CHAPTER FOUR

Transforming Government-Linked Companies through Mergers and Acquisitions

The drivers for mergers and acquisitions (M&A) do not typically include a desire for culture change. However, we suggest that for some government-linked firms, with a heavy hold of the bureaucracy, this could be a real and transformative benefit. The post-acquisition period shakes established habits and could allow for a new regime. We have identified several mechanisms for engineering a mindset shift and suggest this might be a better way to kick-start a transformative program.

Government-Owned or Government-Linked companies dominate a large part of the domestic economy in most Asian countries. These incumbent government players tend to be somewhat lethargic, ponderous, and bureaucratic. They are typically slow to adapt, slow to change, and slow to make decisions. They can’t, however, afford to continue to operate that way.

Consider the onslaught of private sector competition that has emerged in the past decade in high-cost industries that have traditionally been dominated by government companies, including airlines, energy, and telecoms. In most cases, when faced with newfound competitive pressures, government incumbents have looked inward and opted to take on moderate improvement initiatives.

A viable, aggressive, and more proactive strategy to address their competitive shortcomings is the pursuit of M&A. M&A provides access to new products, technology, strategies, and ideas, and this kind of event offers a unique chance to shake up the corporate culture. M&A can be transformative. During a merger or acquisition, legal day one offers companies a chance to reinvent themselves: It can be a new day for a new company that plans to approach the market in a new way. This fresh-start approach gives executives a chance to reassess whether their processes make sense, whether the culture makes sense, and whether their internal promotion cycle makes sense. As the merger team maps out the strategy of the enlarged entity—ranging from products to markets to processes—it has a unique opportunity to chart a new course and shake up an otherwise large, moribund institution.

This may be critical to Asia’s economies, which remain dominated by government-linked corporations (GLCs) and state-owned enterprises (SOEs). Governments that want to continue to use GLCs to nurture and grow their economies must use the most powerful tool on hand to get those enterprises into fighting form. M&A is the tool.

THE ROLE OF THE PUBLIC SECTOR IN KEY ASIAN ECONOMIES

Asia’s public sector typically plays a large role in its local domestic economy through myriad state-owned companies or GLCs. GLCs may be publicly listed, but the government remains the largest—usually the majority—shareholder.

We compiled a list of GLCs in key Asian countries and calculated their 2010 revenue as a percentage of the country’s gross domestic product (GDP) as a proxy for how big the GLCs are relative to the size of their respective domestic economies. This allows us to make some comparison across countries although it doesn’t precisely map out the exact contribution of GLCs, private players, and multinational corporations in each country, as revenue of GLCs will include contribution from overseas. The revenues of China’s state-owned companies and GLCs constitute 14.5 percent of GDP, which is on par with Thailand; India’s revenue of GDP makes up 6.5 percent and Malaysia’s is 17.4 percent. Singapore stands out at 48 percent. The revenue earned by Australia’s GLCs equates to 3 percent of GDP; the ratio in the United States is 1.68 percent. We included GLCs in which the respective government had a stake of 50 percent or more. The actual list is much higher; some government investment agencies control GLCs through a minority stake that leaves them as the largest, controlling shareholder.

Even though Asia’s GLCs command a sizeable portion of the economy, they’re not doing a standout job. Singapore’s GLCs are competitive, but they are probably the exception: Most of these companies are nowhere near as nimble or well run as their private sector peers. As an example, consider the gap between Asia’s state-owned banks and their private sector peers. We compared the average return on assets (ROA) of Asian government-linked banks in 2010 against the average ROA of private sector banks. We included all banks in our GLC list in which the government has a controlling stake even if that stake was less than 50 percent. There is a consistent lag in returns.

The average return on assets of India’s government-owned banks was just 0.88 percent, but their private sector peers returned 1.4 percent, as shown in Table 4.1. In Japan, GLC banks underperformed as well, with a 0.18 percent ROA, compared to 0.26 percent from the private sector. The picture is worse in parts of Southeast Asia. Indonesia’s government-owned banks returned an average of 2.3 percent, compared to the 3.5 percent average of the private sector banks. Thai government-linked banks underperformed by the widest margin of all, with an ROA that was less than half of that of their private sector peers.

TABLE 4.1 Private Sector Banks Outshine GLC Peers: 2010 ROA of Publicly Listed Banks versus Government-Linked Banks in Selected Countries

Source: Bankscope; A.T. Kearney analysis.

If government-run companies continue to claim such a large slice of the economic pie, surely they owe it to the country’s taxpayers, and shareholders, to operate in the most efficient and competitive manner. By merging with competing state-linked companies to gain better synergies and reduced costs, by acquiring private players who can galvanize their operations, or by selling a majority stake to a market leader who can provide the cutting edge technology, services, and competitive returns required, these companies can better justify their outsized presence in the country’s economy by delivering more to shareholders and voters. Privatization may not be the best answer for state-linked companies that offer critical services in thinly populated markets, but in thriving industries crowded with nimble competitors, the option should be on the table.

