The Hindu Business Line : `India Inc's large leveraged buyouts a concern'

Mumbai June 16 Large leveraged buyouts (LBOs) of overseas companies by Indian corporates are a concern now, said ratings agency Crisil, which recently downgraded the non-convertible debenture programmes of Hindalco and Tata Steel following their mega acquisitions overseas.

"LBOs involve using the cash flows of the target company to service the acquisition consideration, which is in the form of debt," said a statement from Crisil.

"In the Indian context, acquirers have also attempted to protect their balance sheets by setting up ring-fenced special purpose companies to take on debt for the acquisition, without legal recourse to the acquirer," it said.

Both the acquirer and acquiree are affected, according to Crisil. Large LBOs typically impair the acquired company's financial risk profile since most of the debt taken on for the acquisition has to be serviced by the acquired entity. The acquirer's financial risk profile is also adversely affected, prima facie, to the extent of the equity consideration, and ultimately, by the necessity to support the acquired entity in time of distress, to protect the economic value of the acquisitions.

In the past, said Crisil, strong business risk profiles underpinned the overall credit risk profiles. Examples of these M&As were the acquisition of Tata Motors of Daewoo's commercial vehicle unit in Korea in 2004 or Ranbaxy's acquisitions overseas. Value-driven deals in niche markets drove acquisitions then, and the fact that commodity and equity markets had not reached their peaks then, kept M&A valuations at manageable levels.

Several commodities and equity markets are nearing their peaks now, and valuations have been rising significantly. This could potentially suppress returns and extend the pay back period, entailing long periods of sub-optimal returns. Not much of M&A activity has yet gone wrong, but the euphoria surrounding M&A deals could drive corporates to rush into deals without undertaking proper due diligence, cautioned Crisil.

An increasing number of lower-rated companies can facilitate the growth and deepening of India's under-developed bond market, said Crisil.

Impact on bond market

Issuance and trading is heavily skewed towards AAA rated paper. In developed bond markets, there is a much greater interest in lower-rated papers and active issuance and trading at all rating levels from AAA to junk bonds, driven by risk-based pricing. Only 2 per cent of Standard & Poor's outstanding ratings are AAA and 22 per cent A, as compared to 39 per cent and 2 per cent, respectively for Crisil ratings. Globally, companies such as Philip Morris and Unilever have been comfortable with lower ratings at A Category levels instead of AAA because it gave them the leeway to scale up operations, said Crisil.

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