The Hindu Business Line : MBO: Management or `managed' buyouts?

In 2007, the private equity firm Blackstone Group agreed to buy Indian back-office company Intelenet Global Services, marking its first management buyout (MBO) in India. MBO, as it is known in the PE or private equity circles, is not something new in India; but it has occurred far and few between in India for the informed public to take note of. For instance, the year 2004 saw a string of similar deals involving ICI Paints' nitrocellulose business, Escorts Auto Components and Gilbey's Green Label.

"MBOs were traditionally considered high-risk transactions, but in India they have proven to be good for companies and are considered an attractive option by managements. Significant increases in revenues and profits have been witnessed in victims of MBOs - Phoenix Lamps, Nitrix, Intelenet to name a few in India," says Mr Rohit Kapur, Head-Corporate Finance, KPMG, India. Explaining to Business Line over the course of an email interaction, Mr Kapur feels MBOs are also becoming the preferred option for company managements.

"Management teams typically want to gain independence and autonomy, apart from having the power to influence strategic decisions and give the company future direction," he comments. With economies all over the world in a tailspin, which may change the fortunes of some companies, it only remains to be seen which big industrial house would be the next on the radar for a buyout. Read on.

Edited excerpts from the interview:

Do you find companies more open to funding now?

India has been growing at an average rate of 7.5-8 per cent for the last few years and this trend is only expected to continue. Similarly, China, another Asian giant, has been on a phenomenal growth path attracting investments from all over the world.

Therefore, it comes as no surprise that five of the 10 newly announced buyout deals in the first quarter of 2008 feature targets in either India or China.

The two economic powerhouses, however, still have a long way to go before cementing their position in the financial world as the buyout transactions have been relatively insignificant compared to global transactions.

An inherent factor fuelling growth in both these Asian giants is the emergence and diversification of industry. Leading industrial houses in India have expanded into new, previously untested non-core competency areas. This has been largely feasible due to two fundamental factors - a large appetite to absorb risk and readily available funding.

How has the advent of private equity helped the scene?

Funding has become easier with the emergence of successful PE firms such as Actis, Blackstone and ICICI Ventures. PE firms have increasingly started playing the role of `company builders'. Whether it is management wanting company ownership, or a family-managed firm facing succession issues, PE firms usually help provide answers by taking care of the all-important financing aspect. By partnering with professional managers they encourage entrepreneurship and enhance business growth.

They also bring with themselves abundant relationships, portfolios and knowledge about vendors and networks, spanning industries, geographies and customers. Also, PE firms typically have knowledge of leading industry practices and can turn around company fortunes much faster than traditional lenders.

Tell us more about MBO.

Blackstone, the world's largest PE firm, has bailed out firms facing financial distress by buying out management stakes in these firms. Traditionally, Management Buy Outs (MBOs) involved the management wanting to purchase a controlling interest in the company and working along with financial advisors to fund the change of control.

Today, MBO activities involve promoters divesting their stake in a firm by selling out to PE players willing to finance the asking price. The PE players are flexible enough to enter into a partnering relationship with the existing management. This sort of arrangement is basically just a stake buyout and not a classical MBO.

It is common in scenarios where owners want to hive off entities with poor results and the management lacks funds to hold on to the entity (and their jobs) and are, in turn, bailed out by the PE firm.

Similar to Blackstone, Actis - a veteran of five MBOs in India - bailed out Phoenix Lamps in 2006 for $700 million. Additionally, they introduced the management of Phoenix Lamps to newer suppliers, reducing production costs and provided numerous customer introductions enhancing revenues.

Once the business had settled, they provided access to technology enabling Phoenix Lamps to develop into a complete lighting solutions company.

Recently the US-based PE fund First Reserve Corp agreed to acquire oil and gas services provider Abbot Group. The œ906 million MBO was the largest PE funded buyout in the drilling services industry, and the first European oilfield services to be made private.

However, the Abbot Group avoided terming this buyout as an MBO because First Reserve intended to work with the company's existing management and employees, limiting its involvement to supplying cash resources to fund a focused expansion programme in the UK and Europe.

What's driving MBOs today? There are lots of deals happening in this part of the world.

MBOs were traditionally considered high-risk transactions, but in India they have proven to be good for companies and are considered an attractive option by the managements. Significant increases in revenues and profits have been witnessed in victims of MBOs - Phoenix Lamps, Nitrix, Intelenet to name a few in India.

