The Vanity Deal

By Knowledge@Wharton | November 24, 2011

It took Mumbai-born, London-based entrepreneur Sanjiv Mehta five years to buy the East India Company (EIC), a 400-year old brand and possibly the world’s first multinational trading giant. The United Kingdom-based EIC, which was founded around the year 1600, is believed to have laid the foundation of British rule in the Indian subcontinent. In 2003, when the management of the EIC first approached Mehta, a 49-year old diamond dealer-turned beverage distributor and manufacturer of oral care products, it was to ask him to supply pre-packaged tea under the EIC brand. Two years later, Mehta bought EIC’s branded tea business. He went on to purchase all of EIC’s intellectual property rights (which had been dormant for over a century) from private investors for an undisclosed sum. He then invested around $33 million to turn EIC into a luxury brand and in August 2010, launched its flagship luxury food shop in the Mayfair district of London.

According to Mehta, EIC’s storied lineage creates a significant connection between the brand and consumers. Mehta is hoping EIC, which has a range of products including tea, coffee, spices, chocolates, furniture, leather goods, fabrics and housewares, can compete against global luxury establishments like Louis Vuitton, Pinault-Printemps-Redoute and Richemont. “We could be the fourth luxury group and the first from the East to be truly global,” he says. Mehta’s next move is to launch a line of gold biscuits and coins in partnership with the Royal Mint of England.

Meanwhile, in January, Anand Mahindra, vice-chairman and managing director of Mumbai-based auto to IT conglomerate the Mahindra Group, acquired a minority stake in EIC. Mahindra is believed to have invested more than £20 million (approximately $30 million) for his stake in the company. According to Mehta, the Mahindra Group, which entered the retail sector in 2009 with Mom&Me, an infant and mother-care line, will help roll out the EIC brand in furniture, real estate, health and hospitality, and other businesses in India and globally.

The moves by Mehta and Mahindra reflect a growing trend among Indian companies for making major acquisitions that in many cases have little connection with their existing operations. The purchases are often a way for the buyer to gain a presence in the global arena. And in that sense, Indian companies are only playing catch-up with counterparts in countries including China and Japan, who have been making such acquisitions for years. But experts warn that, when considering such purchases, firms must be careful to choose “trophy” buys that will enhance shareholder value.

Another prominent recent acquisition was when Pune-based poultry company Venkateshwara Hatcheries (better known as Venky’s) about a year ago acquired the Blackburn Rovers, an English Premier League (EPL) soccer club for £43 million pounds (around $69 million). Venky’s became the first Indian company to own an EPL team. Following the announcement of the purchase, Venky’s chairperson Anuradha Desai said her firm planned to “focus on leveraging the global influence in establishing Blackburn Rovers as a truly global brand.” Since then, Venky’s (which has also made forays into filmmaking) has been trying to get Rovers to play in India. It is also on a search to discover the league’s first Indian player.

Other companies, too, have considered investments in soccer. Two years ago, EPL team Manchester United approached the Sahara India group, which has business interests in diverse areas including real estate, finance, media and retail, for a sponsorship. The deal did not materialize, but it whetted the appetite of Subrato Roy, managing worker and chairman of the group. When the Liverpool team was looking for new investors last year, Sahara India was one of the initial contenders (the firm later pulled out.) Also rumored to have been in the race, though he denied it, was Reliance Industries’ Mukesh Ambani. Earlier, Mukesh’s younger brother, Anil Ambani, who heads the Reliance ADA group that operates in sectors ranging from power and entertainment to telecom and finance, was also rumored to have eyed a possible £260 million takeover of the Newcastle United soccer club.

Hotels are another favorite with Indian companies. Earlier this year, the Sahara India group made its first foreign hospitality acquisition with Grosvenor House in London’s Mayfair district. “London will be the gateway for Sahara to introduce some of its new business ventures internationally,” Roy said in a statement soon afterward. Smaller firms are making similar moves. The hospitality arm of New Delhi-based aviation company the Bird Group, for example, has snapped up the 48-room Royal Park luxury hotel in London.

A Buyer’s Market

Unlike in earlier times, when M&A activities were fueled by a booming stock market and readily available financing, the current round of acquisitions are a byproduct of business affordability, a natural fallout of the global economic downturn. For instance, three years ago, Grosvenor House, then owned by the Royal Bank of Scotland, was valued at more than $1.5 billion. Sahara bought the property at half that price — $726 million.

“Bottom fishing is where the value is, and a turnaround is possible,” says Krishnamurthy Subramanian, a professor of finance at the Indian School of Business in Hyderabad. Sanjeev Krishnan, executive director heading the M&A practice at PricewaterhouseCoopers in India adds that rather than going in for top-dollar deals, many companies are making purchases that “create significant impact and bring quick rewards.”

The wealth of opportunities for Indian companies in the overall M&A market is reflected in the numbers. According to consulting firm Ernst & Young, in the past year, 263 outbound deals with an aggregate value of $32.4 billion catapulted the outbound share in the total India M&A pie to 47%, a 9% increase over the previous year. There was a sprinkling of vanity deals, too. But Ashok Wadhwa, CEO of Ambit Holdings, a Mumbai-based investment banking and portfolio management company, says, “There are no trophy deals, only game changers.” Wadhwa refers to the Venky’s soccer deal as “following their passion.”