M&A: A TOOL THAT MAKES BOTH COMPANIES AND ECONOMIES MORE COMPETITIVE

Many Asian governments have traditionally used state-owned companies and state-linked companies to execute broader economic policy. Singapore’s GLCs, for example, were a core part of the government’s strategy to develop its external economy. Singapore, with few natural resources, had to look outward for growth momentum since the earliest days of nationhood. Outbound M&A have been a key part of that strategy. Singapore’s GLCs have led the city-state’s corporate push into the region, and indeed the world, by snapping up stakes in everything from telecoms to ports to financial institutions. China’s SOEs are doing the same, pushed by the need to secure natural resources to fuel economic growth back home.

Still, there are few examples of GLCs undertaking domestic mergers to consolidate fragmented industries at home, to gain better synergies, or to use M&A to shake up the organization. Across Asia, a lot of resistance exists to M&A within the public corporate sector even though they are active in cross-border acquisitions.

Many of these organizations could do with some transformative changes. China’s SOEs, for example, remain largely opaque, and the listed companies lack transparency. These enterprises are acquiring companies all over the world, but they’re not transferring the business know-how or the commercially driven corporate culture of those targets back to their own operation.

In May 2011, China’s National Audit Office published a report that revealed irregularities and disciplinary violations in the financial statements of 17 high-profile SOEs in the 2009 fiscal year. The state agency that supervises the country’s SOEs said it would work to make the SOEs’ management more transparent in the wake of the report. In a statement posted to its website, the supervising agency said the SOEs have made progress in management, risk controls, and social responsibilities in the past years but noted they still lag far behind top-level international enterprises and should take advantage of the disclosures to enact further changes, according to a report by The China Daily. Acquiring or merging with private sector competitors and harnessing their best practices and top talent would help propel the typical state-owned entity up the ladder.

Even Singapore’s GLCs, which are run on a commercial basis and held up as the gold standard in Asia, could do more to leverage M&A. The city-state’s GLCs have been criticized as being less nimble than their private sector peers partly because GLC managers are often appointed from the ranks of senior civil service and not from private industry.1

Sovereign Wealth Funds, which typically hold the government’s stakes in the GLCs, have taken a few steps to drive change at GLCs through M&A. Malaysia’s state investment fund Permodalan Nasional Berhad (PNB), for example, drove the three-way merger of Malaysia’s government-linked plantation companies. Khazanah Nasional Berhad, the investment-holding arm of the Malaysian government, has been active in driving change in Malaysia’s public sector.

In 2005, Khazanah, which owned a 22.7 percent stake in Commerce Asset-Holdings Berhad, then the country’s second-largest financial group, encouraged the merger of two of Commerce Asset’s majority-owned units: Bumiputra-Commerce Bank (BCB), a large bank that was widely viewed as badly run, and CIMB, a much smaller but more nimble investment bank.2 The move, which transformed CIMB into a dominant player, came at a time when Malaysia was promoting consolidation within its banking sector ahead of plans to open the market to foreign competition in 2008.

The outcome of that forced marriage has been stellar. Since it swallowed BCB, CIMB has gone on to become Malaysia’s second-largest financial services provider and Southeast Asia’s fifth-largest lender (see “Regional Ambitions” sidebar in Chapter 3).

Asia’s governments should use M&A to prepare the domestic sector for foreign competition. Trade barriers are coming down all over Asian groups, including the Association of Southeast Asian Nations (ASEAN), the Asia-Pacific Economic Cooperation (APEC) forum, and the World Trade Organization (WTO), as the Trans-Pacific Strategic Economic Partnership Agreement (TPP) phases in agreements to liberalize trade. Many Asian nations are busily signing bilateral trade agreements with each other and Western countries to bolster economic activity, adding to the momentum of deregulation. State-owned companies across Asia are going to have to become more competitive to survive in this new era.

Many state-owned companies were set up to help build nascent industries, from telecoms to automotive manufacturing, to help diversify Asian economies; protectionist laws were put in place to keep foreign competitors out to ensure they could achieve those goals. That era is drawing to a close. Asian governments are working on a host of regional and bilateral trade agreements designed to bolster economic activity by cutting import duties, lifting ownership limits, and improving two-way access for investors and companies. The members of ASEAN, a combined population of 550 million, have committed to remove obstacles by 2015 to the cross-border flow of goods, services, and investment. The six most developed economies of ASEAN—Thailand, Malaysia, the Philippines, Indonesia, Singapore, and Brunei—have removed import taxes for ASEAN companies. The four least developed—Vietnam, Cambodia, Laos, and Burma—are scheduled to follow suit by the 2015 deadline. In 2010, China got on board and signed the ASEAN-China Free Trade Agreement, which, with a combined population of 1.9 billion, will create the world’s largest free trade zone.

