May 2007

insight

Corporate India in M&A Mode : Global Ambitions may

Weaken Credit Risk Profiles
Analytical Contact:

Gurpreet S Chhatwal

gchhatwal@crisil.com

Executive Summary
Indias corporate landscape may well witness an unprecedented
number of mergers and acquisitions (M&As) in 2007, with companies
actively considering inorganic growth options. The number of M&As
has surged over the past three years, with 2006 being the first year
when foreign acquisitions by Indian companies exceeded inbound
and domestic M&A activity. As the number of deals keeps mounting,
deal sizes have been inching up as well.
Owing to the improved financial strength, declining leverage, and
improving cash generation of Indian companies, the rising tide of
M&As has yet to affect the companies credit risk profiles significantly.
Companies business diversity has also improved as a result of the
acquisitions, lending a measure of stability to their overall credit

.........

profiles, and negating the impact of debt undertaken to fund

CRISIL RATINGSCAN

May 2007
acquisitions. The balance may tip, however, given the ambitions of
corporate India with regard to major acquisitions abroad, and growing
reliance on debt to fund buy-outs, thus weakening their credit risk
profiles. The prevailing hyper-liquidity and greater risk tolerance among
investors and lenders also fuel this pattern.

USD11.9 billion2 (refer Chart 1).

Outbound M&As were the flavour of 2006; the Indian corporates desire
to expand beyond the subcontinent saw the average international
deal size increasing by more than 50 per cent to USD62 million.
Increasing valuations and dwindling domestic acquisition options

Inorganic growth strategies driving M&As

resulted in a drop in inbound M&A activity. Pharmaceutical and

The number of M&A deals in India increased by 26 per cent in 2006:

the number increased to around 3491 (from 276 in 2005), valued at

information technology and its enabled services (IT-ITeS) sectors

continued to drive activity in the M&A space.

Chart 1: Inbound and outbound M&A activity in 2005 & 2006

Inbound
16%

Inbound
23%

Domestic
25%

No. 27
Size: 72

No. 17
Size: 158
No. 79
Ave. Size: 76

No. 73
Ave. Size: 40

Domestic
51%

No. 77
Ave. Size: 40

No. 114
Ave. Size: 62

Outbound
26%

Outbound
59%
2005
Industry Sectors

2006
USD mn

IT & ITES

Deals (Nos)
68

25%

974

8%

IT & ITES

79

23%

2014

17%

Pharma

39

14%

674

6%

Pharma

34

10%

2158

18%

Auto Ancillaries

22

8%

453

4%

Media

23

7%

345

3%

Industry Sectors

Deals (Nos)

USD mn

M&As to increase, Acquisitive industry segments to expand

Pharmaceuticals

The appetite for inorganic growth is expected to increase over the

The Indian pharmaceutical industry (Indian Pharma) has graduated

medium term. The two most active sectors in the pastpharmaceuticals

to acquisition sizes of over USD500 million in the past two years (refer

and IT-ITESare likely to see fairly intense M&A activity over the next

Chart 2); this has doubled the balance sheet sizes of some players.

few years, while M&As are likely to increase in commodity industries

Funding has not been a constraint: Indian Pharma has leveraged its

in the immediate future and in the emerging domestic retail sector

strong balance sheets and tapped a buoyant stock market to fund

over the medium term. The key drivers for the increasing M&As in these

acquisitions with a mixture of debt and equity. The main drivers for

industry segments are discussed below:

the increasing M&A activity in this sector include the sheer size of the

This includes M&A deals involving change in management or buy-out of controlling stakes. It does not include creeping acquisitions, buy-out of non-controlling
stake by either existing promoters or financial investors or re-alignment of equity stake within the same promoter group or mergers of subsidiaries.

The aggregate value of M&A deals in 2006 pertains to only 214 deals for which the acquisition consideration was in public domain. Chart 1 also pertains to M&A
deals where the acquisition consideration was disclosed publicly.

.........

CRISIL RATINGSCAN

May 2007
Chart 2: Increasing number & size of acquisitions by Indian Pharma

Sabah Forest Industries of Malaysia are few instances of the initial

(in a sample of top 15 companies)

M&A deals that are expected to be completed in 2007. Deal sizes can
be very large in the sector; Tata Steels bid for Corus, at over USD10

No. of acq.