Passion, symbolism or otherwise, there are a host of reasons why companies covet particular assets. Most often, the deals are strategic and in sync with the firms’ core businesses. Even so, the market reaction can still be adverse. Take the case of Tata Motors acquiring iconic brands Jaguar and Land Rover (JLR) for $2.3 billion in 2008; Tata Steel’s buy-out of Anglo-Dutch steelmaker Corus for $12 billion or Mumbai-based aluminum and copper company Hindalco Industries’ acquisition of Atlanta-based aluminum sheet-maker Novelis for $6 billion. All of those deals were considered “trophy” buys initially, but concerns about the high acquisition price and profitability adversely affected the share prices of the Indian companies.

It’s a different story today. Riding on improved performance and a good product mix, JLR helped Tata Motors’ consolidated profits increase four-fold to $2 billion in the fiscal year that ended in March. The robust performance of Corus’s European operations saw a turnaround in Tata Steel’s bottom line, with a $2 billion profit after tax in the same period. The Novelis turnaround in fourth quarter earnings in May lifted Hindalco shares. Even so, Ambit’s Wadhwa says that Tata’s and Hindalco’s initial struggles have made other Indian companies cautious about similar buys.

The ‘Olympic Syndrome’

With abundant cash on hand, companies are faced with two options: Reward the shareholders, or look for opportunities to invest. “Many managers believe that they are better off investing the extra cash instead of giving it back to the shareholders, as managers never, ever want to shrink companies,” notes ISB’s Subramanian. According to S. Rajeev, a professor of corporate strategy and policy at the Indian Institute of Management in Bangalore, investing in vanity buys is one way companies hedge their bets. “In an environment where currencies are plunging and the rupee is strong, companies tend to … buy overseas assets instead of [holding onto their] cash and getting hit by inflation,” he says. “It’s … an Olympic syndrome where companies acquire to announce that they’ve arrived, or a late entrant into a category may want to make a splash.”

Anil Ambani’s Reliance Big Entertainment is a prime example. A late entrant into the entertainment industry, Reliance Big Entertainment made global headlines in 2008 when it entered into a joint venture with Hollywood director Steven Spielberg’s DreamWorks Studios. Ambani paid $325 million for a 50% stake in DreamWorks and the exclusive distribution rights for India. Since then, the studio has had four international releases and three more are in queue. At the Cannes Film Festival in 2008, Reliance announced deals with the production companies of eight Hollywood actors, including George Clooney, Brad Pitt, Tom Hanks and Julia Roberts.

Vijay Mallya, whose businesses range from liquor to airlines, has also made such purchases. In addition to strategic acquisitions in his core businesses, Mallya has invested in fancy boats, thoroughbred horses, a game lodge in South Africa, and small newspapers in the San Francisco Bay area.

Not all acquisitions have to be strategic, notes Sanjay Bhandarkar, managing director of investment bank Rothschild. “Indian promoters are classic entrepreneurs, more like private equity players. They may like a particular idea or a business, which has its own glamour and benefits,” he says. Adman Prahlad Kakkar agrees that acquisitions are not always purely about business. Talking to a news channel about Mukesh Ambani’s reported interest in Liverpool, Kakkar said: “It is not just a business deal. It is also a branding exercise. Mr. Ambani is very well known in the [Indian] subcontinent. Some people know him internationally. But everyone from Russia to Timbuktu knows Liverpool. Suddenly, if the ownership of the club changes hands to an Indian, then the Indian becomes center stage. He becomes a world personality.”

Global ambitions are clearly key drivers in these trophy acquisitions. When Anand Mahindra bought a stake in EIC, he noted on his group’s website that EIC’s stature reflected his organization’s goals. Mahindra wrote, “EIC had a profound impact on the development of international trade. This immense vision and scope finds a parallel with our own global aspirations to think beyond its size.” Venky’s Desai had a similar logic for the Blackburn Rovers buy: “As the VH Group globalizes, sets up feed plants and hatcheries around the world, the Venky’s brand will get an immediate recognition.”

Creating Shareholder Value

When it comes to scale and intent in global acquisitions, Indian businessmen are way behind their Japanese and Chinese counterparts. In the 1980s — well before India even started on its liberalization journey — affluent Japanese individuals rushed to buy key pieces of the American landscape like New York’s Rockefeller Center and Pebble Beach Golf Links in California. China’s hunger for global resources has resulted in Beijing — both government and private firms — investing across continents, with technology and consumer markets as focus areas. According to Hong Kong-based deal tracker Dealogic, China has spent $122 billion for outbound M&A deals since 2009 and Japan spent $118 billion. India, on the other hand spent just $38 billion. “In comparison to others, Indian companies have been more restrained,” notes H.V. Harish, a partner at global accounting and consulting firm Grant Thornton.

One big challenge is funding. “If a [business owner] is funding a deal with his own personal wealth, then it is nobody’s business,” PwC’s Krishnan points out. “If not, the shareholders will hound him.” Koushik Chatterjee, group chief financial officer of Tata Steel adds, “Nobody can do trophy deals, because at the end of the day you have to create shareholder value.”

That can be a challenge because, in many cases, companies don’t have much experience in the industry where they made the acquisition. “Sports is a good business to be in, but the question is do these companies have the capabilities to pull it off?” ISB’s Subramanian asks.

IIMB’s Rajeev offers different perspective: “People experiment. If it’s rational, it’s a bet worth taking.”