Hubris Hypothesis in the Indian M&A Context
70% chance Air India acquisition will fail
In 2010, automotive major Mahindra & Mahindra (M&M) announced with much fanfare its deal with ailing South Korean auto firm SsangYong Motor Co (SYMC). At Rs 2,100 crore (then $463 million), the deal to acquire 70% of SYMC was among the largest in the Indian automotive industry and was touted as a decisive move to consolidate M&M’s position in high-end SUVs.
Cut to 2022. In January, amidst rising losses and falling sales, M&M sold its stake in SsangYong to a consortium led by Edison Motors. The deal size: $254 million, only little over half of what M&M paid to acquire the company. If that’s not bad enough, the entire proceeds of this sale will be used to pay off SsangYong’s debts. M&M isn’t going to make any money from this deal, although it will be cutting its losses. Not quite the success story M&M envisaged.
Of course, M&M isn’t alone in having a deal turn sour. Far from it. Corporate history is littered with instances of mergers and acquisitions going south with a vengeance, sometimes dragging the acquirer down as well. And more often than not, the ones that go belly up are the most hyped deals, where the acquirers pinned incredible hopes on the outcome while patting themselves on the back for seeing it through.
A 2013 study by KPMG said that 75% of M&A deals fail to create value. The study added that the failure was because acquirers and their management were unable to add value to the acquired company and let it run as is.
Another 2011 study showed that failed mergers are often caused by overconfident managers. In the US alone, there was a whopping Rs 75,300 crore spent per day between 2003–2008. And yet, 60–80% of these deals turned out to be failures.
Remember the proverb from elementary school: “pride goes before a fall”? Long before that, Greek mythology had already laid out the consequences of arrogance and pride. Those who succumbed to hubris, or excessive pride and overconfidence, the ancient Greeks warned, would soon be visited by Nemesis, the goddess of retribution, to ensure they were humbled.
The hubris-Nemesis dynamic has outlasted the ancient Greeks. Especially in the corporate world, there are all too many examples of business leaders whose overconfidence and misplaced belief in the worth of their acquisitions has led to disaster. So much so, that there’s now even an economic theory on the phenomenon.
The Hubris Hypothesis of Corporate Takeovers is a theory propounded in 1986 by American economist Richard Roll. Very simply, it states that acquirers can become over-optimistic when evaluating acquisition candidates. This means that either the target is overvalued or the ability to turn around a weaker company is overestimated. In both cases, the shareholders and company balance sheet suffer.
Let’s return to M&M for a moment. SsangYong was already in the doldrums when the Indian automaker took over. The anticipated turnaround didn’t happen, though. On the contrary, sales fell drastically and by 2020, it was clear that M&M was looking to exit. Too little, too late. In the period of January-September 2021, SsangYong’s operating losses stood at $198.6 million while vehicle sales fell 22% in that calendar year.
Like M&M, other conglomerates have fallen prey to hubris — and paid the price as well. From the Tata group to Sunil Bharti Mittal’s Airtel and Godrej, big Indian corporations have often made expensive acquisitions that failed to meet expectations.
And it is not just large companies alone. Startups have also made acquisition errors. For instance, Edtech firm Unacademy bought Mastree in 2020 and shut it down a year later.
Why does this happen? Back in 1981, investment guru Warren Buffett had offered a colourful, insightful reason. Many CEOs get fixated on the story where a kiss from a princess turns a frog into a prince, Buffett stated. And the CEOs are then certain that their managerial kiss will do wonders for the profitability of the target company. “We’ve observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses — even after their corporate backyards are knee-deep in unresponsive toads,” said Buffett.
Unplanned deals edge to a collapse
To be fair, there have been cases where the “managerial kiss” has actually worked, albeit with a delay. A case in point is Bharti Airtel’s 2010 acquisition of Zain group’s African assets for $10.7 billion. The deal bled for close to a decade and in 2017, Sunil Mittal admitted that the investment had been “rushed” and should have been better thought through. But Airtel’s perseverance and patience did finally pay off. The Bharti Africa business recorded 18% growth in December quarter revenue to $1.21 billion.
Bharti Africa though, could well be the exception that proves the rule. Consider the Tatas. The group made two headline-grabbing acquisitions in 2007 and 2008 and has continued making headlines with the deals for all the wrong reasons. First, Tata Steel took over Corus Steel and then Tata Motors bought Jaguar Land Rover (JLR).
Tata Steel bought Corus for $6.7 billion, beating out Brazilian rival CRN in the auction. The British company has been drilling holes into Tata Steel’s P&L statement ever since the deal. The group has been struggling to keep Corus — now renamed Tata Steel Europe — afloat for over a decade, even selling subsidiaries to keep it going. In 2017, Tata Steel inked a deal to sell its UK specialty steels business to Liberty House Group for $112 million. But that wasn’t enough. In 2020, the Indian parent told the British government that it wouldn’t be able to fund the losses in the UK for Tata Steel Europe.
