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Let us try to put a perspective on the corporate trends that have evolved in our country spanning three generation of entrepreneurs since independence. In the post-independence era the first-generation entrepreneurs in India seized the opportunity to build, whichever way they could. The second generation grew the business through both capacity expansion and diversification of product range under the then license regime of the Indian economy. They also got into several technological collaborations with international companies.
The third generation has realized that the world has changed drastically. The government-blessed protectionism of Indian businesses is now over. Technology has taken massive strides. The markets and consumer behavior too have changed. Some of the old businesses have lost their relevance in today’s world and ownership structures have become increasingly complex due to multiple families involved, leading to succession issues. When the third generation looks at return on investments, they often find investing as a financial investor through a family office across multiple sectors more lucrative than only running an old economy company. Hence, they are restructuring their businesses, separating ownership from management and are even open to consolidation or selling out.
Some of the trends that are emerging indicate certain sectors to be ripe for M&A activities.
A. Exiting non-core assets
Large corporates and conglomerates have, over the last few decades, built presence in various sectors which have little or no synergies with large group companies. With evolving capital structure and business strategies we are beginning to see some of the “non-core” assets being divested as they neither meet return metrics nor have market leadership potential. We expect this business churn to continue from the larger business groups especially in industrials and infrastructure segments. At present, we find most conglomerates with presence across natural resources, industrial businesses, technology, consumer and financial services including across the value chain. The “Big is better” approach will change to “Relentless focus on Return on Equity (RoE) and Return on Capital Employed (RoCE)” across all business segments.
B. Separation of asset ownership from operating businesses
Indian companies have always believed in asset ownership and management. However, in the last 10-15 years, creating assets across roads, power generation and transmission, telecom infrastructure, hospitality, real estate and logistics entailed significant capital investment, complex regulatory approvals and substantial offtake risks. This led to stressed balance sheets, with limited capital to expand. Holding operating assets for an INR 10-12% yield is feasible for global funds with lower cost of capital not corporates where cost of equity is at least 500- 1000 bps higher than operating yields. For instance, we are already witnessing this phenomenon in hospitality sector with leading operators focusing more on management contracts, power sector with majority of fund owned platforms and expect to see similar platforms in transmission, roads and warehousing. I foresee, over the next 5-10 years, the Canadian, Middle Eastern and European sovereign funds confronted with sub 5% yields in their home markets, will emerge as the largest asset owners in India while Indian business groups will be participating as a minority equity partners for asset development and focusing their efforts on asset management.
C. Consumption growth
India is poised to be the fifth largest economy and the third largest consumption economy in the world in next two years. These buoyant macros will drive investment and consolidation activity in the retail, consumer and technology space, driven by both Indian and global consumer players filling up their white spaces in food & grocery as well as the fashion & lifestyle categories because of convergence of digital and brick & mortar models. Many online businesses will need to have offline footprints while several offline businesses will need to jump on to the online bandwagon to capture burgeoning demand, for e.g. Walmart’s acquisition of Flipkart, Future Group’s acquisition of Koovs.com, Amazon’s minority stake in Shoppers Stop and the proposed stake acquisition in Aditya Birla Group’s More are early M&A trends of this sector. Global funds will keep pouring money into Indian technology companies as India remains an attractive battleground given the high growth prospects. Berkshire Hathaway’s investment in PayTM platform, Softbank’s investment in Ola, Uber and OYO and Ant Financial’s stake buy in Zomato signal the intent of the global funds.
D. Resolution of stress in the system
Arguably, the most important trend will continue to be the resolution of the stressed assets. Thermal power sector, where assets of the value greater than INR 2 trillion are stressed is likely to see strategic players with strong balance sheets and relatively easier access to capital cherry picking assets which have certainty of offtake and fuel and can be acquired at near replacement cost. An example being Prayagraj Power. Similarly, I see a great deal of M&A activity in the real estate sector during the months and years ahead. Stressed developers will sell land parcels and inventory stuck for last mile finding. Special situation funds are actively scouting the stressed space for quality assets but are more likely to partner with strategics given operational expertise required to turn around the assets.
E. Bulking up both asset & liabilities in financial services
With cleaning up of the NPAs, the financial services industry is also likely to witness investment and eventually domestic consolidation. In PSU banks, the theme of smaller banks getting consolidated with the larger ones will continue, such as SBI merging with its associates or the proposed merger of Dena, Vijaya and Bank of Baroda to increase geographical reach, ease governance, enhance productivity through the rationalizing branch network and, more importantly, to give weaker banks, the ability to manage NPAs. In the private sector, banks and NBFCs will need to continue to raise capital from financial investors to take advantage of lending requirements of both Corporate India and the increased demand for consumer loans in housing, education and consumer durables segments.
I believe a challenge to scale, both distribution and collection, beyond a point and to get access to lower cost of funds especially given the liquidity stress will see NBFCs merging or getting acquired by banks; recent examples being IDFC – Capital First, Bandhan - Gruh. The above trends indicate heightened M&A activity in the domestic economy driven by financial and strategic investors.