How Indian firms are buying big abroad
There is a form of financing where a firm has to put in only 20-25% of funds needed, reports Ranju Sarkar.india Updated: Oct 23, 2006 04:29 IST
A year ago, nobody would have thought that an Indian company could take over a larger foreign company. Not anymore. Leveraged buyouts (LBOs) have made it possible for companies like Tata Steel to acquire giants like Anglo-Dutch steelmaker Corus.
So what exactly is an LBO? It’s a form of financing by which the buyer uses the cash flow and assets of the acquired company as collateral to raise money for the acquisition. The buyer needs to bring in only 20 to 25 per cent of the funds required, while lenders put up the rest. LBOs thus allow companies to make large acquisitions without committing a lot of capital.
The Tatas were among the first Indian companies to use an LBO when it acquired Tetley for $502 million. But it’s not just the Tatas. Dr Reddy’s Laboratories bought out German firm Betapharm for $570 million through an LBO, while wind energy firm Suzlon acquired Belgium’s EVE Holding for $565 million.
"The buyer provides a guarantee if needed, but lenders don’t bother if the acquired company has good cash flows," said Sumit Chandwani, director (investments), ICICI Ventures, which has done four LBO deals in India.
Typically, lenders are comfortable extending debt that is four to five times the acquired company’s EBITDA (earnings before interest, tax, depreciation and amortisation) — operating income with expenses for depreciation and amortisation (distribution of a single lump-sum cash flow into many smaller cash flow installments, chiefly used in loan repayments) backed out.
"LBOs are a smart way of financing an acquisition, and will remain popular till we have a failure or two — when an acquired company defaults on repayment of debt," said Dhanraj Bhagat, practice director, Grant Thornton, a firm which tracks mergers and acquisitions. There are risks. LBOs have been criticised for piling debt on acquired companies. If there’s a significant economic slowdown, the acquired company may fail to repay debt.
But a buyer could also grow the business. For instance, when ICICI Ventures bought Tata Infomedia (now called Infomedia India) in 2003, it was only into yellow pages and niche magazines. Under ICICI, Infomedia acquired two more companies in outsourced publishing, which generate good profits. India Inc is hoping its honeymoon with LBOs has a similar ending.