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Decrypting – McKinsey Paper on India Post-COVID Recovery : The M&A Imperative

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Konsult – The Consulting Club of NIBM proudly presents the result of a fruitful collaboration with The Financialist to decrypt and break down the nuggets of some impactful ideas in McKinsey India McKinsey & Company recent paper on “India’s post–COVID-19 economic recovery: The M&A imperative”.

Introduction

India is one of the world’s worst hit countries in the coronavirus pandemic, with reported cases spiking in recent weeks as the country emerged from a strict nationwide lockdown.

Cumulatively, India has reported more than 45,00,000 cases of infections since January. And the graph is yet to hit the peak.

Although the lockdown has been more or less uplifted in the country, But, The economic fallout from the lockdown has been massive and unprecedented. Early economic indicators are sobering.

Some Numbers

The economic activity in April-June 2020 was 23.9% lower than in April-June 2019. The IIP (Index of Industrial Production) has three components by economic activity:

Mining and Quarrying, Manufacturing and Electricity. These three sub-sectors had a share of around one-fifth of the total Gross Value Added (GVA) in 2019-20.

IIP felt by 57.6% in April & 33.9% in June

Another Index, PMI (The Purchasing Managers’ Index) is based on five major indicators: New orders, Inventory levels, Production, Supplier deliveries and the Employment environment

An index value above 50% indicates a positive development in the industrial sector, whereas a value below 50% indicates a negative situation. In April 2020, the value of the PMI in India stood at 27.4 points & in June the value was 47.2 points

The severity of the situation can be understood by the fall in Market Capitalisation of various Sectors in India between December 2019 to May 2020. A net outflow of $ 5 billion in foreign investment from January to April.

Change in Market Capitalisation by Sector, Dec’19 – May’20 (%)

What’s Merger & Acquisitions

Mergers and acquisitions, or M&A for short, involves the process of combining two companies into one. The goal of combining two or more businesses is to try and achieve synergy – where the whole (new company) is greater than the sum of its parts (the former two separate entities).

Mergers occur when two companies join forces. Such transactions typically happen between two businesses that are about the same size and which recognize advantages the other offers in terms of increasing sales, efficiencies, and capabilities.

Acquisitions occur when one company buys another company and folds it into its operations. Sometimes the purchase is friendly and sometimes it is hostile, depending on whether the company being acquired believes it is better off as an operating unit of a larger venture.

Why M&A is a suitable strategy in the current scenario

As per a study by McKinsey, “companies that pursued acquisitions and divestitures (the action or process of selling off subsidiary business interests or investments in order to maximize the value of the parent company) in a structured way tended to outperform their peers. Careful study of the Asian financial crisis of 1997, the dot-com bubble of 2000, and the world financial crisis of 2008–09 justifies this conclusion”.

In the current crisis, to regain momentum the companies will have to forego the status quo and adopt – a strategic approach to recovery by visiting their past M&A strategies.

Why ? Here are the reasons

Comparatively low yields on debt – Ten-year government securities were at 5.79 percent on June 8, 2020, compared with 7.0 percent one year ago.

Falling valuations – Overall market cap–weighted valuations fell 20 to 25 percent from December 2019 to March 2020.

Increased liquidity stress – More than 60 percent of top-500 companies had less than 90 days’ cash on hand.

This highlights the need for Recapitalization by the companies, to help them sustain in the market. Meanwhile, there are government policies in place to protect Indian companies from takeover by certain types of foreign investments.

Sources – McKinsey Paper on the same topic

TYPES OF M&As IN THE POST-COVID ENVIRONMENT

Consolidation of Sectors

Gaps appearing in the structure of Industrial sectors due to the pandemic could be the indicator of opening gulf between companies with sufficient available funding & the companies without it. Because the companies with available funding will have competitive advantage due to available capital, customer relationships & liquidity.

The graph clearly presents the distinction between Industry Leaders and Laggards (a company that is slow to adopt the changing trend) with respect to their cash positions as of December 2019.

Days of Cash Available amongst Leaders & Laggards

Divesting Subsidiaries

A study conducted by McKinsey on 5 of those conglomerates with combined revenue of $ 80 billion in 2019, revealed that top 3 subsidiaries in each conglomerate accounted for at least 70 percent of the group’s earnings before interest, taxes, depreciation & amortization (EBITDA), and the remaining subsidiaries (more than 100 per group) contributed less than 30 percent of earnings and had most of the Debt in each group.

Before the pandemic, the debt ridden subsidiaries were surviving because of two factors – One, Marginal attention and focus given to them and Marginal capital allocated.

Now, in the post-covid world, the businesses (subsidiaries) will find it tougher to grow as the capital becomes scarce and leverage pressures forces conglomerates to act.

Since, many such businesses compete in high growth environment – they could thrive under a different ownership, interested in running them as a core business rather keeping them on the sidelines.

Acquisition of Regional Companies

In sectors like, Consumer goods, Pharma & Retail, success requires both a strong brand value & a deep distribution and supply chain. In this case, stablished companies may want to acquire local brands with strong network in a particular region, state or market etc. And since due to fall in sales these local players are facing liquidity issues, acquiring such businesses at a lower valuations will help established companies to improve their brand values and penetrate different markets.

Enhancing Technological capabilities by Digital-native Start-ups

In the pre-covid era, companies were reluctant to invest and slow in adopting digital and analytical capabilities by using automation, customer-personalization strategies. And, on the other hand, digital-native start-ups had sufficient funding and higher valuations, hence were reluctant to discuss M&A propositions. In the Post-covid world, the fundings are now scarcer, there has been 38% reduction in number of series A start-ups in April’20, as compared to a year ago & a 65% reduction in series B start-ups. Hence, due to liquidity pressures Start-ups will be much more receptive to discussing and considering strategic Acquisition and Joint venture strategies to stay afloat.

Integrating Value Propositions across Industries

In the covid-world, use of mobile phones rose by 3 to 4 hours per user in a week. Which included increased usage for apps offering Online Courses, Chat services, Gaming, Health & Fitness and Video Streaming services.

Due to this, digitally inclined companies will try to solidify their presence on such domains by using cross-sectional platforms. For example – Conglomerate like Reliance has already started talking about venturing into online gaming and edu- tech domains.

This trend will and already is blurring the lines between Industries like – Banking, Pharma, Entertainment, Logistics etc.

All in all – Changing Times calls for Change in Approach as well, and will help in adopting the New normal

Author: Toshan Tamhane and Gaurav Sharma

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