The year 2006 is emerging as a strong year for mergers & acquisitions (M&A) activity. India Inc. has completed more mergers and acquisitions in the first half of 2006 than in the whole year of 2005, Indian companies struck deals worth $25.6 bn in the first six months of 2006, up from $8 bn in the first half of 2005 and $23.6 bn in the whole year of 2005.
Corporate India's mergers & acquisitions growth rate outperformed the average increase of 32 % in the Asia Pacific region during the period. Only Japan and Australia, which completed deals worth $64 bn and $ 33.2 bn respectively, scored over India. South Korea ($25.2 bn), China ($21 .bn), Hong Kong ($17.1 bn), Malaysia ($9.1 bn), Singapore ($8.2 bn), Thailand ($6.6 bn), Indonesia ($6.5 bn) and Philippines ($1.7 bn) lagged behind India. Moreover outbound acquisitions are outpacing inbound acquisitions this year both in volume and value. The average cross border deal size this year has increased to $47 mn from $32 mn in 2005.
A strategic approach
Overseas acquisitions were the highest in pharmaceuticals, information technology (IT) and automotive ancillaries. The key driver of Indian investments abroad has been growing competitive pressure in high growth sectors like pharmaceuticals, that forces them to scale up and service global operations more efficiently.
The pharmaceutical industry in India today is at crossroads. The operating environment has changed substantially after 2005 with the onset of product patent regime. The introduction of new products, which can serve as a strong driver for growth, is not very high. In fact, the number of new products launched in 24 months decreased from 8% in 2004 to 7% in 2005. With the continuing pricing pressure the contribution of price to value growth in the last year has been hardly 1 %.
Most of the companies are beset with challenges of building new brands as also with revitalization of mature brands. While these constraints operate, new challenges have emerged like structural changes to realign with the changing environment and benchmarking with global standards.
On the other hand, opportunities to leverage the industry strengths in cost effective contract manufacturing and clinical trial research have opened up. Pharma The merger mania and companies are evolving their own acquisitive aggression have business models to cope up with infected pharma business the new business realities. Having alongwith other economic realized that stronger growth exists sectors. in capturing a lead in global markets, many companies are resorting to the inorganic growth route. M&A offers a good medium to secure inorganic growth.
Activity analysis
The merger mania and acquisitive aggression have infected pharma business alongwith other economic sectors. Within the healthcare sector the pharma deals occupy a dominant place in healthcare. Next comes diagnostic devices followed by research services. However the M&A activity in the Pharma business seems to have acquired a plateau in 2005. In fact, the number of Pharma deals in 2005, is lower than that in 2004. Asia Pacific region is however witnessing the highest number of deals.
Indian scenario
Indian pharmaceutical companies spent $1.6 bn in 2005 on buyouts over six times the $ 265 mn spent in the previous year according to Bloomberg Data. Indian drug makers raised over $1 bn in foreign convertible bonds in the year upto March 2006.
The large and medium scale Indian pharmaceutical companies are likely to invest about $ 3-3.5 bn for acquiring companies in Europe, US and Latin America within the next 12 months. The process is being facilitated by favourable market conditions and willingness of financial institutions to bet money on Indian Pharma.
According to merchant bankers and investment funds firms, the Indian big and medium size generic players are keen to enter European market. At least 8-10 deals are currently in various stages of negotiations, most of them worth about $ 20 -700 mn. It is estimated that Indian pharma companies may invest about $2bn in Europe within the next 1 to 2 months. About 50-60 units, including those of many multinationals, are up for sale in countries like Italy, Spain and Germany. Indian companies are likely to target many of these units as part of their inorganic growth strategy and entry plans for European market.
Generics are being encouraged increasingly in the west as a cost cutting measure in health management. To make generic business viable, two pre-requisites that are necessary related to low cost manufacturing and speed to launch the product first. Indiancompanies have both these qualities. They need volume to become more competitive through inorganic growth. As a result many Indian companies are prepared to buy assets in Europe for threemain reasons. Pricing is less competitive in Europe. Price erosion is 80-85 % against 90-95% in US generic market. Secondly, assets in the US remain relatively expensive compared to Europe. And finally, European markets are less volatile
After the first wave of mergers in the 1990s, many pharma companies are selling off some of their plants and farming out an increasing share of their production to lower cost production sites. These plants are easily available targets for Indian companies. Big Pharma companies feel more comfortable working with companies which have a plant in western markets.
