Consolidation: The winner takes it all

The Rise of Oligopolies

Back in April 2011, in their seminal article ‘Monopoly and Competition in 21st Century Capitalism’, in the Monthly Review journal, authors John Bellamy Foster, Robert W. McChesney, and R. Jamil Jonna had posited a contrarian argument.

They had argued that the economic defence of capitalism, as premised on the “ubiquity of competitive markets, providing for rational allocation of scarce resources and justifying existing distribution of incomes”, no longer holds true.

This line of thought is getting validation across the world. Capitalism is no longer seen to be promoting competition. Instead, it is pushing economies towards greater consolidation and creating oligopolies. India, a late entrant to this game, is experiencing this trend, particularly in the telecom, steel, cement, and e-commerce sectors where only three to four big players are still standing.

Those that have fallen by the wayside (either acquired or shut down) have been singed by one or many factors: Increased competition, entry of players with better technologies, changes in government policies, stringent regulations, new Supreme Court rulings or a slowing economy. Often, this can get compounded by internal issues such as operational inefficiencies, mismanagement and even siphoning off of funds by promoters.

The trend of consolidation is notable among state-owned banks. In 2019-20, the number of public sector banks is being brought down from 21 to 12, with the government hoping that stronger balance sheets and good governance would create sounder credit growth and command better valuations. Conglomerates, too, seem to have realised the futility of running multiple (non-core) businesses on a stretched balance sheet in these unforgiving conditions.

Of course, consolidation can also take place during a significant upswing in the economy. “However, more acquisitions happen during a downturn because good quality assets are available at reasonable rates, which are then picked up by financially strong companies,” says Sanjeev Krishan, partner and lead-deals, PwC India. Moreover, companies—badly bruised by falling margins—accept the upside of letting go rather than become an insignificant fifth player in the market, adds Krishan.

The implementation of the Insolvency and Bankruptcy Code (IBC) Bill in December 2016 has hastened the pace of or, at least, facilitated acquisitions. “The IBC, though a work-in-progress, has been a crucial driving force as a mechanism for price discovery and recovery of distressed assets in the time frame,’’ suggests Bain& Company’s India M&A report 2019.“Distressed asset acquisitions accounted for 70% of the growth in the deal value in 2018compared to 2017,” it adds.

For the acquirer, it is inevitably a win-win. Existing leaders gain economies of scale and market share, helping them pull further away from competition or becoming better equipped to fight it. For instance, UltraTech’s acquisitions of Jaypee Cement (2017) and Binani Cement (2018) have solidified its position at the top of the cement sector. Airtel’s purchase of Tata Teleservices’ and Telenor’s assets in India will help it take on the might of Reliance Jio. Global companies also use the acquisition route to make a foray into the growing Indian market: Take Wilmar Sugar Holding’s takeover of ShreeRenuka Sugar (2018) or ArcelorMittal’s bid for Essar Steel.

Not surprisingly, the consolidation drive has seen a jump in the market share of the top five players across sectors. In telecom, they control 99.6% of the market as of FY19, compared to 79% in FY14. (Sooner rather than later, the sector is likely to turn into a two-horse race.) The corresponding leaps in cement are to 50% from 46% and in steel to58% from 51%.

The question that needs to be asked, then, is: Should a developing country like India, which needs huge investment and several players to build its infrastructure, see the rise of oligopolies? On the one hand, the U.S. experience is not comforting because dominant players have used their muscle power to throttle competition, invested less in the real economy, brought down productivity, hiked prices, resulting in greater inequality in the system. On the other, as PwC’s Krishan points out, in an economy characterised by low demand and excess capacity, having limited players with strong balance sheets can be a boon. When demand picks up, new players will rush in despite high entry barriers and imposing competition.

In the paragraphs that follow, Fortune Indiadecodes how the consolidation story is playing out in various sectors of the economy.

Steel stronger together

For an industry that is highly capital-intensive, prone to cyclicality, critically dependent on the state of the economy and easily hurt by price volatility, consolidation is a welcome trend. No wonder Seshagiri Rao M.V.S., joint managing director and group chief financial officer of JSW Steel, is a happy man. “It [consolidation] allows major players with sound financial health to sustain their businesses even in the most challenging times and also provides some stability to the sector,” he says.

