Europe and Chindia edit

Nov. 22, 2006

Overseas acquisitions by Indian companies have suddenly gone on top gear. In the first nine months of 2006, there were 112 foreign acquisitions by Indian companies with a combined deal value of $7.2 billion. Last year it was $4.5 billion, which was itself several times more than the figure for 2004. What is triggering this surge, why now, and why it should worry the Europeans?

-->Let us examine the combination of the four factors which seems to interplay in this sharp turnaround:

1/ The economic and financial situation of the world economy with abundant liquidities in the world since the turning of the American monetary policy in 2000-2002. India, as well as China, are among the most beneficiaries countries of this boom of the cycle if one judges by the expansion without precedent of their economic growth. On a micro side, this has resulted in a cash accumulation without precedent, an explosion of profits and finally a capacity never seen by the Indian firms to borrow on an international market over liquid. The international loans of the Indian companies thus increased by 91% during the second quarter 2006 to reach 4,5 billion $.

2/ Second factor, what we can call “the Chinese challenge” to judge by the way the Indian economic press publish more and more reports on the relative gap between India and China and particularly in the fields of cross-border acquisitions where the Chinese companies have been quite active since 2003. This race, which holds as much with national pride of the two protagonists than to real geopolitical stakes, should constitute a durable factor in the future.

3/ Third, the new BRIC paradigm after the publication of this famous report by Goldman Sachs in October 2003. This has triggered a strategic shift of the largest global companies towards India, which was lagging behind in terms of FDI. A virtuous circle of integration of the largest emerging market is now on but this force as well the Indian companies to engage in defensive and offensive reactions since they are aware that their survival will depend on their capacity to reach critical mass and comparable technological levels and know-how.

4/ Lastly, the progressive maturity of the Indian corporate, like the Chinese ones again: on a micro-economic level, the famous OLI paradigm of the well-known economist John Dunning [1988] seems to be the most important structural factor to account for the recent acceleration of their internationalization:

i) The existence or the search for a specific advantage of the firm (“Ownership”): the Indian firms which have an original know-how want to protect it and to develop it on a worldwide scale, it is typically the case of the producers of generics at a time where their share in the global drugs consumption keeps growing for reasons of reduction of the public health expenditure.

ii) An advantage of « Localization » to profit abroad from the comparative advantages of the host country. That relates to intense research by the Indian or Chinese firms of recognized trade-marks (Rover), sales networks (Marionnaud), infrastructures (P&O), natural resources (Africa or Central Asia), and of advanced technologies like in the case the Arcelor acquisition by Mittal or the string of acquisitions by Wipro or Infosys in the USA and in Europe.

iii) An « Internalisation » advantage which consists of an organisational behaviour which chooses to integrate the various stages of the production process at the world level. Such can be the justification of various acquisitions by the Chinese groups in the textile or food industry, or by the Indian groups Tata in food and now in steel.

Now, where these factors can lead to, and on what scale? Any serious economic assessment leads to two broad conclusions:

1/ The first relates to the size of the operations. Even a doubling in ten years, compared to the 2005 Unctad data on FDI for example gives investments abroad rather small compared to incoming FDI from developed countries. Thus, the recent conjecture of FICCI of 10 billion USD Indian acquisitions in the next three years has to be compared to the nearly 700 billion USD of annual FDI from developed countries in 2005 or to the 60 billion received by only continental China. Much more interesting in fact is the identification of the sectors in which Chinese and Indian companies can claim in the short run to go up in the first ten global players. And very clearly, one would realize that very rare seem to be the sectors concerned: energy, steel, consumer electronics, some sub-sector in pharmaceuticals, maritime transport, and possibly mobile telecom in the medium term and automotive but on a scale of time even longer.

2/ The second limit is the so-called learning curve process and its costs. To confine to the Indian case, two issues in particular could be at the origin of certain brittleness:

i/ The over-estimation of the M&A benefit, particularly the unfriendly ones. The success rate of mergers and acquisitions especially of cross-border ones, is abysmally low with reputed studies showing that less than a third actually add value to the acquiring company. The assessment of the Arcelor acquisition will appear in a few years only but some months after the operation, there are few negative signals. In question in particular the mode of unfriendly acquisition, and some obvious problems of structure and of management which result in a fast departure of Arcelor executives vis-a-vis a purely family management.

ii/ The undervaluation of the operating risks in third countries. First of all in poor countries which are often a privileged target of the multinationals from the developing countries. Second, in the industrialized countries where some Indian business groups underestimate the complexity and the intensity of competition, in particular on technology. From this point of view it will be again useful to closely follow the results of operations like that of Mittal or Ranbaxy. And one should see appearing here the same difference between family-led businesses and those, which like Tata, have already modern management organisation.

To conclude, there will be breakage and the road should be longer and tortuous that some want to make it believe. Clearly the Europeans have time to adjust. But the wheel of the world economy is definitely turning. Good luck Mother India!