KOLKATA - The recent acquisition of the
Indian software development arm of Singapore-based
Flextronics International, the world's largest
contract electronics manufacturer, by the New York
private-equity firm Kohlberg Kravis Roberts (KKR)
was not only the first leveraged buyout in India,
but it also exemplifies an increasing trend of
debt-backed private equity deals in Asia, which
has emerged as a new focus for global
private-equity investors.
In last week's
deal, which stunned the financial world, KKR
agreed to buy out 85% of Flextronics Software
Systems in a two-part transaction totaling US$900
million. The first part calls for
KKR
to pay $600 million in up-front cash to
Flextronics International for the controlling
stake. The second part will be funded by the 10.5%
interest on a $250 million face-value note, which
will earn Flextronics International between $210
million and $305 million, depending on how it is
structured over the next eight years.
The
deal was historic in several respects. It was
simultaneously India's largest-ever corporate
buyout and its first conducted using
leveraged-buyout methods. The transaction also
marked the first India foray of KKR, the world's
biggest buyout firm, which earned public notoriety
in 1989 from a bitterly contested $31 billion
takeover of cookie maker RJR Nabisco, made famous
by the book Barbarians at the Gate, later a
made-for-TV movie.
Reportedly, KKR is
borrowing about $400 million to leverage the
buyout Indian software unit, which would make it
the country's first debt-backed
merger-and-acquisition (M&A) deal. In
leveraged buyouts, the acquirer puts up a little
of its own funds and borrows the rest to pile the
debt on the target company, then expands the
company or otherwise improves its performance
(sometimes by asset-stripping) before selling it
again. All private-equity-funded M&A deals in
India were, in the past, funded mostly by
private-equity investors' own money.
All
these firsts were not, however, what really set
tongues wagging in Indian private-equity finance
circles: that would be the price paid for
Flextronics, which eclipsed all previous M&A
deals in the country's information-technology
sector, setting a new Indian record in the
process. According to analysts, KKR paid four
times the annual revenues of Flextronics Software
Systems, which beats the just-concluded RR
Donnelley-Office Tiger (a back-office service
provider) deal - concluded at a revenue multiple
of 3.4 - and Electronic Data Systems Corp's buyout
offer of the local software-services company
MphasiS (at three times).
"If anything,
the recent deals signal that valuations have
touched new highs that show no signs of easing.
Just [a] couple of years back, the valuations were
about twice the revenue multiples, compared to the
deals now at almost four times the revenue," said
an analysis in the Economic Times, India's largest
financial daily, adding that "the coming months
will see more M&A activity and valuations
could go up further".
But more important,
this deal also signifies that Asia has again
emerged - as Forbes magazine put it - as "the new
Shangri-La" for global private equity investors
after the region lost its attractiveness for such
deals in the Asian financial crisis of eight years
ago.
Take Kohlberg Kravis Roberts for
instance. Despite its three decades of existence,
the Flextronics Software buyout was the firm's
first deal in India (and only its second in Asia).
In fact, KKR opened it first Asia office in Hong Kong only late last
year and in Tokyo a short while later.
Similarly, Bain Capital LLC, a
Boston-based buyout firm, is recruiting all over
Asia, while Carlyle Group, which claims to be one
of the world's largest private-equity firms, also
claims that it is now the biggest private-equity
investor in the region.
According to
Bloomberg, buyout firms have already announced
$11.7 billion of Asia-Pacific acquisitions so far
this year, more than twice the amount in the first
four months of 2005. The amount of money raised
for Asian investment in 2005 was impressive, too,
nearly tripling from $6.5 billion in 2004 to $17.6
billion, according to the Center for Asia Private
Equity Research.
Although India still lags
far behind its Asian peers, particularly China and
Japan, in terms of private-equity investment, this
is starting to change. According to Venture
Intelligence India, private-equity and
venture-capital firms invested $2.2 billion in
India in 2005, spread across 146 deals.
India's prospects have drawn some of the
sector's biggest names to set up shop in the
country, including Blackstone Group, Carlyle
Group, General Atlantic Partners, Warburg Pincus
and Temasek Holdings. The industry says that about
15-20 private equity funds, including new players,
are set to enter the domestic market this year and
despite rising valuations, about $3 billion to $4
billion is lined up for fresh investments this
year, compared with about $2.2 billion invested in
2005.
But why - with global equity
investors pumping billions into India to cash in
on "the new hotbed of innovation", as Oracle
chairman Jeff Henley put it - did Flextronics
International sell out its Indian software arm?
After all, the software unit was not an organic
expansion of Flextronics: it bought the company
only two years ago, when it was the offshore
software-development subsidiary of US-based Hughes
Electronics. At the time, Flextronics paid $226
million for a 55% stake, which, ironically, was
one of the highest-valued deals then too.
Reports in India say that Flextronics was
forced to sell out. In fact, rumors suggested that
the deal had its roots not in India, not even in
Singapore, but on Wall Street, because Street
analysts were not happy with the company's recent
diversification in software and were pressuring
Flextronics to concentrate on its core electronics
manufacturing business.
Indeed, increasing
competition from multinational software giants
such as Electronic Data Systems Corp, Accenture,
Computer Sciences Corp, Hewlett-Packard, and IBM
as well as local software biggies such as Infosys,
Wipro Technologies, and Satyam Computer Services,
are making it increasingly difficult for mid-tier
software companies to stay afloat. Most
high-profile mid-tier software companies,
including MphasiS, Hexaware, Geometric, and
Hindustan Computers Ltd, have been relative
under-performers in recent times.
Even
Flextronics chief executive officer Michael
McNamara hinted at a similar reason for the firm's
divestiture of its software unit: "This
transaction is in line with our strategy to focus
on 're-acceleration' of growth opportunities in
our core electronics manufacturing services
business - which includes design, vertically
integrated manufacturing services, components and
logistics," he said.
"By monetizing
non-core assets at substantial gains over carrying
values, Flextronics will have generated cash
proceeds of over $1 billion," McNamara said. "In
addition, we will have retained ownership
interests in both the software and network
services businesses, which should provide
additional cash and potential future upside when
monetized."
Nevertheless, analysts say the
recent mega-deals in India may well usher in the
next phase of change in the Asian private-equity
space: According to Asian Venture Capital Journal,
a Hong Kong-based newsletter, with institutional
investors' interest in Asian private equity at an
all-time high, there will be an increasing number
of prominent American and European private-equity
firms setting up operations in Asia. And the
recent deals confirm that Asia, India in
particular, is a place the new private-equity
funds can really put money to work for big
returns.
Indrajit Basu is a
Kolkata-based equity analyst turned journalist
with more than 12 years of experience in
business/finance and technology journalism.
Besides writing for Asia Times Online, he also
writes for US-based publications, as well as IT
companies.
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