Solution A
HABIL F. KHORAKIWALA
Chairman & Managing Director, Wockhardt

Ashutosh Mukherjee's apprehensions that the strategic and financial planning functions are pulling each other in different directions at Deepak Abrasives are well-founded. It only shows that the CEO is fully aware of the problems that can beset an acquisition. Team-building can never be a one-off attempt; it must be an on-going endeavour in which the CEO must lead from up-front. Recognising the role of human resources development (HRD) in team-building is crucial. It is noteworthy that Mukherjee would not have been able to build a business from scratch without the help of an effective team. But tomorrow's business challenges require a different set of managerial skills. With Deepak Abrasives' expansion plans under way, the need for a team of senior managers on the same conceptual wavelength is imperative. Evidently, HRD is going to prove to be crucial to the success of Mukherjee's game-plan for the future.

Post-liberalisation, the external business environment has changed rapidly for companies like Deepak Abrasives. Despite high entry-barriers in the domestic market, the opening up of the economy and the fall in the Customs duty on electro-minerals has intensified competition. In fact, with the advent of the transnationals, the number of players has also increased. So has the activity-level of domestic competitors; Deepak Abrasives' competitor, Sunrise Abrasives, which is planning an investment of Rs 100 crore, is bound to increase its marketshare at the cost of the former. In this high-pressure scenario, Mukherjee must deal with a fundamental problem. Should he strive to acquire a position of strength in the industry in the long run to ward off the competition? Or should he strive to create short-term value for the organisation so that it becomes an attractive proposition for a potential bidder? Don't forget, Mukherjee should be open to the idea of selling off Deepak Abrasives if the price is attractive enough.

Interestingly, the company is a market leader largely because of Mukherjee's entrepreneurial skills and risk-taking abilities. If the CEO still feels energetic enough to carry on for the next 5-7 years, he should opt for an acquisition. Deepak Abrasives can acquire Zen Abrasives at Rs 75-Rs 80 per share, which is about 50 per cent more than the present market price. This would cost the company about Rs 50 crore. However, Mukherjee could stretch the offer price upto Rs 100 per share. Even at this price, the acquisition would make strategic sense because of the following reasons:

It is important for an organisation to add to its pool of competencies regularly. One way to build competencies is to complement your existing strengths, or to venture into new areas of learning. Zen Abrasives offers unique learning opportunities for a buyer. Over the years, Deepak Abrasives has acquired certain competencies in both technology and marketing. This acquisition will help the company benefit from the target's competencies as well. While the latter's strengths in technology would overlap Deepak Abrasives', its strengths in marketing would be complementary.

With a 9 per cent marketshare, Deepak Abrasives can gain a foothold in the bonded-abrasives segment. Zen Abrasives could provide an opportunity for growth in this segment in the long run.

Together with Zen Abrasives, Deepak Abrasives will have a much bigger share of the total abrasives market. The company already has a 40 per cent marketshare in coated abrasives.

Deepak Abrasives' A-Team is highly enthusiastic about the acquisition. That can be fruitfully channelised to provide momentum to the entire business. For Mukherjee, this is, perhaps, the most challenging task.

The extra premium which Mukherjee will have to pay for Zen Abrasives will be compensated for by both synergy and reduction in costs. The latter, especially in the area of common corporate overheads, would improve the profitability of Zen Abrasives' product-range.

It would be advisable for Mukherjee to hire the services of a M&A consultant. That would ensure that both Deepak Abrasives and Zen Abrasives derive the benefits of the acquisition uniformly and fairly. Often, buyers impose their systems and cultures on their acquisitions without assessing the benefits of such moves. A consultant, invariably, brings with him enormous experience in acquisitions and benchmarking, which will be available to both the companies. In essence, external intervention will be far better than any in-house exercise.

Despite its entrepreneurial character, a 35-year-old organisation like Deepak Abrasives is bound to have developed pockets of high costs over the years. This merger should provide the new entity with an opportunity to look at its non-value-adding operations more rationally in order to become a leaner organisation. Unfortunately, Mukherjee's biggest concern is Zen Abrasives' customer-profile, which comprises the automotive sector. Even though this sector is more vulnerable to a slowdown in demand than the leather industry, the combined entity should be able to absorb external shocks much better than the individual units. In fact, given the fact that the automotive sector is set to grow, Mukherjee's apprehensions are not fully justified. Obviously, the CEO is looking at the short run.

Even as Mukherjee weighs the pros and cons of an acquisition, he must realise that a greenfield project is really not a sound option because it entails a long learning curve and a higher investment. This would mean that, based on an initial rate of return, an investment of Rs 100 crore is unlikely to be attractive. Given its financials and size, Deepak Abrasives cannot afford this. It makes better strategic sense for the company to take the M&A route to growth. That would pre-empt its rivals since it would provide Deepak Abrasives with a head-start in a new segment like bonded abrasives. With such an advantage, all that Mukherjee then has to do is to bank on his entrepreneurial skills.

