The power of many

There’s a story we were told as children about an old man who had three quarrelsome sons. Worried about what would happen when he was no longer alive to mediate, the old man decided to teach his sons a lesson in staying together. He gave them a bundle of sticks and told them he was running a contest to see who could separate the bundle and break the most sticks. The sons broke all the sticks and began squabbling again. Their father then told them the second part of the contest was to break the sticks, this time as a bundle. None of the sons managed. The moral, the father told his sons, is that unity is strength.

It’s an allegory that most of the leaders of India Inc. seem to have internalised. Over the past few years, as the overall economic environment began getting more and more unfriendly, companies saw the virtue in combining forces. Across industries—telecom, oil and gas, banking, iron and steel, pharmaceuticals, and more—companies are merging to create stronger, larger entities that can take on the unforgiving economy and cut-throat competition.

The result: 2017 saw a 9% increase in value of mergers and acquisitions over the previous year. And these have been huge moves, including the mammoth exercise of six banks merging with the already gigantic State Bank pay of India (SBI). In telecom, Vodafone and Idea announced a merger; in oil and gas, ONGC announced that it was going ahead with its plan to buy the government’s 51.1% stake in Hindustan Petroleum Corporation; in power, Adani Transmission took over Reliance Infrastructure’s generation, transmission, and distribution business in Mumbai, and Tata Steel is set to acquire Bhubaneshwar Power; in information technology, Infosys acquired British company Brilliant Basics (although its 2015 acquisition of Panaya was more in the news); and in the new economy, e-retailers and other digital players are on an acquisition spree. Which is why, when it came to deciding the move of the year, the answer was not hard to find. If ever a move defined 2017, it was consolidation.

To be sure , none of this is new. Ever since there’s been a corporate universe, companies have been acquired, have been merged with subsidiaries and competition, and have created larger, more sustainable giants. Think of the rise of the robber barons in 19th century America. Some of their practices were predatory and unethical, but the result was usually a giant that lasted decades, if not centuries.

Now consider 2017 India. The year began on a shaky note, with the country still trying to come to terms with the November 2016 announcement that made Rs 1,000 and Rs 500 notes illegal. Those notes were said to account for 86% of the value of all cash in the system, so the announcement hit hard. Then, a few months later, the goods and services tax (GST) was implemented in a way that pleased no one. Companies were left scrambling to fix their billing and payment mechanisms to account for GST and all the changes in the tax that followed.

Add to this the ever-increasing non-performing assets on banks’ books and their unwillingness to lend, increased competition from global players, policy changes, and a generally difficult market, and it gets easier to understand why companies floundered. We are talking marquee names like the Essar Group, Reliance Anil Dhirubhai Ambani Group, Lanco Infratech, Videocon Industries, Jindal Stainless, and the Jaypee Group. While many of them continue to languish with debt-laden subsidiaries, waiting for a bailout, others have already sold off assets to pare their debt levels and stay afloat.

These developments are a far cry from the gung-ho years between FY04 and FY08, and even FY12. Fuelled by a fast-growing economy (9% GDP growth was taken for granted), easy availability of cheap capital, and a helpful government, many large companies threw caution to the winds. Remember the Tata Steel acquisition of Corus in 2007 came at a time when steel prices were at record highs. Sunil Sinha, principal economist and director, public finance, India Ratings, says consolidation typically happens when there is a significant upswing in the economy or when there is a sustained downturn. “But acquisitions happen more during a downturn because even good assets are available at reasonable rates,” he says.

Bharti Airtel, for instance, did not have to spend a single rupee to acquire Norway-based telecom operator Telenor’s India business. What it did do was to take on the company’s existing debt; outstanding spectrum payment of Rs 1,650 crore and other operational contracts, including tower leases with Bharti Infratel and Indus Towers. The deal will not only help the New Delhi-based operator gain another 44 million customers but also pocket 43.4 units of 4G spectrum in the 1800 MHz (megahertz) band.

Similarly, Anil Ambani-led Reliance Infrastructure sold off its entire 5.5 million tonne cement business—its two plants at Maihar, Madhya Pradesh, and Kundanganj in Uttar Pradesh, and a grinding unit at Butibori in Maharashtra to Birla Corporation -for Rs 4,800 crore to bring down its debt.

The year saw consolidations in almost every sector, but “the telecom sector with the tower business, the newly minted e-commerce sector and the capital intensive, asset-heavy infrastructure players have had to bear the maximum pain”, says Sanjeev Krishan, executive director, PwC India.