Tata Sons’ auditors have questioned the sustainability of the business since it is still fully dependent on the parent company. This was a clear case of biting off more than they could chew, with company veterans such as Ratan Tata and JJ Irani themselves admitting that buying Corus was a mistake.
Harvard Business Review has said that 70–90% of acquisitions fail. Here, the key reason for failure is inability to integrate the businesses. And that’s now being seen across major M&A deals within the Tata Group.
The Jaguar deal isn’t faring any better. While Tata Motors got the iconic British brands for a bargain price of just $2 billion (half of what Ford had paid to acquire them in 1989), industry experts and analysts questioned the deal right from the start. As it turned out, their doubts and apprehensions were justified. By March 2021, Tata Motors had to write-down $2.13 billion in the JLR business as total losses mounted. It is now waiting for a revival through the shift to electric vehicles.
Sometimes experiments to enter allied businesses can also lead to an M&A failure. When Ola acquired Foodpanda’s India delivery business in 2017, the idea was to expand into the food business using their existing fleet infrastructure. About 18 months later, the cab aggregator realised that the food business was way too competitive to burn any more cash and chose to shut FoodPanda India instead.
Inorganic expansion bets are perilous
When managers succumb to hubris, their overconfidence and pride makes them unwittingly blind to the real potential and pitfalls of the acquisition. They often make hasty decisions about the possible future of the business. This can mean either an under-estimation of the investment requirements in the acquired entity or an over-assumption of future earnings.
That’s what happened with Dewan Housing and Finance (DHFL). The housing finance company acquired DLF’s stake in the latter’s life insurance joint venture in 2013. Four years later, DHFL entered the general insurance business as well. The idea was to enter the untapped insurance market and build a significant market share.
Four years later, DHFL acquired the general insurance business as well. It didn’t work out that way. Instead, DHFL’s mountain of debt grew ever larger even as investments declined. By 2019, the company had gone bankrupt with over Rs 90,000 crore of debt. In 2021, in the first resolution under the Insolvency and Bankruptcy Code, the Piramal group acquired DHFL for Rs 34,250 crore while the general insurance business was sold to Sachin Bansal’s Navi.
Hubris in deal-making can also lead to over-paying for the target company. The start-up universe, especially, has seen several such deals where irrationally exuberant managers have virtually handed over blank cheques to founders, only to repent later. In 2015, e-commerce platform Snapdeal acquired Freecharge for $400 million to create the country’s largest mobile commerce platform. Snapdeal may have either overestimated Freecharge’s potential or underestimated the expansion potential of its biggest rival, Paytm. Or both. Freecharge couldn’t scale as anticipated and just two years later, the business was sold to Axis Bank at a 90% discount.
In a few cases, the thirst to grow bigger in an existing category has pushed startups to make an M&A bid. Take the case of Flipkart. Through its subsidiary Myntra, the e-commerce platform acquired retail startup Jabong in 2016 in a Rs 2,000 crore deal. The investment failed to generate any returns and instead was eating up existing cash. Four years later, Jabong was shut down, with a strategy to solely focus on Myntra. The strategy to become bigger inorganically didn’t really work because by the time of the acquisition, Jabong’s popularity had already started to drop.
It’s also important to remember that partial successes at one end of the spectrum during acquisitions don’t necessarily extrapolate to the business as a whole. Unilever’s failed bid for GlaxoSmithKline’s global consumer goods business is a case in point.
In 2020, Hindustan Unilever paid Rs 3,045 crore for GSK’s Horlicks and Boost. The deal was part of a larger, global strategy. Unilever made a $68 billion bid for GSK Consumer globally, despite investor concerns that the price was 18X the earnings. It wasn’t nearly enough as far as GSK was concerned, though. The British conglomerate wasn’t satisfied with the price on offer, calling it an undervaluation.
Finally, Unilever declined to raise the bid price and the deal fell through. The ‘big brother’ syndrome of Unilever that made the management perceive GSK as ‘another company’ they could takeover didn’t work. But the deal that never happened still took a toll. Unilever ended up cutting 1,500 jobs after the failed takeover.
In their 2005 study, Ulrike Malmendier and Geoffrey Tate said CEO overconfidence has been a key factor for M&A candidates being overvalued. In India too, several deals have failed as a result of such incorrect and over-optimistic projections.
Having yes-men near the top can exacerbate CEO hubris during takeovers. In such cases, an effective board of directors offering critical feedback as well as active shareholders can prevent CEOs from taking the big plunge without proper and extensive due diligence. Treading cautiously on M&As while keeping the long-term business sustainability in mind can help Indian companies expand horizontally and vertically. And avoid an uncomfortable meeting with Nemesis.
