What is intangible capital?
Broadly speaking, intangible capital is of three kinds:
- Organisational capital – the ability of an organisation to innovate, its R&D ability, governance etc
- Relational capital – brand of the company, internal and external networks
- Human capital – quality of employees, their ability and engagement levels
Firms which take cognisance of intangible capital at early stages of the deal, actually realise better shareholder value and EBIDTA margins (if listed). It is easy to identify intangible capital, difficult to manage it, because at the due diligence stage it is difficult to get accurate information on it. The more firms delay getting this information, the more delayed they get to realise the value of the merged entity. Organisations wake up to the need for merging intangible capital, only when they face crises.
What is the value of intangible capital? How does it determine the success of M&As?
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Mitali Bose
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The important question to ask is- what is the state of intangible capital, for unlike physical or financial assets which are static, it changes. So for instance if an organisation has a set of motivated employees, the longer it takes for the pre closing and closing stages, there is a chance that employees may get frustrated and disenchanted. Intangible capital changes from an active state to an inert state and the more inert it is, the more difficult it is for an organisation to get any kind of value out of it. For example, a lot of inbound M&A in the generic industry depends on their drug pipeline, or the reach in certain markets. So if we don’t take into account what creates that, is it the dealer network or is it the ability to quickly replicate what is already there in the market and deal with them clearly in the beginning, there is a confusion which results in the merged entity losing value, over a period. So the longer it takes to get to the integration points, the higher the chances of intangible capital becoming inert over the acquisition timeline. Most firms start thinking about intangible capital once they start facing issues in the early stages and that’s too late. One needs to think of it at the due diligence stage and close out planning at the pre closing stage.
What have companies doing inbound M&As been looking for?
Inbound M&As in India have been from Japan. The volume of deals have gone down, but the deal sizes have gone up, simply because they are trying to integrate a lot of acquisitions they made earlier. However, some of the issues that they have been facing include- longer than anticipated integration timelines and cultural differences. Generally, for companies entering India the challenges would be around understanding the geographical difference, getting accurate and transparent data, etc. For Japanese companies, stability and risk profiles are important, in India, they find it difficult to get accurate information about intangibles.
Are Indian pharma companies proactively looking at enhancing their intangible capital?
The pharma sector is going through a lot of changes and there is bound to be consolidation. How attractive a company is from that point of view is a function of two things, the industry itself and the companies showcasing the kind of talent they have, the agility they display, their reach and networks. These are some of the intangibles that Indian companies are building upon, but not consciously. But if a deal is imminent, then they are projecting their brand. In fact in all of Asia, the focus on intangible capital is much underdeveloped as compared to mature markets.
How far is valuation an indicator of the intangible capital of a company and how far is it an enabler?
Valuation is a factor of the profitability of the company and its image. The image is in turn driven by the R&D ability and the kind of market it has, reach and access to market(determined by regulators), Brand, agility, quality of supply and distribution networks, quality of key resources. All these attributes determine the valuation of the company and so such companies have a high intangible capital. It needs to be remembered though that there is no valuation on intangible capital.
Has the perception of companies doing inbound acquisitions changed and how far have Indian companies helped change that perception?
Companies doing inbound acquisitions still tend to face red tapism and bureaucracy, general cultural orientations around transparency, data, risk, compliance, governance, etc. most of them underestimate the amount of complexity in the market and therefore most deals take longer. Indian companies are waking up to these challenges to build credibility with the international community.
How do you see the role of PE firms in the M&A environment? What percentage of the deals can be attributed to them (in India and globally) and then specifically in pharma? Elaborate the reasons for the same.
Rising shareholder activism is influencing corporate governance and increasing the level of broad activity. Deal terms have come under greater scrutiny. Moreover, companies are looking to make very specific acquisitions and becoming more targeted in their deal seeking as well – PE firms focus on providing expertise and specific advice on such targeted opportunities. In PE backed firms – they help in capital infusion. PE firms will continue to play a strong role in cross-border deals.
With this in mind, in the past, we have seen private equity firms willing to invest in about half the pharma deals that take place in a year. However, their investments between 2007-09 have not paid off as anticipated, given a slow or negative growth environment, and even issues of corporate governance plaguing high-profile deals. Going forward, while the outlook remains moderately optimistic, we are expecting the momentum to continue, albeit with an enhanced cautiousness about the tangible and intangible synergies expected from a deal.
PE funds are increasingly interested in small R&D based pharma firms. Your comments.
PE funds are focused on deal success; hence they try to look for a win-win approach for both the acquirer and acquired, or the investor and the investee from a deal fitment perspective. So their investments focus on future growth – be it through R&D, technology, manufacturing, healthcare accessibility, product portfolio, etc. To that extent, a lot of factors come into play – the relationship with the PE firm of both parties, how the relationship between the buyer and seller is cultivated before and after the deal, and so on.
Innovation is the life blood of the life sciences sector and it will continue to play a dominant role in 2014. Major pharma companies will remain focused on building a strong pipeline of initiative products / solutions – leveraging both internal and external assets. In this scenario, high quality / unique assets focused on innovation will continue to generate a lot of interest.
Cultural integration sits at the core of an M&A. What is the perception of Indian companies in this respect globally? Also, how have Indian companies pulled themselves up here in the past few years?
Cultural integration is, in essence, the key component in the valuation of intangible capital during and before an M&A deal. Hay Group’s research breaks down culture fit into four measurable components – open and honest communication, courageous follow-through, similar risk profiles, and compatible response.
In India, people enjoy discussions. Management should take advantage of this and initiate frank and open dialogues as soon as possible. If not done so, employees will quickly fill the void with rumors – hence the need for ‘open and honest communication’.
On the other hand, ‘courageous follow-through’ was the missing component in the case of the merger of Air India and Indian Airlines, where the losses escalated post merger. In the six years after the merger, the merged entity had a rotating door of four chairmen with no one willing to bite the bullet on tough decisions like cutting employee-aircraft ratio, standardization of HR policies, or even the type of aircraft to fly.
In measuring ‘risk profiles’, one way is to use Geert Hofstede’s Uncertainty Avoidance Index (UAI), a tool to measuring a nation’s appetite for risk. UAI scores can range from zero (pure risk takers) to 100 (pure risk avoiders), where India scores 40, indicating a medium-low preference for avoiding uncertainty. This must be factored in the market screening process; the closer two companies’ UAI, the better the outcome.
Finally, ‘compatible response’ is the gauge of whether or not both parties have a similar time-frame in mind for decision-making and execution. In India, we have a tendency to delay decision making in order to gather more or better information. If this style is not shared by the other party, then it will be perceived as hesitation and ultimately, backfire on the deal.
So my take is, there are good deals to be made, if companies keep all four factors of cultural integration in mind. Armed with the right insights to make the best deal – a clear understanding of what you are buying and how it ‘fits’ with your existing company – M&A can be a winning strategy for driving long-term growth for the future.