12
12 Median size ($ mln)

31

18

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2006

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2007

billion and Hindalcos bid for Novelis at USD 6 billion, for instance,
would be amongst the top three Indian M&A deals in history.
Retail
Indias retail industry is likely to witness the emergence of several
midsized players in the near future. Initial losses, a desire to gain
market share, price competition, and the importance of scale economics
in the retail industry are among the factors that could drive
consolidation in the sector over the medium term.
M&As likely to weaken corporate Indias credit risk profile

generics opportunity in the international markets, the desire to acquire

Corporate Indias credit risk profile has remained relatively stable thus

and improve access to distribution networks in regulated markets, the

far; in some cases, it has even improved as a result of M&A activity.

broadening of product offerings, and the leveraging of Indias cost

The future, however, may be different. With M&As expected to increase,

advantage. CRISIL expects Indian Pharmas search for inorganic growth

corporate credit quality appears likely to deteriorate. While large-scale

to increase over the next few years, as deal sizes continue to soar.

acquisitions tend to have a positive bearing on the business risk

profile of the entities, the incremental debt required to finance the

IT/ITeS
While this sector has seen some inbound action, the main M&A activity
has tended to cluster around Indian IT/ITES players investing abroad.
The deal sizes, though smaller than in the pharmaceutical sector,
have been increasing. The main drivers for the increasing M&A activities

transaction tends to weigh heavily on the financial profile of the

combined entity. The key reasons for the expected deterioration in
credit quality are discussed below.
Strong financial profiles supported M&As in the past

include the Indian companies desire to migrate up the value chain,

The balance sheets of Indian companies had improved during the

expand domain knowledge either within a vertical market or in multiple

past five years, and were, in most cases, strong enough to withstand

vertical markets, and acquire a stable, diverse customer base in the

the adverse financial impact of M&As. M&As often result in increasing

lucrative, developed countries. This trend is expected to continue, with

leverage as a associated with debt funding for the acquisition or

deal sizes rising further. Debt could become a funding option, though

takeover of the existing debt of the acquired or merged entity.) In this

equity and internally-generated cash have been the preferred funding

article, CRISILs financial medians3 (refer Table 1) have been considered

source thus far.

as proxy for the financial health of corporate India; this is because 66

per cent of Standard and Poors (S&P) CNX Nifty comprises CRISIL-

Manufacturing sector
To acquire global scale inorganically and diversify revenues, Indian
commodity players have been weighing the M&A option; this is because
organic growth could impact the present favourable global demandsupply dynamics. These M&A options are amply supported by sizeable
internal accruals in the face of favourable commodity cycles. Tata
Steel Ltds bid for Corus Group of the UK, Hindalco Industries Ltds bid
for Novelis Inc in Canada, and Ballarpur Industries Ltds interest in

and access to cheaper funds saw margins improve for most companies
during 2001-2006 (as represented by profitability ratios such as profit
after tax margins and returns on capital employed (RoCE)). Buoyant
equity markets, robust accruals and absence of significant capacity
expansions were also among the factors that contributed to
considerable improvements in corporate Indias capital structure, and
consequently, debt protection measures (represented by ratio of net

CRISIL calculates medians of key financial ratios to study aggregate trends in respect of financial risk profile of its rated portfolio. They are indicative in nature
and are not intended to be used as hurdles for companies to cross.

.........

rated entities. In general, strong demand growth, improving productivity

CRISIL RATINGSCAN

May 2007

.A=JKHA
cash accruals to total debt, interest coverage and cash debt service

M&A activity in the country in 2006). Such large M&As are likely to

coverage) improved significantly. As a result of this improvement in

affect the financial risk profiles of both the acquiring and acquired

financial risk profile, Indian companies were well positioned to

entities. The deals, involving sizeable debt funding, are also sensitive

withstand the increased leverage and higher interest burden of bigger

to the value addition or synergy benefits from the M&A, and to the

M&A spending.

outlook on revenue growth, profitability, and the stage of the industry

1 CRISIL calculates medians of key financial ratios to study aggregate

trends in respect of financial risk profile of its rated portfolio. They are
indicative in nature and are not intended to be used as hurdles for

cycle. Any adverse deviations from the original assumptions could

result in a disproportionate impact on the financial risk profile of the
entities involved.

companies to cross.