Europe has smaller companies which fit the country specific strategies of companies. They also provide access to other countries, products and market authorizations. Europe which is acting like a hedge to the US market has companies of all sizes and valuations.
The next big destination is the US. About 20 acquisitions worth $ 1 - 1.5 bn are likely to take place within the next 12 months. Another major destination for Indian pharmaceutical companies will be the Latin America with the expected investment on US acquisitions to the extent of $ 250 mn. The mid size pharmaceutical companies adopt inorganic route as the best option for quick growth when compared to a normal growth of 10-15 percent, per annum in the organic route. Moreover, the emerging generic players who were opportunistic in their growth over the years and were reluctant to invest in R&D are now forced to grow by growing in different markets in the post patent era.
There is a growing interest in investment bankers and venture fund companies in the acquisition activity. State Bank of India has recently set up a joint venture with $100mn from Soft bank of Japan and VC Arm, with a considerable interest in pharma business. The banks are also interested in the emerging Indian Contract Research Organisations (CROs). They have shown an interest in atleast 6-7 Indian CROs, which are in various stages of acquiring similar firms in the US and Europe, each deal with size ranging from $ 3mn to $ 80mn. The Indian CROs are likely to invest $3 bn on such acquisitions in the near future.
With opening up of economies and internationalization of markets, leading Indian pharmaceutical companies are aspiring to be global players. Many of them prefer an inorganic growth route to acquire a cutting edge in competitiveness and score in speed to win new markets. The process of consolidation in the industry which had commenced a decade back, is now gathering momentum through increased M&As.
Considerations to drive the M&A activity cover mainly:
*Enhancing revenue through global presence
*Better market access
*Widening product portfolios
*Strengthening R&D capabilities
*Strengthening Distribution network
*Increasing efficiencies through leveraging economies of scale
*Gaining access to new technologies
*Establishing a new area in Pharma value chain
Continued pressures on public health budgets and stronger competition from generic manufacturers are driving inten-sely the process of conso-lidation in the pharma-ceutical industry.
Issues and concerns
While M&A activity is intensifying the success rate is not uniform. Atleast 8% of mergers, analysed by AT Kearney did not end successfully. They did not meet expectations and objectives. The reasons vary. AT Kearney says that some mergers failed to meet expectations because they were much too high. Others met some of the initial objectives but did not achieve the same performance in terms of growth and returns to shareholders as compared to their competitors.
There were even a few cases where mergers destroyed value instead of creating value. In 1999 KPMG International published a global research report entitled 'Unlocking Shareholder Value : The Key to Success'. They looked at shareholder returns relative to the overall trend in the relevant industry segment one year after the deal was announced. They found that 83 % of mergers failed to unlock value.
Acquisition objectives
It is, therefore, critical to ensure achievement of the following key objectives of any acquisition by pre-empting and managing the
road blocks through a well designed strategy :
1. Capturing value of business
2. Improving market share
3. Creating operational efficiency
Concerns in Acquisitions :
The issues which adversely affect the effectivity of any M&A deal primarily relate to :
1.Choosing a target
2.Correct price for acquisition
3.CapturingEconomic Value Addition (EVA) for stakeholders
4.Effective integration
5.Risk analysis
6.Communication to external stakeholders.
7.Choosing a target
The first and foremost process in an acquisition is related to selection of an appropriate target. Before the search for a potential target starts, the firm should clearly define the basis of acquisition: Whether it is a scale building exercise, or filling capacity gap or entering a new market/ expanding existing market. This will involve determining the existing core competencies and identifying supplementary competencies that are required for expanding the business.
With clearly defined objectives the due diligence process becomes more transparent and focused.After identifying the objective of acquisition, a corporate team should be developed to scout for the ideal candidates through merchant bankers and investment firms as also industry sources.
After identifying the potential targets a screening of these candidates will have to be undertaken to align the best fit for acquisition. This can be done by developing detail profile of the potential candidates in terms of their market share, competitive position, core competencies, recent performance and current managerial strengths.
After the profiles are completed a clear statement should be prepared as to how the particular deal would create value for the company. Bain & Company has called this exercise as an investment thesis. This will be a critically important tool in ensuring the success of an acquisition deal.
Correct price
There are frequent reports in the media that the acquiring company many a time pays more than what an acquisition is worth. CLSA report points out that high acquisition prices have resulted in payback periods being extended to over 10 years. This leaves acquirers susceptible to adverse changes in market and regulatory environment. Ranbaxy's acquisition in RPG Aventis in France in December 2003 for $ 84 mn and Dr.Reddy's acquisition of Betapharm at $573 mn have been cited by CLSA as two examples of acquisition pay-back periods being extended longer than initial management expectations.
