What drives small companies to acquire bigger, formidable rivals?

In the world of corporate deal-making, companies typically buy smaller players that promise to contribute to their own operations in a significant way. Alternatively, companies buy, or merge with, their peers in the same sector, roughly equal in size and market dominance.

The concept of smaller companies buying larger firms — not rare in the Western world — has now begun to take off in India in a significant way. The reasons vary from needing to reduce competition, to gaining access to specific products or markets, to expanding the customer base with that of the bigger rival.

Sometimes, buying a larger listed company allows the smaller firm to access public market funds, though there are strict regulatory norms to be met.

No rival is too big

Listing out examples, a Times of India report pointed to the recent surprise announcement of PharmEasy, a six-year-old pharma e-tailer, to buy diagnostics giant Thyrocare, a 26-year-old publicly listed firm. Among other examples, three-year-old fintech firm BharatPe, along with Centrum Finance, is set to take over the 37-year-old Punjab and Maharashtra Cooperative (PMC) Bank, under the Reserve Bank of India’s directive.

Similarly, edutech player Byju’s has acquired 33-year-old test preparation firm Aakash Educational Services — which has helped lakhs of Indian students write IIT-JEE and other engineering and medical entrance exams down the decades — for $940 million.

Funding options

How the small companies fund the giant deals is varied. PharmEasy, an e-commerce unicorn (a start-up with a valuation of over $1 billion), is raising fresh capital of $300 million to fund its latest acquisition. In addition, it is selling a 5% stake in itself to A Velumani, founder of PharmEasy, though this is seen as more of a strategic move than a financial one.

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Typically, the small-sized buyers in such deals have deep pockets — they are well funded by prominent private equity or strategic investors. Also, they mostly enjoy high valuations, which lets them swap stocks with bigger firms. For instance, Byju’s, which is again a unicorn, used the share swap option, apart from cash, for its purchase of Aakash.

The backing of global investors not only gives the young firms a strong financial backing, but also access to sound strategic guidance. The spotting of potential targets, the numerous rounds of talks and bargaining, and the post-deal synchronisation of operations — all these are mentored by the investors.

The need for such acquisitions

Small firms buy larger ones only when there is a substantial gain to be made. An online player like Byju’s might need a traditional operation like Aakash to gain instant access to brick-and-mortar classes in every part of the country.

Throcare presents a similar opportunity to PharmEasy. The former also offers a wide range of services that can help the latter immediately scale up operations.

It is not just about the younger firms making gains. The older firms, by getting acquired by small rivals, mostly benefit from the fund infusion. Also, the change in management style — typically more agile and open to innovations — can revive sagging operations.

Win-win combinations

For BharatPe, the RBI-led deal to take over PMC Bank helps it use the partnership with co-buyer Centrum to widen its product offering, said another ToI report. Under the plan, BharatPe and Centrum will set up a new small finance bank (SFB) that will take over PMC Bank.

Additionally, having a traditional bank like PMC in its fold means BharatPe can reach a huge, loyal customer base with its fintech products. Merchant acquisition becomes relatively seamless as issues such as KYC (know your customer) norms are already taken care of.

For PMC Bank, of course, the deal means a revival of its operations — critical not only to its survival, but also the lifetime savings of numerous customers.