My Advice To Indian Companies Making Acquisition Plans

Mistakes to Avoid

In yet another demonstration of India’s growing buying power, the Tata Group acquired Jaguar and Land Rover from Ford Motors at a cost of USD 2.3 billion. The deal was ranked as one of the record breaking deals by corporate India.

Acquisitions, outbound or not, have one common feature. The buyer pays the target firm a premium above its current market value. Underlying this willingness to pay a premium is the belief that the target would be worth more if it were owned by the buyer. This increase can arise from a reduction in combined costs (cost synergies) or an increase in combined sales (revenue synergies) due to the acquisition.

A key tenet for financial success in acquisitions is, “Do not overpay.” In other words, the price paid for the target should not exceed the value of the target to the buyer. When it comes to affecting the value of the target to the buyer, cost synergies and revenue synergies are very different. Most changes required to realize cost synergies are internal to the firm, so they tend to be realized faster — often within a year or two. On the other hand, since cost synergies essentially come from replacing one firm’s method of producing by another’s, it might entail some political resistance, especially in cross-border deals.

Revenue synergies, in contrast, depend not only on internal factors but also on the reactions of several players outside the firm, such as competitors and customers. They consequently take time, often longer than three years, to truly take effect. Many acquirers, when they estimate the increases in sales due to the acquisition, assume the competitors will remain as they are today. In reality, rivals react to the acquisition and hatch their own plans to combat this expected increase in sales to the buyer. As a result, part of this “revenue synergy” simply evaporates.

Revenue synergies also require a greater level of integration between the merged firms. Often this is a process fraught with the potential cultural conflict between the two organizations. Such cultural conflicts make the process of integration difficult. Often the conflict between divisions is so high that liberation turns out to be a better option than integration. The ill-fated Daimler-Chrysler merger is a classic illustration of this failure.

A good buyer should thus be realistic in assessing revenue synergies and cost synergies. Given the uncertainty associated with revenue synergies, a careful buyer should not consider a dollar of revenue synergies to be equivalent to a dollar of cost synergies.

There is nothing like practice to reduce the degree of uncertainty in one’s estimates of these synergies. This explains why most Indian companies are starting small when looking abroad. Even the steel companies in the news over the past year had previously completed several smaller deals. But one has to be sure that the lessons of the previous deal are applicable to the one at hand. There is nothing like overconfidence to ruin your estimates.

To buy a company at the right — or the lowest price — it helps to be the only interested buyer. If possible, the companies should avoid competition. The best tactic for this is to think differently. Doing so makes it more likely that you will be the only one approaching a target. Additionally, targets that have a lower profile often face fewer buyers. They might be smaller firms or sometimes private firms.

Private targets have another advantage. Since owners of private firms typically have a large part of their wealth in the firm, they are less diversified and value their firm less than a diversified owner might. For a diversified firm, this creates a greater possibility of paying a reasonable premium to the seller and still not overpaying.

If a buyer does get into a competitive environment, the discipline to walk away at a pre-determined threshold price is critical. Many acquirers make the cardinal mistake of underestimating their competition.

Companies sometimes also underestimate the importance of non-price dimensions in a merger. This is especially the case in cross-border deals. The support of workers and other non-shareholder groups is critical in cross-border deals. These groups support firms that have a good track record with respect to social factors.

Indian companies that are prowling for targets to take over would do well to understand these basic issues, because it can help them avoid the single biggest mistake that many new acquirers make — overpayment. The old saying “caveat emptor” — let the buyer beware — applies as much to a merger as it does to any other kind of purchase.