How Indian Companies Fund Their Overseas Acquisitions

If one considers the huge amounts of money chasing promising deals driven by strong balance sheets and proven management teams. More and more foreign investors, bankers, private equity and hedge funds are betting on and backing Indian companies in the latter's foreign acquisitions.

Most people would not think of United Phosphorus when discussing mergers and acquisitions.

Yet, this Punjab-based exporter of agrochemicals has emerged as a star player, buying up no fewer than six companies overseas in 2006, and spending Rs 1,100 crore (Rs 11 billion) in the process - about 10 times its post-tax profit.

Among the companies United Phosphorus bought during the year was the Dutch seeds firm Advanta Netherlands - and the case is typical of how relatively small Indian companies are buying up much bigger overseas businesses.

The United Phosphorus case is not unique. For India Inc went on an unprecedented shopping spree this year, sealing 145 mergers and acquisitions worth $7.8 billion till October, compared with 136 deals amounting to $4.3 billion in all of 2005, according to Grant Thornton.

The secret to how minnows can swallow whales is of course the leveraged buyout method of financing, which leverages the target company's balance sheet to fund the acquisition.

"The acquirer's equity dilution is often a very small component of the deal size," said Ganeshan Murugaiyan, executive director, investment banking, UBS Securities India. The trend will last as long as the benign interest rate regime does, he added.

Two other elements address the risks inherent in such financing: One is the confidence of Indian companies that they can improve the performance of the acquired company - thus delivering the cash flow required to service the debt. The other is risk-mitigation through financing structures that cap the danger from interest rates climbing.

Facilitating the trend has been the progressive easing of foreign exchange restrictions by the Reserve Bank of India, which has made it possible for companies to take out the equity portion of deal finance, up to a specified proportion of their net worth.

The acquisition spree would gather momentum if Indian companies could trade their stocks while buying abroad. Till now, most acquisitions have been cash-based.

An emerging trend when it comes to financing is earn-out deals, where shareholders of the target company earn their payments as their company meets a fixed target in a stipulated time. The payment is made in tranches.

This financing method is getting popular with mid-sized software companies, and is usually adopted if the management team owns the company and continues to hold a stake after the change in majority shareholding.

"The appetite of corporate India is increasing, and so is its risk taking ability. Indian companies now are not just looking for assets overseas but also for brands," said Swaroop.

Meanwhile, the refrain among deal-makers is: "A company needs to have a strong balance sheet and aspirations. To strike a deal is the banker's responsibility."