JSW’s acquisition of the bankrupt BhushanPower and Steel was recently approved by theNational Company Law Tribunal (NCLT). It is one of the many moves that have followed the implementation of the IBC bill in December 2016; several erstwhile major steel producers found themselves on the defaulters’ list, divest-ed of management powers and with their assets in the custody of the NCLT at the behest of the Reserve Bank of India (RBI). The first list of 12 names included the likes of Essar Steel, Bhushan Power & Steel, Bhushan Steel, andElectrosteel Steels. The latter was picked up by the Vedanta Group and Bhushan Steel has been merged with Tata Steel. “Today, there are only three major flat steel producers left in the country,’’ says Rohit Sadaka, director, corporate ratings, at India Ratings and Research, down from eight key players earlier.

Apart from the obvious economies of scale, consolidation also allows new players to enter the fray. The Supreme Court recently gave its nod to ArcelorMittal to acquire Essar Steel, paving the way for the Lakshmi Niwas Mittal-led firm’s comeback into India. Having a limited set of players also provides stronger negotiating power with suppliers, reducing the cost of logistics and raw materials procurement. This improves margins and profitability.“Higher margins allow companies to invest in research and development and thereby improve the quality of their products and add new items to their portfolio,” says Rao.

Acquisitions can positively impact the efficiency of distressed assets too. “Even by merely changing the coking coal blend and using different kinds of iron ore [inputs for steel making], we were able to cut costs and improve the efficiency of the plant significantly,’’ says PankajMalhan, deputy chief executive officer, Electrosteel Steels.

However, there won’t be any increase in pricing power, says Rao. “Since steel is a tradeable commodity in the international market, any attempt to hike the price of a product unilaterally by one company is likely to boomerang because customers will shift their allegiance to another player,’’ he says.

Benefits of consolidation notwithstanding, Sadaka believes that if the steel industry wants to achieve its stated goal of 300 million tonnes by 2030—an additional 160 million tonnes in the next 10 years—it needs to have more players, big and small. “It is virtually impossible for the three or four players such as TataSteel, JSW, Steel Authority of India Limited, and Jindal Steel & Power with healthy balance sheets to increase their capacity by 4-5 million tonnes a year,’’ he says. But for potential new entrants, long-term financing will remain a challenge in the absence of development financing institutions like the erstwhile Industrial Finance Corporation of India and Industrial Credit and Investment Corporation of India. “We need to have these kinds of institutions again,” says Rao.

Cement on solid ground

For an economy, the harbinger of growth is construction—think buildings, offices, roads, ports. Not surprisingly, the cement sector was among the first to begin consolidating and attracting investors in post-liberalisation India. By the mid-’90s, foreign companies were already on the prowl for prized domestic assets: Take French cement giant Lafarge (now LafargeHolcim), the second-largest player in the world, which bought Tata Steel’s cement business.

Indian promoters also stepped up to retain market share. Gujarat Ambuja (now Ambuja Cement) picked up a stake in ACC Limited. The Aditya Birla Group sought to take over engineering giant Larsen & Toubro, only for its cement assets (these were eventually carved out and sold to the business house). Smaller players like Shree Cement and Dalmia Cement kept pace in expansion and are among the top 10 players in the country now. This drive to expand capacity also gave the Indian stock markets its first hostile takeover: Chennai-based India Cements took on more debt than its balance sheet allowed to buy out shares of Raasi Cements from the open market to oust its promoters.

By 1996-97, the Indian cement industry had an installed capacity of a little over 100 million tonnes and its market capitalisation stood at about ₹20,000 crore. It had become a stock market darling, with then market bull Harshad Mehta counting ACC among his top picks.

That bullishness hasn’t waned given the frenetic race to acquire debt-laden Binani Cement last November. Aditya Birla Group’s UltraTech increased its bid by nearly ₹1,000 crore at the last moment, and even agreed to pay all its creditors. As Dalmia Cement MD and CEO Mahendra Singhi puts it: “India is on the cusp of great growth and infrastructure development. Though we have had weak demand so far this year, in the long term, as incomes rise, the outlook for the sector is bullish.”

