July 7, 2006

Mittal-urgy

Posted in Current Affairs, Rant at 11:30 pm by falstaff

Will everyone please get over the Mittal Deal? Or at least explain to me what all the exuberance is about?

To begin with, I’m sick to the teeth of the press going to town about how this is somehow a victory for India. You expect idiocy like that from the imbeciles at the ToI, but last week’s India Today (which I had the misfortune of glancing through – forgive me, I was bored) has Anand Mahindra telling us how the merger “proves the tenacity of Indian entrepreneurs globally and will raise the aspiration levels.” And, of course, politicians like Chidambram and Kamal Nath rah-rahing about how they’re so proud. Huh? Will someone tell me in what way Mittal is representative of Indian entrepreneurs, or of the health of the Indian Economy? Is the money for the deal coming from India? Not as far as I know. Is Mittal Steel primarily an Indian company? Not unless the nationality of a company is decided by the origins of its founder, in which case the Vikings are probably the greatest entrepreneurs in the world, or, if you go back far enough, all companies are African. Are we likely to see a spate of other Indian entrepreneurs pulling off deals as large as Arcelor-Mittal? I can’t think of a single one. Then why is Mittal’s success reason for India to feel proud and celebrate?

More to the point, is it a success at all? Empirical research on M&A over decades now has generally found that returns to acquirers are marginal or negative. This is especially true when the acquisition is hostile and contested – the general argument is that competitive bidding tends to drive up the price of the target, until the price finally paid equals, if not exceeds, the value of the target to the acquirer. This is the familiar winner’s curse – the person who bids too much wins the auction, but gets no profit from his purchase. A number of researchers have suggested that escalation of commitment plays a large part in this – once acquirers are publicly committed to a deal and have invested time, money and reputation in it, they are reluctant to back out and may continue to bid even after it ceases to be profitable for them, especially if the initial context is uncertain (see, for instance, Haunschild, Davis-Blake and Fichman, Org. Science, 1994 and Puranam, Powell and Singh).

Could this apply to the Mittal-Arcelor deal? We know that the deal was hotly contested, with Severstal being brought in to resist the Mittal bid. The New York Times (June 26th) article about the deal says:

Arcelor’s foot-dragging led to other concessions from Mittal as well. The offer that was agreed to is nearly 40 percent higher than Mittal’s initial offer in January. That bid was 27 percent higher than Arcelor’s stock price at the time. The current offer also represents a hefty premium to Mittal’s last bid of about 36 euros a share, and to Arcelor’s last trading price of 35.02 euros a share.

The report also says that in getting the deal completed “Mittal made several concessions, including his family’s voting rights”.

None of that is conclusive, of course. I’m the last person to trust the NY Times’ take on business issues, and I certainly haven’t looked at the Arcelor-Mittal deal in any detail. It’s possible therefore that there are huge synergies to be had here that outweigh the premium Mittal is paying (what kind of value multiples would that imply I wonder? And how would they compare to multiples for other steel companies?). It’s possible, given Mittal’s considerable reputation for turnarounds that he can make Arcelor yield high enough profits to justify the valuation he’s put on it. Maybe this is, in fact, a good deal to have made. But prima facie at least, the evidence would suggest the opposite. Everything I read about the deal suggests to me that it’s actually the Arcelor shareholders who are the winners here – that Arcelor has successfully used a number of classic defensive tactics to negotiate itself an extremely sweet deal from Mittal. And while it’s possible that I’m wrong (I don’t claim to understand global steel) I think it would be interesting if we were to see a discussion of why exactly this deal is a real success for the Mittals, rather than empty tom-toming of the fact that the deal got made. Not all deals are worth making.

One last thought on Mittal as the great Indian success story. Assuming for a minute that in some bizarre way Mittal is actually representative of India, how much of a paragon is Mittal Steel really? How much should we aspire to emulate him? Research on corporate governance in family businesses has generally found that heir-controlled firms tend to destroy shareholder value (see, for instance, Amit and Villalonga) . In fact, Morck, Stangeland and Yeung have argued that a large proportion of a country’s wealth being tied up in the hands of billionaire heirs may actually slow GDP growth. The abstract to their article reads:

The basic finding of this paper is that countries in which billionaire heirs’ wealth is large relative to G.D.P. grow more slowly than other countries at similar levels of development, while countries in which selfmade entrepreneur billionaire wealth is large relative to G.D.P. grow more rapidly than other countries at similar levels of development. We consider several explanations for this finding. First, old wealth may entrench poor management and control pyramids may distort their incentives. Second, a sharply skewed wealth distribution may create market power in capital markets causing inefficiency. Third, entrenched billionaires have a vested interest in preserving the value of old capital and thus in slowing creative destruction. Fourth, old money becomes entrenched through control of the political system, and most especially by rearing barriers to capital mobility. In contrast, substantial self-made billionaires’ wealth is observed where such forces are ineffectual and creative destruction occurs.