There is a systematic way to think about pricing acquisitions. It includes analytical rigour and strict process discipline. Senior managers will have to acquire these skills to guide their board members. Pricing involves several distinct concepts of value. The key to success in buying another company is knowing maximum price you can pay and then having the discipline not to pay anything more.
Successful acquisitions include a premerger planning phase. In this phase, the acquiring company identifies and measures , the source of value and timing when the value will be obtained. While doing this, it also recognizes negative signals in business development and pre-empts them in valuation of the business or plans strategies to overcome these barriers.
In a process of acquisition from the perspective of an acquirer 3 sets of value become important. There is an actual value of business. The acquirer has his own perception of the current business of the company which is perceived value. The main purpose in acquisition of business is to realize the potential value of the business when the two businesses are combined.
The critical aspect of a successful acquisition is calculated as per the synergy value and unlocking the potential value. The most common type of synergy which is easier to estimate relates to cost savings. But a more important task is revenue enhancement. This is hard to estimate because it involves external variables beyond management's control. Despite this, revenue enhancement can create real value. Sometimes the target company brings a superior or complementary product or extensive distribution channel for the acquirer. Revenue enhancement occurs when the post acquisition company gains adequate critical mass to attract revenue which neither company would have been able to realize it alone.
In deciding pricing of the acquisition, estimating the values and assessing the processess like Process improvement, Financial engineering and Tax management play a significant role in arriving at a correct pricing of an acquisition.
Economic value addition
There is no globally accepted benchmark to measure economic value addition of the combined business after acquisition. However, a commonly accepted benchmark of a successful acquisition is one that generates an excess return of 10 percent or more. This involves quantifying the ability of the new entity to earn excess returns to capital. This means total shareholders return minus the acquirers cost of equity. This is measured by using the capital asset pricing model.
Calculating economic value addition is complicated as there are both positive and negative synergies of the value. The positive synergies include cost savings due to rationalization of corporate functions, shared operating activities, economic utilization of facilities and revenue enhancement through more marketing channels. While capturing the value in each activity will generate considerable rewards, this may not really materialise, as the actual speed to secure these economies may be more than what was estimated. The level of investment to realize economies may also exceed the estimate.
Equally well, there are negative synergies when the businesses are combined. There is a possibility of losing some customers. The supply chain may also be affected due to change in ownership. Some of the shared services like IT may disappear. Very imminent risk relates to loss of management talent and key employees. The more realistic the calculation of Economic Value Addition, the more correct will be the pricing of an acquisition.
While it would be unrealistic to expect the acquired company to show results immediately it will be a mistake not to monitor its performance. It is necessary to monitor the economic rewards of acquisition thoroughly and periodically. One option is to consider the Economic Value Added (EVA) of the acquired company, by checking whether the profit after tax is higher than the capital employed.For example, Godrej Beverages & Foods Ltd. Only buys firms whose projections show that they will be EVA positive for the next ten years. If the company's performance drops after acquisition, its targets are revised based on these projections. Nutrine, Godrej Beverages & Foods latest purchase had to pass this test before its purchase.
Post merger integration
The critical success factors of an integration phase are primarily the soft factors. Some of these factors are:
*Communication of the new strategic objectives and vision of the new enterprise.
*Development of a new management structure.
*Harmonisation of compensation and incentive systems.
*Managing cultural complexities
*Knowledge transfer
*Maintenance of customer relationship
*Management of people issues
Integration of two businesses and organisations is the most critical part of an acquisition. As is well known, any acquisition becomes painful and anxiety producing experience due to the required restructuring. This involves loss of some jobs, derailment of a few careers, shift of power, change in strategies and above all a new organisational culture. The psychodrama, which implies insecurity and uncertainty felt by new managers of the acquired company and euphoria of acquiring managers become debilitating. This makes the integration process difficult. If issues of security are not addressed immediately, they result in lower productivity, decline in customer services and a setback to innovation. Most importantly, the employee morale deteriorates. Under these conditions the challenge is to restructure quickly but with sensitivity.