A few firms have voluntarily gone down the MBO route to gain access to other portfolio companies apart from receiving funding from a PE house. When Blackstone bought out the stakes of Barclays Bank and HDFC in Intelenet, in what was the Indian IT industry's largest MBO, Intelenet CEO Susir Kumar admitted that they "wanted a player who could introduce us to other portfolio companies that could give us business. Blackstone was a good fit."

This deal was Blackstone's first BPO investment in India, having previously tested the pharma (Emcure Pharmaceuticals) and media (Ushodaya Enterprises) sectors.

India has been witnessing increased activity in the MBO space in industries as varied as IT/ITES to chemicals to Fast Moving Consumer Goods (FMCGs). PE initiatives are spurring buyouts where the management and the PE firm enter into a power sharing agreement with the latter providing the funding.

What are the pros and cons, for both the buyer and the seller?

MBOs are also becoming the preferred option for the company's managements. Management teams typically want to gain independence and autonomy, apart from having the power to influence strategic decisions and give the company future direction. MBO through PE-funding enables not only this, but also provides the much-needed capital gain.

If the management decided to sell the company to a new firm it would most likely not only bring with it a new management team, but would also leave existing management without a say in strategy matters. Strategically, a company would not want to be faced with the threat of a competitor acquiring controlling stake or even getting access to confidential information that might occur during a trade sale.

A recent example of a firm resorting to an MBO to ward off competition is the $560 million buyout of Japanese LCD glass venture NH Techno Glass Corp by US PE firm The Carlyle Group. NH Techno Glass was facing increasing price competition from bigger rivals who could invest in newer equipment and effect economies of scale. The infusion of capital by Carlyle helped expand the venture's manufacturing facilities overseas and even aim for an IPO.

MBOs help safeguarding jobs as well. Scottish backplane and power control boards manufacturer Signum Circuits Ltd was rescued from a receivership through an MBO in 2002. The transaction also helped safeguard 94 jobs at the company which was a victim of the slowdown in the mobile communications handset market. Eventually, the company shut down its telecom handset operations unit in 2004 and focused on power control and circuit boards.

From a funding house's point of view, an MBO is not only more attractive due to the speed of the transaction (it is faster than a trade sale) but it enables them to work with a well-balanced existing management that has handled the business and knows the industry well.

It saves the PE house the trouble of finding a new set of skilled management to run the new business. Moreover, from a pricing point of view, MBOs are cheaper for a PE house because more often than not it is firms in financial distress and not doing too well commercially that are hoping to be bailed out.

Are MBOs more successful than other types of private equity deals?

Feasibility criteria are important factors which determine whether an MBO is successful or not. There have been instances in the past where an MBO didn't produce the desired results and the PE house sold the company soon after buying it.

Results apart, if there is conflict between existing management and the PE investor over company perspectives/aims/goals, in most cases the MBO won't be very successful. PE firms aim to maximise their returns and exit after three to five years and the management is more concerned with the wellbeing of the company and the jobs and are not too forthcoming when taking risks. They adopt approaches that the existing management might disregard because the latter are trying to protect short-term earnings and stock prices since their own compensation is also linked to the company's performance. This difference in perspective and aim can cause investor and management conflict.

Additionally, an important factor to consider before entering into a buyout agreement with the existing management is the commercial viability of the business as an independent or standalone entity.

Where do you see MBOs going? Is Asia going to feature more?

Today, with oil prices at around $140 a barrel and global investor sentiment at a low, getting funds is not only becoming increasingly expensive, but also elusive. The risk appetite of investors and funding houses has diminished. However, this is contradicted by the volume and value of deals that have taken place in the first quarter of 2008, both being higher than the numbers for the corresponding quarter in 2007.

Globally, buyout scenarios were even brighter than in Asia-Pacific - the buyout revenue from Japan, North Asia and Australia was just $19 million, compared to $135 million each for Europe and North America. Japan accounted for 25 per cent of buyout revenues (including revenue from debt and equity capital markets, syndicated loans and mergers and acquisitions), while India and China together accounted for 24 per cent of regional revenue.

As oil prices scale new heights every week and finance powerhouses resort to a management shake-up to help boost revenues, it only remains to be seen which large industrial house would be the next to bank on a buyout as

D. MURALI

KUMAR SHANKAR ROY

(Illustration by R. Rajesh)

AccountSpeak.blogspot.com

More Stories on : Interview | Venture Capital | Account Speak

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Nuclear Disarmament: Myths and realities in India

The redemption millstone

A ‘windfall’ best avoided

Financial statements of NBFCs — More responsibilities for the auditor

Nuclear deal: UPA could have handled it better

MBO: Management or `managed' buyouts?

Auditing the China economics

Expansion of G-8

Inflation hurts