSINESS LOGO)   -  REUTERS


(FILES) This file picture taken on January 26, 2009 shows the Corus steelworks in Scunthorpe, north-east England. The steel industry was dealt a fresh blow Thursday July 9, 2009 with news that Corus is to axe hundreds more jobs at one of its biggest plants. The firm, owned by Indian giant Tata, is expected to announced later that 366 posts will be cut at its site in Scunthorpe in North Lincolnshire. AFP PHOTO/PAUL ELLIS/FILES   -  AFP


Coffee beans are displayed at a premium Cafe Coffee Day outlet in Bangalore, India, Tuesday, Jan. 31, 2012. Starbucks aims to open 50 outlets in India by year's end, through a 50-50 joint venture with Tata Global Beverages, the companies said Monday. Starbucks currently operates over 17,000 stores in 57 countries. (AP Photo/Aijaz Rahi)   -  AP

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Majority of M&A activity is known to destroy value due to various reasons and the risk of failure is higher with increasing deal size.

The Tata Group has definitely grown leaps and bounds under Ratan Tata’s tenure, through both organic and inorganic means, and there’s been enough stories in the media recently, recounting the achievements.

Most of them were in praise of the large M&A deals struck, especially during the last decade. Now M&As definitely make good news material, but the question is how did it aid shareholders?

The topic is especially interesting because majority of M&A activity is known to destroy value due to various reasons and the risk of failure is higher with increasing deal size.

It is also very pertinent from a Tata Group perspective, for it has steered some of the largest deals in Indian business history, and made the leap from India to global early.

M&A performance

So I decided to dig through data on Tata Group M&A activity for this article. The analysis involved taking the top 15 listed companies of Tata Group and grouping them into two buckets.

Bucket one: Let’s call it large deals bucket, consisting of firms such as Tata Steel and Tata Motors, which bet heavily on M&A and consummated large deals during the last decade.

Bucket two: Let’s call it small/no deals bucket, consisting of firms such as Titan Industries and TCS, which have depended primarily on organic growth but may have done smaller M&As relative to their size, from time to time.

Then I computed the last 10-year stock returns for each firm in Bucket 1 and Bucket 2 separately, to arrive at the composite average 10-year market performance for Bucket 1 and Bucket 2. While the large deals bucket clocked 21 per cent average returns p.a., the small/no deals bucket clocked 32 per cent average returns p.a..

During the same period, the Sensex & Nifty registered approx. 20 per cent average returns p.a.

Basically, the market data from the last 10 years shows that firms involved in large deals have delivered less shareholder returns compared to their peers.

Interpreting the results

Do the results mean that a predominantly organic strategy or only doing smaller deals is the better way to grow from shareholder returns standpoint? I would resist coming to such a drastic conclusion but, clearly, a large dose of inorganic growth can dent returns in the short/medium term, since the acquirer typically pays a premium for the acquisition (unless it’s a fire sale) and carries the risk of realising it through synergies/turnaround/asset stripping as required.

One could argue that it is only because the firms couldn’t successfully compete/grow organically, they resorted to inorganic growth in the first place.

This means that had the firm not done an acquisition, its performance would have been poorer, which may be true, but will remain a hypothesis that can never be proven.

What can be observed, though, is that some of the larger acquisitions done by the Tata group have been in sectors that border on commoditisation, where size may provide an advantage in the long run. So the last ten years may be too short a period to judge the outcome.

Divestiture performance

Now let’s move to the other side of acquisitions, that is, divestures. Here too, the Tata group has done some marquee transactions. Some of the key names that come to mind are Lakme and Nerolac.

These transactions were done due to various reasons, for example, when business goes through a lacklustre phase or owing to perceived lack of competence/industry leadership .

Moreover, the philosophy of “core competence” was in vogue then and Jack Welch at GE espoused the strategy of either being No.1/No.2 in every industry that one operates in or to get out of the space.

All these obviously seemed like perfectly good rationale to exit from what were otherwise worthwhile businesses back then, but with the passage of time, some of these decisions look meek — especially because they involved powerful consumer brands that offered multiple extension possibilities. Watching these divested companies prosper, in hindsight, it appears the Tata group may have possibly underestimated the power of Indian consumer brands and its own capability to pull it off.

The success of Titan — once a fairly small Tata company — is a case in point. Titan has been a stellar performer within the Tata group portfolio both in terms of Return On Capital Employed (ROCE) (>50 per cent now) and stock returns (53 per cent p.a.) during the last decade of consumer boom.

The takeaway is that size may not necessarily be a key competitive advantage; brand recall could be more valuable, especially in the consumer space.

Also, core competence is a concept that may be applicable to an individual company, not necessarily to a group, for which a portfolio return maximisation approach would be more appropriate.

Published on January 26, 2013
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