The process of integration cannot be uniform in all acquired organisations as acquisitions come in different shapes and sizes. Sometimes, the acquisition is an asset purchase that adds volume to a particular business without adding people. In other cases it is a consolidated acquisition in which a company is purchased and then consolidated into the existing business. It is also possible to have a hybrid acquisition in which some parts fit into one or more existing businesses while other parts stand alone or become joint ventures. In view, of this integration should not be looked upon as a discreet phase of a deal. It should rather be implemented as a process that should begin with due diligence and carried forward as an ongoing management of the new enterprise.
If planning for integration can begin with the first round of discussions, it can give an early start to bring a new company into the fold.
Decisions about management structure, key roles, reporting relationships, rationalization of manpower and career affecting decisions are an integral part of integration process. It is, therefore, prudent to make these decisions as fast as possible, announce them and implement them without any delay. This helps in reduction of uncertainty, anxiety and tension. Successful integration is not so much about size and composition of the new enterprise but more about the manner in which restructuring is carried out. The acquired company should be straightforward about its plans and implementation mechanisms. People in the new acquired company appreciate most the truthfulness of the acquiring company. It is also critical to treat the individuals negatively affected by the change with dignity, respect and support. This works out as a signal to those who remain in the new company. A successful integration includes not only the technical aspects, but makes a serious attempt to integrate different cultures. Orientation programmes and a communication plan facilitate the process of integration.
Integration management is a full time job. It should be recognized as a distinct business function, just like any other function like marketing or finance. However, in actual practice, the functional directors of the acquiring company typically focus only on integration of their particular units.
every business there are known and unknown risks. While acquiring a company the indicators for risk pertaining to that company's business can be identified through financial diligence
It is, therefore, necessary to have a dedicated manager to exclusively look after the integration process. Heshould be heldaccountable for the delivery of desciplined integration plan and monitoring its progress. The job essentially involves connecting various issues between the acquiring company and the new organisation and evolve acceptable solutions. In case it is not possible to appoint a dedicated integration manager, the task should be entrusted to an independent consultant.
Internal restructuring to become a truly international organisation is crucial. The organisational structure will have to be revamped suitably to manage across borders. Ranbaxy, for example has acquired companies and subsidiaries in about 46 countries and reorganized itself to adapt an international environment. Integrating multicultural teams is also important. Accounting norms, corporate governance and board structures have also to be aligned to international practices.
Risk analysis
In every business there are known and unknown risks. While acquiring a company the indicators for risk pertaining to that company's business can be identified through financial diligence. The financial statements reveal facts relating to ratio of cost of goods to revenue, inventory level, bad debts, loans and advances, employees cost and earnings.
However, certain items like liabilities arising out of legal cases, contracts with suppliers and international partners need to be studied more closely. Another aspect relates to shared services and if these services are not available in the combined business, investment that would be necessary needs to be quantified.
The risks many a time go beyond these parameters. These risks relate to the changing nature of business and the shift of markets. In pharmaceutical industry authorized generics has given a setback to the expected revenue of generic business of Indian entrants in US market.
The availability of larger public funds in Eastern Europe may drive a change in the global business ofpharmaceutical another CRO in a different companies. When a CRO acquires another CRO in a different country, regulations and admissibility of clinical trial research will have to be studied in depth. During the development stage of a discovered molecule, it is not unlikely that further clinical tests may fail the expectations of advancement of a molecule. All these risks should be anticipated to the extent possible and the corresponding risk valuation will have to be built in the initial valuation or in the expected returns after acquisition.
Communication
In the entire process of acquisition, communication plays a central role. The leader who continues to communicate the vision and its meaning in the new enterprise after acquisition helps the integration process to be both effective and meaningful. The ongoing communication conveys managerial support to the people involved in the change process after acquisition.
While the internal communication is of vital importance, communication with external stakeholders like equity firms, stock exchanges, media and the regulatory authorities should not be ignored.
The following are some of the key issues in communication which should be addressed adequately throughout the process of acquisition:
*Lack of plan for external communications
*Initiative to be proactive in communicating
*Communicating with all stakeholders
*Lack of or inadequacy in clear, consistent, timely, honest and accurate communications
*Lack of coordination in communications between the organisations during the negotiations and announce-ment phases
*Poor internal communication
While there is a commonality of issues across industry sectors, there are specific drivers and concerns in considering pharma acquisitions.The specificity of the drivers and concerns in pharma acquisition is due to the fundamental changes that are occurring recently in the nature and structure of the pharmaceutical business.