Yet we’ve all seen the picture of LN Mittal and his son grinning away after the Arcelor deal, and the Economic Times informs me today that Mittal’s 25 year old daughter is on the board of directors. Again, I don’t know anything about the Mittal children. For all I know they may in fact be the most competent people for the roles they play within Mittal Steel. Still, given the empirical evidence on value destruction by heirs, it does make you wonder.

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17 Comments »

  1. anacreon said,

    No denying the fact that Mittal victory is no way an Indian victory. It’s a personal achievement. But then what’s wrong in taking inspiration from a guy who is India-born. Guess, what people are trying to take is “If he can, why can’t we? “. Maybe not to that extent, but we do have Indian Cos. making in roads in the field of IT, automobiles, telecom etc. And regarding Aditya Mittal ,well the guy did put in two years at a leading i-bank, has been working behind the scenes…give the guy a break, after all he has his Dad to fall back on.
    BTW: liked all the references you have put.

  2. km said,

    ..the Vikings are probably the greatest entrepreneurs in the world

    And they have the coolest headgear!

  3. confused said,

    Falstaff,

    As usual you are right on the money. This is no victory for India, infact I was pretty surprised that when Mittal played the race card, India played along and actually talked tough with E.U. Mittal, no doubt still retains his Indian passport, but apart from that almost his entire fortune has been made in Europe. Infact he has never invested in India till now.

    Your second point, I am not so sure. I wont pretend to understand economics as well as you do, but the Mittal empire has been built entirerly on M&A. Even in US, they aquired the US steel and have turned it around by cost cutting. So, they might actually make some money through this deal.

    About heirs, very interesting point. In US, there has been a tradition of giving your entire wealth away, reinforced by recent donations made by Gates and Buffet. In India, not only there is a tradition of keeping the wealth in family, but more dangerously the future generations practise hands on management. We have many examples how disastrous this can prove to be,starting from the Modis, family fueds and bad managers. Admittedly, there has been some success stories too, Aditya Vikram Birla comes to the mind. Perhaps, in Indian context the best is the TATA tradition, where though the chief comes from the family, he is the usually the most suitable one and not the direct heir of the previous chief.

    It is quite interesting why families in India do not give away their wealth. Perhaps, because they are not large enough and they still have something to prove or because of our strong family traditions.

  4. Cat said,

    IMHO, a huge huge victory for India.

    Had it not been for the glory days of the license raj, Mittal may have never have left India in the first place. And poor old Laxmi would be going after SAIL instead of Arcelor (horror of horrors! Don’t you touch my Narvaratna!).

  5. Neela said,

    well falstaff, its at least better than those gushing headlines that read “Third-generation Indian reaches final round of Geography/History/spelling/Grammar Bee”.

    n!

  6. Dipanjan said,

    I think Indian media frenzy was partially triggered by Arcelor CEO Dollé. Some of his remarks made during the time when he was actively resisting the hostile bid had somewhat racist undertones. Don’t know if he was just bigoted or it was a clever ploy to further escalate Mittal’s resolve and commitment. As a reaction to that, Indian media suddenly discovered a lot of empathy and pride for “India’s Mittal”. It is irritating and probably annoys Mittal the most. He himself has always downplayed his Indian-ness.

    However, the Viking and African analogy is bit of a stretch though. After all Mittal was born, brought up and educated in India. So if someone claims that there is something in Indian gene pool or in Calcutta’s polluted air or in our archaic education system that precludes the rise of globally dominant entrepreneurs, Mittal does work as a good counter-example.

    The tight family control of India’s private sector has always worried me a lot. Do you know of well-researched literature that tries to compare it with other major economies and quantify its potential impact on Indian GDP?

  7. Falstaff said,

    anacreon: As Pankaj Mishra says in his op-ed piece on the NY Times:

    “For India, it is a harbinger of things to come — economic superstardom.”

    This sounds persuasive as long as you don’t know that Mr. Mittal, who lives in Britain, announced his first investment in India only last year. He is as much an Indian success story as Sergey Brin, the Russian-born co-founder of Google, is proof of Russia’s imminent economic superstardom.”

    Mishra’s trying to sell his new book, of course, but the point holds, I think. And sure there all these other entrepreneurs doing good things in India. All the more reason not to make a poster boy out of someone who’s barely connected to India at all.