Solution B
RAJU BHINGE
CEO, Tata Strategic Management Group

Synergy is, often, the magic word that drives an acquisition. But synergy is more hype than substance--a mantra used to justify fancy premiums for the target instead of reflecting its true value. Evidence suggests that acquisitions, often, destroy shareholder value. The destruction of value is accentuated further when there is a war of bids for the target. Then, managerial enthusiasm replaces strategic rationale and shareholder commitment. These are some pitfalls that Ashutosh Mukherjee should guard against.

A few important questions beg his attention before he thinks about the acquisition of Zen Abrasives. What strategic options are available to Mukherjee? Does he intend to tap other businesses? Can he create a formidable position in the coated-abrasives business through expansion? Or should he establish a presence that spans multiple segments of the abrasives industry? In the bonded-abrasives segment, Mukherjee needs to assess the long-term attractiveness of the segment by seeking answers to the following questions: how is the bonded-abrasives market likely to evolve in the future? Who are the customers, and what are their buying patterns? What levels of quality and service do they require? What will be the nature of future competition? How will trade reforms and the entry of transnationals impact his future prospects? What key capabilities are needed to succeed in this business?

If the bonded-abrasives segment is attractive enough to merit an entry, Mukherjee has 3 options: set up a greenfield facility, forge manufacturing and marketing alliances, or enter the market through an acquisition. The choice depends on the merits and demerits of each option. Only after making certain that an acquisition is the preferred route does the question of identifying a target arise. Deepak Abrasives' A-Team seems to have ignored such a systematic approach to the issue. It needs to assess how competitive Zen Abrasives is in its market. Can Deepak Abrasives' management enhance the merged entity's competitiveness by pumping in money and increasing capacities? To realise such benefits, Mukherjee needs to ensure that Zen Abrasives enjoys a strategic and a cultural fit with his company.

Consider the price that Mukherjee should pay to acquire Zen Abrasives. As Robert Williams, the investment banker, rightly says, comparing the acquisition price with the cost of setting up an equivalent greenfield unit will lead to a case of over-payment. The big question: what is the maximum price that Deepak Abrasives can pay? To answer this, the company has to value Zen Abrasives' business by discounting its future cash-flows by the WACC (Weighted Average Cost of Capital) method. A realistic assessment of the synergies that improve future cash-flows should be made. Simultaneously, strategic and financial analyses must be conducted to assess value-creation. Any premium above the present market value of Zen Abrasives has to be justified by the improvements that Deepak Abrasives' managers can bring about there. These incremental benefits could accrue due to levers such as:

• Revenue-enhancement through increased market power, or cross-selling to a larger customer-base.
• Cost-reduction through economies of scale across the value-chain, in areas like sourcing, marketing, and distribution.
• The transfer of superior managerial and financial resources from Deepak Abrasives to Zen Abrasives.
• Improved time-to-market benefits arising from quicker inflows of cash.

A closer examination would show that Zen Abrasives may be far less attractive than it appears to be. With a 9 per cent share of the bonded-abrasives market, the company is, clearly, not a dominant player. Its products serve the automobile industry while Deepak Abrasives caters primarily to the leather industry. Since auto-makers are usually big, the bargaining power of a supplier like Zen Abrasives would be low. Not only are the quality and service-levels expected by the automobile industry likely to be more stringent than those in the leather industry, its buying practices would also be different. So, there is limited scope for synergy in the area of marketing. The fact that the automobile industry is also prone to cyclical demands impacts the performance of its suppliers--like Zen Abrasives. Moreover, there is a threat from transnationals in this sector. Not only will they be keen on sourcing from their own global supplier, they would also prefer to deal with a Tier-I supplier who supplies car-assemblies, and not a component-vendor, in the long run.

Deepak Abrasives' internal analysis shows that the replacement cost of Zen Abrasives' plant is about Rs 110 crore. A simplistic calculation suggests that to earn a minimum 20 per cent pre-tax return on this investment, the gross profits must be at least Rs 22 crore per annum. Zen Abrasives, a manufacturing operation with a turnover of Rs 33 crore, is unlikely to yield a 67 per cent return on sales. So, is a greenfield investment in bonded abrasives economically viable? Now, Deepak Abrasives' main competitor, Sunrise Abrasives, is investing Rs 100 crore in a facility for coated abrasives. If this investment fails to generate adequate returns, it is possible that Sunrise Abrasives will face a financial crisis and become an acquisition candidate itself. Acquiring that company at a depressed price could be a far more attractive option for Deepak Abrasives since that will give it a dominant position in its core business of coated abrasives.

To sum up, Mukherjee should conduct a comparative evaluation of his company's strategic options over a 5- to 7-year time-frame, re-assessing the future of the coated-abrasives business. Depending on the priorities that emerge, and the resources available with Deepak Abrasives, a roadmap for the future will evolve. And the acquisition of Zen Abrasives should be pursued only in the light of such a strategic context.

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