Liberalisation—and the resultant consolidation—has been largely positive for the sector. From over 300 mini cement plants operating in pockets across the country, today 180 large and efficient plants account for 90% of the production; 70% of the capacity is spread across the top10 players. The market capitalisation is over ₹3 lakh crore and, with an installed capacity of 460 million tonnes per year, India is the second-largest cement market in the world after China.

A distinct feature of consolidation in the sector is that homegrown players continue to dominate unlike in the automobiles, consumer durables, or electrical equipment sectors where global firms hold sway. This can be attributed to the unfeasibility of importing cement due to freight costs. It helps that domestic firms have been able to keep up with world-class production technology.

The one jarring note is that the sector operates at just 70% utilisation of its installed capacity, down from 94% three decades ago. And for the last few months, it has seen poor single-digit growth. Analysts Lokesh Garg and Gaurav Birmiwal of research firm Credit Suisse say in their latest report: “Low per capita consumption of cement in India provides an easy argument for long-term structural growth. We believe growth in cement demand is driven by growth in construction activity and that is why at times cement demand seems to be delinked from broader GDP growth.”

Financial services coming of age

In recent years, multiple challenges—weak balance sheets, declining credit growth, and liquidity concerns—have forced the wounded financial services sector to regroup. And strategic consolidations seem to be the chosen path to redefine the scale and scope of banks as enablers of economic growth. “We have repaired our balance sheets and are on the cusp of entering a new growth phase. The capability of banks has come of age as we march towards new economic aspirations,” says Rajkiran Rai G., managing director and chief executive officer, Union Bank of India.

Noteworthy are the Kotak Mahindra Bank and ING Vysya Bank merger in 2014 as well as that of State Bank of India absorbing its five associate banks and Bharatiya MahilaBank in August 2016. This was followed by big-ticket PSU bank mergers announced by the government over the last two years. A year after the merging of Bank of Baroda, Vijaya Bank, and Dena Bank in September2018, finance minister Nirmala Sitharaman announced four more mergers: This will reduce the number of public sector banks to 12 from 21.

This move, first outlined in the Narasimham Committee report in 1991, is an attempt to bolster a beleaguered sector. “PSU bank mergers will improve operational efficiency, governance, accountability, and sharper monitoring. Consolidation will help lower capital infusion from the government. As performance improves, larger PSBs can eliminate the stigma of raising capital,” noted Pritesh Bumb, analyst, Prabhudas Lilladher, in a report dated September 1. However, there are concerns that this may not be the remedy for the sector's ills. Critics say asset quality challenges can put pressure on the profitability of the merged entity. Also, banks’ employee unions have been up in arms against the consolidation of PSU banks, as they fear shutdown of branches and also see this as a precursor to the privatisation of banks.

Non-banking financial companies (NBFCs), reeling under liquidity constraints, have also been pushed to merge with banks to achieve a win-win formula. Take the IndusInd Bank-Bharat Financial announcement in 2017, Capital First with IDFC Bank in 2018, and the Bandhan Bank-Gruh Finance merger this year. Keki Mistry, vice chairman and chief executive officer, HDFC, says the last 12 months have been especially challenging for small NBFCs seeking funds. At the same time, he cautions that while merging with banks may seem to be a solution, it is also riddled with challenges. For instance, banks have to comply with RBI norms on cash reserve ratio (CRR), statutory liquidity ratio(SLR), and priority loans, he says. “When merging with a bank the entire balance sheet of the NBFC also needs to comply with norms on SLR, CRR, and priority loans,” Mistry points out.

E-commerce still clicking into place

By 2018, Flipkart, founded by IIT graduates Sachin Bansal and Binny Bansal in 2007, had raised $7.7 billion over 21 rounds from big-ticket investors such as Tiger Global, Accel Partners, and SoftBank. It had also bought 21 companies including letsbuy.com,eBay India, and Myntra-Jabong, making it India’s biggest online retailer. However, it needed more power to handle the heat from Amazon, armed with billions of dollars to conquer the world’s second-largest online consumer base. Enter Walmart and its deep pockets: Last year, the world’s largest retailer picked up 77% in Flipkart for $16 billion, giving India’s most-valued startup ammunition to fight the cash-rich Amazon.

