Tough times, good deals

The global markets recently took note of JPMorgan Chase's better-than-expected first quarter earnings, but they may have overlooked a telling point: acquiring Bear Stearns was more than just a price coup for JPMorgan Chase, it also filled in valuable pieces for its long-term strategy. Only last February, JPMorgan told investors it needed investment-banking capabilities to meet its growth goals.

Of course, JPMorgan Chase's quick action benefited from unique circumstances. But it underscores that—for executives with the right combination of readiness, prudence, and guts—economic turbulence actually presents some of the best opportunities to fill capability gaps, gain market share and change a company's competitive position.

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That's a timely lesson for India where the prospect of turbulence seems to be increasing despite the 8.8% GDP growth in the quarter ended March 2008. The Indian economy is faced with a tighter monetary policy to combat soaring inflation, as well as the rising cost of debt.

This cut factory output growth to a mere 3.9% in March—one of the lowest levels in years—and 7% in April, far from the double-digit figures seen early last year. Moreover, the Indian stock market continues to be battered by inflation and global slowdown concerns after its dramatic crash in January.

However, corporate India's hunger for acquisitions—particularly cross-border deals—remains strong. This can be seen in Tata Motors' acquisition of Land Rover and Jaguar for $2.3 billion this month and Reliance Communications' merger talks with South African telecom firm MTN Group.

Making bold investments when markets are in dire straits might seem reckless to many managers. But our analysis of more than 24,000 deals in the United States between 1996 and 2006 reveals companies that acquired through the last downturn (2001 to 2002) generated almost triple the excess returns of companies that made acquisitions during the prior boom years.

The successful acquisitions ranged from $10 billion mega-deals to relatively small transactions under $100 million. Among industries, the largest increases in excess returns occurred in healthcare and consumer products; the smallest in utilities and telecoms.

But, significantly, the finding of good deals in bad times—higher excess returns on deals completed during the downturn—held true across all industries. Nor was this simple market timing. We also found that executives who buy during both good times and bad significantly outperform the opportunists, a finding that may prove useful to Indian firms in the future.

As a staging ground for improving competitive position through M&A, the current economic downturn in the US has several things going for it. True, credit markets are tight, but corporate balance sheets are generally strong. With the 2007 S&P 500 cash-to-sales ratio almost three times what it was 20 years ago, corporate cash balances are flush and equity is a viable deal currency.

This is also true in India where PE multiples remain strong, despite the January crash in the stock market, indicating that companies have a strong platform from which to launch acquisitions. Moreover, the cash-to-revenue ratio for the BSE 200 went up to 29.9% in 2007 from 25.1% in 2005, emphasising that prospects for continued growth remain bright.

The necessary precondition to a successful deal in periods of turbulence is a well-calibrated compass that shows the company's long-term direction and a thoroughly analysed set of options to get you there. The best deals during downturns allow companies to buy capabilities or market positions that would take years and major investments to create.

General Dynamics and Johnson & Johnson have built strong competitive positions by buying throughout the business cycle. In India, agrochemicals maker United Phosphorus has built an impressive global presence over the past few years through acquisitions, picking up companies from the United States to Holland to, more recently, Colombia.

More than impeccable timing, these companies have developed a well-articulated strategy, coupled with an in-house capability covering the major steps in a deal—strategy, negotiation, diligence, and integration. More companies are adopting this pattern to become serial buyers. From 1987 to 1991, only about 20% of S&P 500 companies closed an average of 1.5 deals or more per year. From 2002 to 2006, that rose to almost 40%.

At US-based diversified manufacturer Danaher, managers use a mix of "new-platform investments" and bolt-on acquisitions to boost growth. During the last recession, Danaher made 10 significant acquisitions. Indeed, M&A has become a growth engine for Danaher, boosting its market capitalisation to $27.8 billion in 2007 from $17.2 billion in 2005.

Indian firms can learn from their US counterparts, despite the differences in the economic conditions of both countries. One lesson is that a slowing economy may be the right time to aggressively chase opportunities domestically in your sector.

Further, global economic turbulence can be an opportunity for cash-rich Indian companies to shop for targets in developed markets. There are many recent examples including Tata Chemicals' purchase of US soda-ash maker General Chemical Industrial Products this year for $1 billion.

In 2007, India led the BRIC nations in outbound M&A with deals worth $34 billion. Its enthusiasm remains undimmed. But as Indian companies look at more foreign deals, they must have a clear rationale and investment thesis in mind. Are they looking for technology, capabilities, or customer access? Should they do a "platform acquisition" that provides them major capacity or a key capability in one shot, or go in for a series of smaller acquisitions that reduces risk but takes longer to get to the destination?

Having a clear sense of what they want and a well-formulated integration plan that focuses on creating value after the acquisition will save Indian companies from getting their fingers burnt.

Sri Rajan leads the M&A and private equity practice in India. Harding is a co-leader of Bain & Company's Global M&A practice.