DEAL OR NO DICE?

Apollo's $2.5-billion bid to acquire Cooper Tire of the US stands the risk of joining a clutch of proposed big bang M&A transactions that never made it to completion :: Malini Goyal      Omkar S Kanwar, 70, wouldn't have seen it coming. In June, when the chairman of Apollo Tyres announced the $2.5-billion acquisition of the USbased Cooper Tire & Rubber, he was upbeat. The deal would have made $2.34-billion Apollo — about half the size of Cooper — the seventh largest tyre company in the world with $6.6 billion in revenues and a foothold in the critical tyre markets of US and China.  Four months later, the deal has run into rough weather. Lenders are jittery, investors are worried and brokerages are downbeat. The two managements have begun squabbling. Cooper has sued Apollo, asking the company to complete the deal. And the Kanwars aren't happy, either. "We are disappointed that Cooper has taken this unusual step and [we] question their motives. The litigation simply has no basis," a statement from Apollo Tyres says.  Deal Going Off-track  To be sure, the Apollo-Cooper relationship started on a difficult note. The June deal sent Apollo shares dropping by a quarter the next day. The problem was both with the valuation (it offered Cooper a fat 40% premium) and the way the deal was structured. Apollo would have funded most of the transaction by issuing high-yield bonds in the US. Cooper's anxious workers — in the US and in China — added fuel to the fire by seeking renegotiation and striking work. According to media reports, the Kanwars have sought a price cut of more than $2.5 per share from the agreed $35 per share. Reportedly, the deal's financiers — Deutsche Bank, Goldman Sachs, Morgan Stanley and Standard Chartered — are also demanding a price cut. "Cooper has acknowledged to Apollo that some price reduction is warranted. The issue is now by how much. On top of the USW [United Steel Workers' Union] issue Cooper has breached material representations and covenants, including with respect to its China subsidiary due to the fact that Cooper has no control over the subsidiary or access to its books and records," Apollo said in a statement. If the deal fails, Apollo may have to pay a break-up fee of $112 million. And Cooper is liable to pay a termination penalty of $50 million.      It isn't yet clear which way the Apollo-Cooper deal will go, but odds are that it may not consummate. "It was too big a deal. Apollo did not have the management bandwidth and had not done enough homework," says a seasoned Mumbaibased investment banker on condition of anonymity.  M&A Deals Gone Sour  A break-up after engagement isn't that rare in the world of M&A. A recent PwC study on emerging markets found that over half of the deals that enter detailed external due diligence fail to reach completion. This figure is much higher than that of the developed markets. The study says that deals in growth markets are inherently riskier (than in developed mar- kets). There is a much bigger deviation or range of potential outcomes. "The delta between a good deal and a bad one is much bigger in growth economies than in developed markets," the study says. Nearly 40% of the deals failed to complete because of a valuation mismatch; about 15% didn't make it due to financial transparency reasons; another 15% failed due to noncompliant business practices; and a little under 20% failed due to government interference.      But it may not be just an emerging market phenomenon. A report released by S&P Capital IQ in June this year reveals that $92.5 billion worth of deals have been cancelled in the US over the past 12 months. The telecom and financial sectors led the pack. And a Deloitte report early this year reveals that 639 deals — where the buyer or seller was US-based — were terminated in 2012.      According to an E&Y global M&A tracker, thanks to global macroeconomic uncertainty, global M&A conversion rates are constantly falling, implying M&A deals are taking a lot longer than usual to achieve closure. In both 2010 and 2011, the average conversion rate was  67%. In 2012 it fell to an average 62% as the number of pending bids rose.      Apollo-Cooper notwithstanding, investment bankers point out that India Inc is learning how to manage M&A deals. "After more than a 10 years experience of cross border M&A in India, everyone — promoters, managers, bankers, analysts and even the press — is now better educated. The financial ecosystem has got better at evaluating transactions, and measuring success and failure," says Frank Hancock, MD, Barclays Capital.  