More importantly, it also underscored the dominance of the two e-commerce giants in the sector, which control almost 70% of the market between them, leaving little room for smaller players. As of 2018, according to ‘The State Of The Online Retail Market In India In 2019’, a report by Forrester Research, Flipkart had 38.45%(31.9% standalone plus the market shares of group companies Myntra and Jabong) closely followed by Amazon at 31.2%. Snapdeal, once a close contender, is a laggard at 1.9%and is focussing on the low-price category to create a niche for itself.

Forrester Research analyst Satish Meena says Amazon and Flipkart will continue to maintain the lead in the general marketplace space, but a few categories are still open for consolidation. Groceries, for instance, is“where we can see new players coming up and giving competition to these [Amazon and Flipkart] ones,” he says.

Saurabh Kumar, founder, Grofers, agrees: “Online grocery is a massive opportunity for every e-commerce player. However, e-grocery is executionally challenging and requires building a complex supply chain, which is very different from a traditional e-commerce supply chain.” The category needs expertise to handle the micro-dynamics of the supply availability and consumer preferences, he says, “unlike categories like fashion and electronics, where you can use deep pockets to influence penetration”.

Earlier this year, the top two online grocers in India saw big funding rounds. While Grofers raised $220 million from SoftBank Vision Fund and other investors, market leader bigbasket closed its Series E financing of about $200 million in a round led by Alibaba. But analysts don’t expect more such deals in the grocery segment anytime soon. Reason: In a market like India, a strong supply chain and the ability to handle different customer needs are critical. And with Amazon and Flipkart also venturing into the space, it will become even harder for smaller players to succeed.“

There is space for players to come at a category level but at a horizontal level, I think the market is just consolidated for the time being,” says Meena. However, he also adds that the overall e-commerce sector is far from maturity, accounting for just about 2%-2.5% of the total retail market. “We may have about 100 million online buyers who have bought something in the last 12 months, but this is, both in terms of percentage of online retail and percentage of those buying online, a very small number.”

Aviation of lofty dreams and broken wings

Till the early ‘90s, the aviation sector was a duopoly between the government-owned and run Indian Airlines and Air India. Indian Airlines controlled the domestic skies; Air India flew the major international trunk routes. (They were merged in 2007 to operate under the Air India brand.)

But in 1992, the game changed: The thenP.V. Narasimha Rao-led government issued around seven private air operator permits, and the likes of Damania Airways, SaharaAirlines, ModiLuft, and East West Airlines introduced a new domestic travel experience to Indians. However, inadequate understanding of running a profitable airline, given the vagaries of crude oil prices, resulted in the demise of many carriers. By 2005, only two—Jet Airways, promoted by Naresh Goyal, andAir Sahara (formerly Sahara Airlines), run by Subrata Roy’s Sahara Group—would survive the ’90s open skies policy.

The first phase of consolidation followed as new airlines, such as IndiGo, now the market leader, entered the fray in 2006 with its low-fare model. During that period, Goyal acquired Air Sahara for $500 million, which continues to be the biggest M&A deal in the country's aviation sector. Erstwhile liquor baron Vijay Mallya, who launched KingfisherAirlines in 2005, had bought India’s first budget airline, Air Deccan, started by Captain G.R.Gopinath, in 2003.

Both the acquisitions turned out to be disastrous for the buyers. In October 2012, reeling under a debt pile of ₹8,000 crore, KingfisherAirlines suspended operations, and Mallya, who had fled to the U.K., is facing extradition to India. In April this year, Jet Airways, the last surviving private airline of the ’90s, shutdown as it came under severe financial stress; the NCLT has been trying to find a buyer for the airline for the last six months.

“Consolidation is a perforce one. If one airline goes out another will take its fleet or add to their fleet,” says Jitender Bhargava, former executive director of Air India. Operationally, the industry is high-cost given the steep taxes on aviation turbine fuel, landing and parking charges at metro airports, and navigation charges over Indian airspace. Analysts view it as being a low-yield, high-cost market, in which only a few will survive. Today, there are seven operational airlines with IndiGo having an overwhelming market share of 48% as of September 2019.