The activity in telecom is not new, but 2017 saw an almost frenzied response to the launch of Reliance Jio. The background to this is the fact that since 2008, when spectrum was being auctioned, a host of small players bid and won licences. Their plan had been to sell out at a profit to the larger companies. But the Supreme Court cancelled 2G licences in 2011, and called for fresh auctions. “As the great arbitrage opportunity disappeared, it was game over for the smaller players,” says Rajan Mathews, director general, Cellular Operators Association of India (COAI).

The game-changer for telecom, policy issues and “scams” notwithstanding, was the threat and ultimate launch of Reliance Jio’s 4G services. Reliance has a history of providing services at low prices, so other operators scrambled to improve their technologies and acquire more spectrum in order to be able to take on Jio. The bottom line was ‘low cost, high volumes’.

“By offering free services for months, Jio Infocomm not only sparked a brutal price war, but also hammered the last nail in the coffin of the smaller players. It made it unviable for the smaller players to survive,” says Mathews. The large players realised that gaining market share was an effective survival tactic.

In March 2017, Vodafone announced the merger of its Indian subsidiary with Idea Cellular in a $23 billion deal. The result will be the creation of the country’s largest wireless telecom carrier, serving nearly 400 million customers. The merged entity will have a 35% share of the market, effectively dethroning Bharti Airtel.

Airtel,meanwhile, isn’t sitting by idly. Over the year, it announced four big buys including Telenor, a largely Norwegian government-owned entity, that has been in India since 2009 but made little headway in the fiercely competitive market here. Airtel also paid nearly $244 million for Tikona Digital Networks, which has 20 MHz of 4G spectrum in five cellular mobile service areas. It also acquired close to 40 million subscribers by taking over Tata Teleservices.

There were 13 telecom companies in 2010; today, there are only five. Of these, there are already questions being raised about the future of Aircel. A recent report from international brokerage firm CLSA says: “Aircel will need to make a choice, either be a single-circle specific player or exit the business completely.”

Even the telecom tower business has been effectively reduced to a three-cornered fight after the entry of U.S.-based telecom tower company American Tower Corporation (ATC). Having entered the country two years ago, ATC has consolidated its position thanks to some smart buys. It acquired a 51% stake in Viom Networks—the mobile tower business of Tata Teleservices—for Rs 7,635 crore in 2016. The big deal was in 2017, when ATC bought the 20,000-odd captive towers of Vodafone and Idea Cellular for $1.2 billion. These acquisitions not only enhanced its India tower portfolio, but also made it the second largest telecom tower company after Indus, which commands 1,23,000 towers.

We may be seeing the rise of Big Telecom thanks to competition. Meanwhile, there’s a lot of consolidation activity in the petroleum sector, this time thanks to a government decree. In the last budget speech, finance minister Arun Jaitley spoke of the need for an “integrated oil major that will be able to match the performance of international and domestic private sector players”. The idea behind such a giant was that it would lower earnings volatility across oil price cycles and create an entity with a strong balance sheet, lending heft that will allow it to bid for global oil and gas assets.

A few months later, Dinesh Sarraf, then chairman of Oil and Natural Gas Corporation (ONGC) announced his company’s intention to acquire the government’s entire stake (51.1%) in refining and marketing company HPCL. The Rs 30,000 crore deal is intended to make ONGC a more diversified player, with enhanced marketing and distribution muscle through HPCL’s outlets, as well as give it a presence in the lucrative lubes market. “Moreover, as an integrated oil and gas major, it will able to ride out volatility across oil price cycles better than just an upstream major,” says Sarraf.

There are others who are convinced that this merger is merely a front for the government to meet its disinvestment targets without actually giving up control of HPCL. “This transaction will allow the government to raise nearly Rs 30,000 crore or nearly 40% of the FY18 target of Rs 72,500 crore,” says a recent report by broking firm Nomura. Moreover, it can easily control HPCL through ONGC, adds the report. Be that as it may, the fact is, there’s going to be a new energy giant created soon.

Meanwhile, Indian Oil Corporation (IOC), ranked 1 on the Fortune India 500, is also weighing its options about an acquisition target. Its options are Bharat Petroleum Corporation, another major downstream player, or GAIL (earlier Gas Authority of India), the country’s biggest state-owned gas distribution and a pipeline company. The other public-sector exploration and production player, Oil India, is too small to catch the interest of IOC.