Why Deals Fail  Deal making is like a marriage — with emotions, chemistry, money and ego thrown in. So reasons why they fail vary. Often, the external environment can play spoilsport. Kosturi Ghosh, a partner at law firm Trilegal, recalls one transaction she witnessed last year. Her client, a large private equity firm, was in advanced stages of acquiring a stake in a large real estate firm. But the rupee devaluation was a spoiler. Suddenly hedging costs became so high that the internal rate of return they were expecting no longer seemed viable and the deal was abandoned.      Experts say that off late the fear of anti-bribery laws like FCPA in countries like the UK has made buyers cautious and any suspicious transactions, even if in advanced stages, may be abandoned. Ramakrishnan Kalyanaraman of Chennai-based Spark Capital says financial misrepresentation is one of the biggest reasons for deals falling through. He recently advised a buyer keen on a southern infrastructure firm. "As we went through the books we realised a lot of potential revenues were suspect and we had to abandon the deal," he says. Regulators increasingly are playing a crucial role as deal breakers. Take the case of Axis Bank's takeover of securities firm Enam. Pending the regulator's approval, the deal announced in 2010 finally went through in 2012. Over two years, the transaction had to undergo dramatic changes — including structure and valuation — before it finally went through. Globally, regulators have played a very important role in shaping M&A. "We will see a lot more of this regulatory intensity in India going forward," says TV Raghunath, head of Kotak Investment Banking. Some deals fail simply because of huge sovereign stakes involved. UB Group's Vijay Mallya withdrew his bid to acquire Taittinger, a French champagne maker, because of strong French opposition. The proposed Bharti Airtel-MTN's $23-billion merger failed partly because the South African government could not see control of a national entity passing into foreign hands.  A volatile macroeconomic environment often translates into more failed deals. At the peak of the 2008 global economic crisis, a record number of deals — 1,309 worth $911 billion — were cancelled amid financing issues, volatile valuations and widespread risk aversion, according to Dealogic, a platform for I-banks.  India vs the West  Seller remorse because of an emotional attachment to a business that's often passed on from one generation to another is a key reason for deals failing in India. Vivek Gupta, partner (M&A practice), BMR Advisors, recalls a recent M&A deal in the consumer services space. Over six months, they discussed, negotiated terms and conditions and were ready to sign the agreement. On the D- day, the entrepreneur came to Gupta's office in the morning with his wife and father to say he did not want to sell. "I am just 40, what will I do if I sell my business," the entrepreneur pleaded to Gupta, and told him to cancel the transaction.      Barring stray cases, India also has not seen much of shareholder and creditor activism that could lead to deal failures. But that may change. Increasingly, brokerages and research firms are putting out deep-dive analyses of deals when they get announced, offering rich insights into their pros and cons. That may be why the Apollo-Cooper proposal got a huge thumbs down from the stock market.  Caution in Dealmaking  In a slowing economy where exuberance has given way to caution, the rigour in due diligence has sharply gone up. "Earlier, if a PE firm was invested in a company, a new PE buyer would take many things for granted. No longer," says Subbu Subramaniam, managing partner, MCap Advisors, a PE firm. Earlier much of the focus was on financial due diligence.  Now business due diligence has become mandatory. As a result the time required to do deals has almost doubled since the upbeat days of 2007-08. Even valuation expectations have sobered. NV Sivakumar, executive director, financial advisory services, at PwC estimates that in 2007, it was common to see valuations touch 16-20 times operating profits and 3-4 times revenue multiples. Today, they are at 10-12 times and 1-1.5 times, respectively. This re-calibration of expectations has not been easy and has led to more deal failures in recent times.      Experts are figuring out ways to minimise deal failures. Gupta of BMR says he works hard to build comfort before signing any public announcement so that parties understand the deal better and there aren't surprises later. For example, besides commercial and financial due diligence (in services businesses particularly) he lays thrust on building comfort through conversations with key customers and clients. Once the framework of the deal is clear and the nitty gritties done, at times he nudges parties to commit to an escrow to bring in some psychological commitment.      Many MNCs, in case of cross border deals, negotiate for a reasonable break-up fee to disincentivise a "rethink" on behalf of Indian promoters.      It is a different matter that break-up fee clauses are rarely enforced in India. Will Apollo-Cooper buck that trend?  •