Equity-funded M&As supported credit profiles in the past

Table 1: Median ratios of companies with AAA, AA, and A ratings

M&A activity was funded largely via retained earnings and buoyant

from CRISIL in 2000-01 and 2005-06

equity markets in the past. In the pharmaceutical and IT/ITeS industries,

2000-01

the preferred sources of funding for M&As were equity or equity-linked

2005-06

instruments (foreign currency convertible bonds). CRISIL reaffirmed its

AAA

AA

AAA

AA

Rs Billion

5.11

2.51

0.81

21.27

4.05

1.57

Balsara Group of Companies (for Rs.1.43 billion) in April 2005 and

Gearing

Times

0.50

0.98

1.53

0.21

0.40

0.63

Sun Pharmaceutical Industries Ltd after it acquired the assets of Able

NCA/ TD

Times

0.25

0.21

0.16

0.61

0.43

0.23

Laboratories Inc, USA (for Rs.1.06 billion) in December 2005. Both

PAT Margins

8.38

6.02

3.61

11.82

7.83

3.8

RoCE

21.00

18.33

15.00

Interest Cover

Times

6.85

3.80

2.50

Cash DSCR

Times

2.00

1.75

1.57

Net worth

24.97 20.19 12.78

30.84 12.08
9.87

3.96

credit ratings of Indian FMCG major, Dabur India Ltd after it acquired

deals were funded through internal accruals. Apollo Tyres Ltd acquired
the South Africa-based Dunlop Tyres International (Pty) Limited for
Rs.2900 million in February 2006, which it funded by a private equity

4.30

placement of Rs.2500 million.

2.35

Leveraged buy-outs (LBOs) are a concern now

In 2005 and 2006, M&A deal sizes were smaller, and therefore, did not

With companies setting their sights on larger and larger deals, there

significantly impact the financial risk profiles of the acquiring or

is a marked preference for LBOs (refer Box 1 for CRISILs treatment of

merged entities. While about five deals in 2006 and six in 2005 were

LBOs). Tata Steel and Ballarpur Industries bid for Corus and Sabah

above USD500 million, the bulk of the deals were smaller. A previous

Forest Industries, respectively, are representative of LBO transactions,

CRISIL Ratings study (M&As Ratings remain stable despite strong

potentially involving sizeable components of debt. LBOs involve using

activity, published in February 2006), had observed that less than 25

the cash flows of the target company to service the acquisition

per cent of the M&A activity involving CRISIL-rated companies in 2005

consideration, which is in the form of debt. In the Indian context,

could be classified as large: large acquisitions or mergers are those

acquirers have also attempted to protect their balance sheets by setting

where the acquired entity is over 30 per cent of the balance sheet of

up ring-fenced special-purpose companies (SPCs) to take on debt for

the acquiring entity.

the acquisition, without legal recourse to the acquirer. Large LBOs

typically impair the acquired companys financial risk profile since

Increasing deal sizes are a concern now

most of the debt taken on for the acquisition has to be serviced by the

Indian companies in various industry segments are currently aiming

acquired entity. The acquirers financial risk profile is also adversely

for large acquisitions, which could change the scale of their balance

affected, prima facie, to the extent of the equity consideration and,

sheets. Tata Steels offer for Corus and Vodafones bid for Hutchison

ultimately, by the necessity to support the acquired entity, in times of

Whampoas 67 per cent stake in Hutchison Essar Ltd are deals in

distress, to protect the economic value of the acquisition.

.........

excess of USD10 billion each (this is almost equal to the aggregate

CRISIL RATINGSCAN

May 2007
Box 1: CRISILs treatment of LBOs

Godavari Fertilisers Limited, a competitor, in July 2003. Similarly,

Despite explicit ring fencing in LBOs, CRISIL determines whether to

Indian pharmaceutical companies, has been able to significantly

take a consolidated view of the acquirer and target company. This

entails an examination of several analytical issues, including:

Ranbaxy Laboratories Limited (rated P1+ by CRISIL), one of the largest

diversify its revenues across the USA, BRICS, Africa, Latin America,
Middle East and the Asia Pacific, through acquisitions, joint ventures,

The stated posture of acquirers management on support to

and new product launches. For the year ended December 31, 2006, the

target company;

companys revenues from Europe, the Commonwealth of Independent

Evidence of support, such as guarantees or letters of comfort,

that acquirer may provide to lenders of the target company;

States (CIS), and African market accounts for 31 per cent of its total
revenues. Tata Chemicals Limiteds (rated P1+ by CRISIL) soda ash
business saw its business risk profile strengthened in the wake of its

Commonality of business between the two companies;

acquisition of Brunner Mond Group (BMG) Ltd, UK, in December 2005.