    As for Aditya Mittal – I don’t know if working two years at a leading i-bank cuts any ice. I mean, I have friends who’ve spent four years working at ‘leading’ i-banks, and I wouldn’t trust them to decide where to go for dinner, let alone run the world’s largest steel company. And of course, falling back on his Dad makes perfect sense for him, but if I were a shareholder in Arcelor / Mittal steel I would be very, very concerned about succession.

    km: That too. Plus I kind of like their gods. Take Thor and his hammer for instance. Now there’s a god who’s really useful for doing little chores around the house.

    confused: yes, they might. My point is that good journalism would involve trying to understand how likely that is. Is Arcelor really underperforming? Is there really enough value to be had from it that a 40% increase in bid price still leaves margin for value creation? And if so, was the original bid just plain ridiculous?

    Notice also that the fact that Mittal has all these successes behind him only make the escalation of commitment story more plausible – hubris is a terrible thing.

    Oh, and I’m not sure about the trend towards giving money to charity being anywhere near as widespread as you seem to suggest. Buffet and Gates notwithstanding, most large family businesses in the US (and they constitute a significant portion of the Fortune 500) continue to hold on to their wealth. It’s only management control that passes to professional managers. So the family will still have a large shareholding and will be represented on the board. They’ll just leave the running of the business to professional managers and enjoy the returns.

    cat: :-). True. Hadn’t thought of it that way.

    neela: oh, absolutely. Or the headlines about how a young man of Indian origin amassed huge amounts of wealth through identity theft.

    Dipanjan: Yes, I know. But that doesn’t make it less illogical. I would think Mittal would want to downplay the Indian-ness and make the point that he’s not an ‘Indian’ entrepreneur in any sense of the term but a global business leader and therefore Dolle’s comments are ill-informed and ridiculous.

    The Viking / African argument was meant to be exaggeration, of course, but as for Mittal serving as a counter-example – that’s fairly illogical too, isn’t it. Just because one person from his background manages to become a leading global entrepreneur is hardly evidence that that background wasn’t a handicap. That’s like pointing to Condoleeza Rice and saying that Black Women in America get equal opportunity. Any logical argument would involve comparing India’s contribution to the global entrepreneurial pool (however defined) to the contribution of other countries. One exception hardly disproves the rule.

    Finally, on tight family control. Khanna and Palepu have a number of papers that look at conglomerates and governance in emerging markets (mostly India) which essentially argue that the success of conglomerates in these markets is a result of institutional failure. Because the stock markets were historically underdeveloped, companies were forced to rely on internal capital markets rather than on the stock market – resulting in tighter ownership (family) control. In a nutshell, if you can’t take your wealth out of the business (because the institutional investors for that don’t exist) you need to manage it more closely. As financial markets develop and the economy globalises, however, family controlled conglomerates may become less viable. See Khanna and Palepu’s 1999 NBER working paper:

    http://papers.ssrn.com/sol3/papers.cfm?cfid=470546&cftoken=92591337&abstract_id=153428

    They also have a (1997?) HBR article and a 2000 Journal of Finance Article, but those are more centred on conglomerates than on family control.

    There’s also a 2004 NBER piece:

    http://papers.nber.org/papers/w10613

    The abstract of which you might find interesting, though the article, unfortunately, is available only to subscribers.

    Finally, there’s a Khanna and Rivkin piece in the STrategic Management Journal (2001) on performance effects of business groups.

  8. anacreon said,

    You choose to be overtly critical.
    1) I never agreed to Mittal being the face of Indian entrepreneurship. But why not get inspired by his achievements?
    2) Aditya Mittal is not yet leading the worlds largest steel co. He is being groomed. And do you really think he will be allowed to take control if he is no good?

  9. Falstaff said,

    anacreon: Oh, always.

    As for the son – the point is:

    a) Why is he trained to be a successor at all? Are we really to believe that, nepotism aside, no one more capable could be found?

    b) Yes, I do think it’s not unlikely that he will be made CEO even if he’s no good. The whole point of the research I refer to in my post is that that happens quite frequently. I have no reason to believe that the Mittals will prove an exception.

  10. scout said,

    Oh I agree. Actually an oped by pankaj mishra in the nytimes the other day said pretty much what you did; and more. Dunno if you have an online subscription, but if you do, give it a dekko.
    Hope the finger’s better 😀

  11. Falstaff said,

    scout: Thanks, and yes, I did see it. I actually quote from it in my previous comment.

    I personally think Mishra’s trying too hard to sell his book. I tend to agree with him in being sceptical about India’s potential to be the next superpower and on the fact that India’s ‘development’ is almost impossibly narrow-based. But I find his negativism a little extreme – there is a lot to celebrate in the last 15 years of India’s growth, and if the popular press is drastically overstating the progress made, I think Mishra is dramatically understating it.

  12. scout said,

    oh, of course you did. sorry, oversight and all. Yes, rather pessimistic – but its a good change from the usual India shining pieces the foreign press loves so. And yes, he wants to sell his book too 😀

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