There’s another set of mergers happening because of the government—in banking. Public sector banks are being made to merge with loss-making or otherwise troubled banks in order that no public bank goes under. This is not necessarily a recipe for success. The mega SBI merger has already seen a more than 90% fall in SBI’s profit, and this is likely to continue for some quarters. The reason: The net loss of the five associate banks at Rs 11,865 crore in FY17 was more than SBI’s net profit of Rs 10,484 crore. Besides, the bloated employee costs, and the pension and retirement benefits, will make a large dent on SBI’s profitability for several years.

It is true that state-owned banks are reeling under Rs 7.34 lakh crore of non-performing assets, and that 10 of these lenders—including Corporation Bank, Bank of India, and United Bank—have been put under the prompt corrective action (PCA) list following a substantial hike in their bad loan portfolio, which prevents them from opening new branches, recruiting new staff or sanctioning new big ticket loans. However, just merging them with better functioning banks may not always be the best answer.

Others in the financial services space tried to consolidate, but met with little success. A proposed merger of HDFC Life and Max Life was rejected by the insurance regulator, the Insurance Regulatory and Development Authority of India, which said there was no scope in the regulations for a merger of an insurance company with a financial services one. Had this merger come through, it would have created a private life insurance behemoth.

There were valuation issues with other proposed mergers, including the Shriram Group with IDFC Bank, which would have resulted in a pan-India financial services conglomerate. The deal between Canada-based Prem Watsa of Fairfax Financial and Catholic Syrian Bank, also fell through after a year-long negotiation over valuations.

Other sectors have not been as constrained. In infrastructure, for instance, the largest takeover in the power sector in recent times was announced in December, with the debt-laden Reliance Infrastructure selling off its generation, transmission, and distribution business in Mumbai, run under the Reliance Energy brand, to Adani Transmission. The transaction, valued at Rs 18,800 crore, entails transfer of a 500 MW power plant based in Dhanu in Mumbai, licence for power distribution in the city, and related infrastructure. This deal will help Reliance Infrastructure repay most of its debt of Rs 15,000 crore. In the brokerage space too, Mumbai-based Edelweiss Financial Services bought out the retail broking arm of Religare Securities, controlled by the billionaire Singh brothers—Malvinder and Shivinder.

The Maximum number of mergers and acquisitions, according to research firm Grant Thornton, came from startups, especially e-commerce. “How can you compete with global heavyweights like Uber and Amazon if you have six or seven players in that sector? The only way to gain market share is by consolidating,” says Avimukt Dar, partner at New Delhi-based legal firm IndusLaw.

That’s something Flipkart for one has taken to heart. A merger of Flipkart and Snapdeal, pushed primarily by the investors in the two firms, failed to materialise. But with Flipkart having acquired Myntra and Jabong in the last few years, as well as eBay India in 2017, the e-commerce marketplace space has well and truly become a two-horse race. Vidhya Shankar, executive director with Grant Thornton India, sees the consolidation in the e-commerce space as a good omen for the future. “The Indian start-up ecosystem is fast maturing—the dip in investments, increasing consolidation among series plus (well funded) startups augurs well for a strong foundation,” he says.

That’s not the only reason. As in the Flipkart- Snapdeal deal, investors are pushing for consolidation. “Since private equity and venture capital funds want to remain invested in a sector, they are forcing companies to consolidate once they realise that the company they had invested in is not doing too well,” says Gaurav Dani, partner at IndusLaw.

Dar believes that once portfolio investments are allowed, there will be a huge spike in mergers and acquisitions. Again, leveraged buy-outs are yet to take off because there isn’t enough transparent information about companies in the open, and whatever is available is sometimes suspect.

Meanwhile, experts are looking to 2018 as another golden year for consolidation. Rather than being bogged down with assets in the National Company Law Tribunal (NCLT) under the Insolvency and Bankruptcy Code, many of these players are willing to take a haircut to sell off their assets or settle the issue out of court. A great example of that is ABNM Restaurant, a little-known Kolkata-based company, which went into bankruptcy proceedings and settled the matter with the financial creditor, Ketan Mehta, out of court. But for the winners it will be all about greater market share, higher pricing power, and greater revenues.

“Foreign players and even many domestic players are still in wait-and-watch mode to see what the outcome of the NCLT cases are and the impact of the Real Estate Regulatory Authority regulation on the real estate market,” says Dani. Others are waiting for the Reserve Bank of India to allow banks to lend on securities, which will tempt private equity raiders like those in the U.S. and Europe to move in. Once all that becomes clear a host of foreign investment banks and others with a taste for distressed assets will swoop in and the consolidation space will explode.

—Additional reporting by Debabrata Das

(The article was originally published in the January 2018 issue of the magazine. )