CRISILs view on the nature and extent of support that target

BMG gave Tata Chemicals control of a low-cost natural soda ash

company can expect from acquirer in the event of distress.

manufacturing facility at Magadi, Africa, which is expected to positively

impact Tata Chemicals cost structure, going forward.
Moreover, corporate Indias M&As were focused on value-driven deals in

Box 2: M&As benefit Indian telecom

The Indian telecommunications (telecom) sector is a prime example
wherein M&As favorably influenced the sector and the players
business risks. The sector saw a great deal of M&As in the early
2000s, driving consolidation in the sector. Interim increases in
leverage during the M&A and uncertain regulatory environment
initially impacted the credit risk profiles of most players negatively.
However, with improvement in the regulatory policy environment,
consolidation enabled players to rapidly ramp up scale; this
benefited their business risk profiles considerably, resulting in steep
improvement in the rating of the Indian telecom industry and of
most players over the last three years.

niche market segments in the past. This, and the fact that commodity and
equity markets had not reached their peaks then, kept M&A valuations at
manageable levels. Tata Motors Ltds acquisition of Daewoos commercial
vehicle unit in Korea (in 2004) for INR5 billion, Dabur India Ltds acquisition
of Balsara group of companies (2005) for INR1.43 billion, and Mcleod
Russel India Ltds acquisition of Williamson Tea Assam Ltd (2005) for
INR1.86 billion are cases in point.
Valuations buoyed by peaking economic cycle are a concern now
Unlike in the past, several commodities and equity markets are nearing their
peaks, and the Indian economy, along with other global markets, has been
booming. These factors, in conjunction with the increasing acquisition

Strong business risk profiles underpinned overall credit risk profiles

in the past

activity, have resulted in valuations rising significantly. The Indian

companies have also set their sights on large and strategic companies,
which come at a high price. The high valuations, in the context of an

In the past few years, M&A activity strengthened the business risk
profiles of Indian companies. This was because most M&As centered
on improving the competitive position of the companies and fostering
higher integration and greater revenue diversity. Box 2 explains how
M&As have strengthened the business risk profiles of companies in

evolving and competitive market scenario, could potentially suppress the

returns and extend the pay-back period. Long periods of sub-optimal returns
could weaken the credit profiles of the companies involved; larger
acquisitions also bring greater challenges of integration and harvesting of
synergies, potentially delaying the positive impact of the acquisition.
Peer pressure is a concern too

Coromandel Fertiliser Limited (rated AA/Stable/P1+ by CRISIL), a

Another key divergence from the past is that there is pressure on

medium-sized complex fertiliser manufacturer, enhanced its market

Indian corporates today to seriously consider inorganic growth options.

share and pricing power in its core markets of South India by acquiring

This is a result of the competitors or other Indian companies success

.........

the Indian telecom sector.

CRISIL RATINGSCAN

May 2007
with M&As. M&As have become the buzzword in corporate India.

Chinas corporates. Given the opportunities for Indian Pharma in

Admittedly, not much of the M&A activity has gone wrong, yet. However,

generic medicine, and the manufacturing sectors desire to acquire

the euphoria surrounding M&As could well drive corporates to rush

global scale inorganically and diversify revenues, deal sizes may

into deals without undertaking proper due diligence, especially in

prove to be big. Throw in factors such as strong liquidity, greater risk

understanding the local environment, cultural differences, and legal

tolerance among investors and lenders, and Indian companies desire

structure. This may result in painful and expensive adjustments that

to extend their reach and expand market share and brands, India Inc

ultimately impact their credit profiles. Integration issues and

may well witness an unprecedented number of M&A deals in 2007.

management synergies constitute other risk areas in large M&As.

However, given the ambitious deal sizes, and increasing levels of debt
funding and valuations, the credit profiles of companies may be

M&As may come at a price

Indian companies have surged ahead on M&A deals in the first two

adversely impacted.

.........

months of 2007; the volumes in dollar terms have eclipsed those of

CRISIL RATINGSCAN