“The aviation industry is mature in age as it has been around for long. But has it become a stable industry with fewer participants? No, because not all of them enjoy the privilege of profit, which seems to be some distance away,” says Harish H.V., managing partner, ECube Investment Advisors, an environmental, social, and governance fund. Barring IndiGo and SpiceJet, both low-cost airlines, no other is profitable. (Inthe September quarter of FY20, however, IndiGo reported a net loss of ₹1,062 crore.)

Bhargava, however, contends that consolidation is not necessarily a sign of maturity.“The simple reason being, if airlines were to show a sense of maturity they would not be selling seats below the cost of producing a seat,” he says. “A sign of maturity in the industry would be if airlines ensure sustainable growth and strike a balance between fares and costing.”

Telecom three’s company

So much can happen in a decade. In 2010, 13companies (Indian and global) were jostling for a share of the burgeoning telecom market. Now, only three private players—Bharti Airtel, Vodafone Idea and Reliance Jio Infocomm (Jio)—have survived the consolidation triggered by a ruthless price war and other regulatory issues. The likes of Tata Teleservices, Reliance Communications, STel, Sistema Shyam, Uninor, Loop, Videocon, Aircel, and Etisalat no longer operate in the mobile telephony space in India. Government-owned MTNL and BSNL exist on the fringes, and are now looking at a potential merger.

The initial two phases of consolidation took place between 2010and 2016. The first was triggered by alleged wrongdoings in the allocation of 2G airwaves by the then government. This led to the exit of small operators offering only voice services. The second phase began when mobile operators engaged in a tariff war to gain market share. Damaged balance sheets for several companies meant they either shut shop or sold out to larger rivals. The latest wave was heralded by challenger Jio, owned by India’s richest billionaire Mukesh Ambani. With its free voice services and cheap data tariffs, the Reliance Industries subsidiary has notched up 348 million subscribers since its commercial launch in September 2016. To face competition from Jio and Airtel better, Vodafone and the Aditya Birla Group’s Idea joined forces and became a merged entity.

Further consolidation in the sector is a possibility after a recent Supreme Court order allowed the central government to recover ₹92,641 crore on account of adjusted gross revenue (AGR). Most vulnerable on this account is Vodafone Idea because of its weak balance sheet. The promoters of the company had recently infused equity and may not want to do so again. Vodafone Idea is al-ready highly leveraged and fresh borrowings may not be an option.

“More than Jio, it has been new technology and operators’ [relative] alacrity and ability to invest in new capabilities that has led to consolidation in the sector,” says Anshuman Thakur, head of strategy and planning at Jio. “Existing operators weren’t agile enough while planning their path to transition to LTE [long-term evolution, or 4G], whereas Jio came in with its LTE-based, all-IP network that was more efficient in terms of cost and quality of service. Those who haven’t been able to invest in upgrading their network infrastructure have found it difficult to sustain [themselves].”

Despite the consolidation, Airtel and Vodafone Idea’s response to Jio’s pricing onslaught has led to subdued average revenue per user (ARPU) in the industry. Copious investments needed for infrastructure upgrade have led to lower profitability and high leverage too. The total debt of the top three telcos in India (Jio, Airtel, and Vodafone Idea)stands at ₹3.9 lakh crore.

A recent Credit Suisse report says that mobile pricing in India has come under significant pressure with Jio using it “as a key tool to gain market share”. “Given it [Jio] is still short of its stated objective (50% share), we expect no major improvement in pricing over the next 18 months. However, we forecast sector ARPU to improve by 25% in FY22with Jio reaching closer to its objective. We think that the current pricing is unsustainable given the sector’s negative return profile. We expect Vodafone Idea to lose the most market share. Our cash flow analysis shows that Vodafone Idea will need additional equity capital in FY21 given our expectation of no price increase, while Bharti Airtel is comfortable.”

Thakur says that the standard global model for telecom markets is the existence of two-three large players. One of the benefits of such consolidation, he says, is that the surviving telcos would get to acquire and keep sizeable chunks of spectrum, leading to efficiency of operations. Also, as he puts it, “A three-operator market can be as competitive as one with 12 players. At the end of the day, the customer is the key and all these battles are being fought for the customer.”

Anshul Dhamija, Ashish Gupta, Arnika Thakur, Aveek Datta, Neha Bothra, and T. Surendar contributed to this story.

(This story was originally published in the December 2019 issue of the magazine.)

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