Different regions/ countries have peculiar disease patterns. The extent of infective / lifestyle / chronic diseases and the population covered by these diseases indicate the therapeutic groups for which the market exists
The entire science of medicines is undergoing a revolutionary change due to the decoding of human genome map and the newly available route of Biotechnology. As a result, the scope of pharma business will change. The business models will be revamped. Moreover, new value propositions may be created in selling medicines. The relationship between the providers, payers and patients may undergo radical change particularly in developing economies.Under the circumstances, the pharma acquisition will have to be viewed from a different perspective. This is due to the imperative of reinventing the business almost on a day to day basis.
It is advisable to include an additional screening process in addition to the usual business due diligence process while acquiring pharma business either from a domestic sector or an international arena. This screening process should include an assessment of both environmental and internal factors - affecting the acquired company. Here is an indicative list of certain parameters which will be helpful to build up this exercise :
Environmental factors :
*Industry characteristics Ascertain the predominant business and its extent in the total business of the company. Characteristics of branded market, generic market and OTC market differ widely. Moreover, the characteristics of these businesses are changing rapidly due to regulatory changes.
*Country / Regional characteristics
Markets in regions like North America, Europe, Africa, Asia represent distinct features. It is important to know the regional / country characteristics relating to an acquired company and locate the currentstatus of the business and the potential for development.
*Disease patterns
Different regions/ countries have peculiar disease patterns. The extent of infective / lifestyle / chronic diseases and the population covered by these diseases indicate the therapeutic groups for which the market exists.
*Health infrastructure
The health infrastructure which consists of hospitals, doctors, medical support staff and pharmacies works as an instrument for the medicines to reach the popu-lation. Hospitals normally purchase medicines through a tender system. These bulk purchases can form a significant part of institutional business of a company. The information on number of hospitals and their purchase systems becomes useful for deciding the share of company's institutional business.
*Intellectual property right (IPR)
The legislative framework and enforcement machinery for protection of IPR is a critical factor to decide innovative character of business and introduction of new products without fear of copying illegally.
*Regulatory laws and machinery
The global pharma market consists of regulated, semi-regulated and mostly unregulated markets. It is useful to know the rigours of regulatory laws and machinery of the country in which the acquired company operates. However, it will also be necessary to find out broadly the changes that are likely to take place in regulations in the near future.
Organisational factors
It is necessary to know the business focus and the current strategies of the acquired company. This will be useful for cost rationalization as also finding out the extent of market potential. The marketing strength, in terms of the distribution network and the field force productivity will indicate the possible synergies between the acquirer and the acquired company. Theorganisational capabilities of the acquiredcompany shouldbe analysed properly as these are important for developing an effective integration process.
This additional screening process will be helpful in estimating a correct price for an acquisition as also to ensure a speedier integration after the acquisition is over.
Acquisition as a growth driver
Business has two key functions - innovations and marketing. Innovation prepares the organisation for future business, while market success ensures the survival and growth of current business.
A successful acquisition creates additional value for the acquiring company. The new investment aims to improve the existing core business or extend the business by increasing the current market size or acquiring new markets. To achieve savings and improve asset utilization, integration should be treated not as a separate process but used as an adjunct to the process of acquisition itself.
Acquisition helps in gathering competitive mass and helps in accelerating speed to gain new business. Acquisition, therefore, should be viewed as a management process and not so much as a unique event. Although, corporate strategies for business development emerge from the board room, real business takes place in the market.
To capture and enhance value out of any acquisition, decision discipline for working out a correct investment thesis is essential
Value capturing in an acquired business rests on 5 basic principles :
1. Synergies of the Business
Prepare a list of synergy initiatives, prioritise them and implement speedily
2. Screen environment impacting Business
Identify changes which will impact bus/ness immedi-ately and preempt through tactical moves.
3. Market dynamics
Conduct a market research study and design strategies for business development of a new enterprise based on the research findings.
4.Manage internal processes
Initiate execution excellence process in operations. Identify lead
indicators in key business processes.
5. Develop a learning organisation
Initiate prog-rammes to re-orient attitudes of internal and external customers, including employees.
Acquisitions is a viable vehicle in globalising a company's business. To capture and enhance value out of any acquisition, decision discipline for working out a correct investment thesis is essential. To ensure that the strategic fit between the businesses works out effectively in practice, mechanics of integration process play a key role. Vision, leader-ship, architecture of management and execution excellence will make the deal a real success.
(The author is a senior consultant -Knowledge Management at Interlink Consultancy, Mumbai)
Courtesy: Interlink Insight