The 21 members of APEC plan to create a pan-Asian free trade zone by 2020. Many Asian countries have pushed ahead of that goal; there are more than 120 bilateral free trade agreements with the Asia-Pacific region. Others are also signing up for the TPP, another multilateral free trade agreement that aims to liberalize the economies of the Asia-Pacific region. The TPP requires members to eliminate trade barriers in a range of sectors, including manufacturing, agriculture, and services, within a period of 10 years from entry. Singapore, New Zealand, Brunei, and Chile are members of the TPP, and five other nations—the United States, Australia, Peru, Vietnam, and Malaysia—are negotiating to join the agreement.

One way to prepare a sector for the tidal wave of liberalization is to trim the number of state-run companies, encourage consolidation, and create larger, more competitive enterprises. There are a few examples of this: Singapore’s DBS Bank, for one, merged with POSBank, another government-linked bank, in 1998, to gain dominant market share. The deal came one year ahead of a five-year plan, announced by the Monetary Authority in 1999, to liberalize access and participation by foreign banks in the domestic finance sector.

The move by Malaysia’s state-run investment fund to push for the merger of three state-linked palm oil companies is another example. That deal created the world’s largest palm oil producer and created economies of scale that enhanced the company’s competitiveness in the international arena.

There’s plenty of scope and many drivers for more of these kinds of deals. Many state-linked companies, from India to China, need improvement. Meanwhile, GLCs or state-owned companies could make much better use of M&A to pave the way for the inevitable liberalization of industries that remain largely sheltered from international competition and from China’s finance sector to Malaysia’s automotive industry.

THE EMERGING THREAT FROM THE PRIVATE SECTOR

The encroachment of private companies into industries traditionally dominated by government companies is not a new phenomenon. In most countries, prior government dominance of the financial sector, agricultural commodity trading, broadcasting, and transportation has long been eroded. However, several industries remained strongholds for government incumbents until recently. The lack of private players was brought about by factors inherent in these industries: high asset or investment requirements, prohibitively high economies of scale that caused a natural monopoly, a lack of private actors with financial or technical capabilities (particularly in developing countries), significant first-mover advantages enjoyed by the incumbent, and regulatory restrictions, such as state ownership over strategic industries.

However, the wave of private competition that we see emerging in recent decades is unique. Whereas past private sector incursions occurred in industries where initial capital investment is not exceedingly large and businesses are highly scalable, the private sector is increasingly targeting industries with high initial investment and technical requirements, such as air travel. Even though previous erosions of government companies’ dominance occur sporadically at a national scale, the recent waves of private sector encroachment occurred simultaneously on an international scale. The explosion of competition in wireless telecommunications in emerging countries is an excellent example. Lastly, where previous private sector challengers limited their focus to their respective domestic markets, private competition is appearing in industries such as metals and mining, which have a high degree of international linkages or may not serve the domestic market at all.

Industries that strongly exhibit this trend are airlines, telecom, energy upstream/exploration and production (E&P), refining and downstream oil and gas, mining, metals, and complex manufacturing. This phenomenon is facilitated by several developments. Wireless technology, for example, invalidates the natural monopoly that was inherent in telecommunications; more than one operator can compete in a single area. Increasing sophistication and specialization of businesses allow the outsourcing of highly complex tasks and delivery of end-to-end solutions and turnkey projects, all of which reduce the technical barriers for new entrants. The largest enabler has been the trend toward liberalization and deregulation that dismantles artificial barriers to entry into areas previously designated as “government-exclusive.” Whatever the causes, one thing is certain: These changes are here to stay.

In some cases, the erosion of the incumbent’s dominance can progress more quickly than anticipated. The cautionary tale of the Indonesian aviation industry, where government-owned flag carrier Garuda Indonesia held a dominant share of the domestic and international passenger market a little more than a decade ago, is a prime example. Garuda, which was hard hit by the 1997–1998 Asian financial crisis, was simply not ready for the onslaught of nimble, private-sector low-cost carriers that sprang up across Southeast Asia after the post-crisis period. Garuda’s share of Indonesia’s international market plummeted from 65 percent in 2001 to just 18 percent in 2011. The airline’s share of the domestic market shrunk from an estimated 55 percent to 23 percent over the same period.

MEETING THE CHALLENGES

Despite these challenges, government incumbents, lulled into complacency by decades of low competition, look inward and undertake moderate improvement initiatives (often half heartedly) as the sole way to address these competitive pressures. Few top-line initiatives are undertaken other than attempts to mimic innovations or strategies developed by the new entrants. Efforts to match the cost efficiency of industry leaders are pursued in a lukewarm manner and/or to a limited scope. Underlying these is the factor of complacency: Rarely is there an urgency to change until it is too late, often until the point of financial distress and/or privatization by the government under unpleasant circumstances.

Government incumbents must consider an alternative approach to regain supremacy. Rather than undertaking improvement initiatives internally and moderately, the transformation toward competitive leadership—in technology, business innovation, or operational efficiency and productivity—can be jump-started through the right M&A deal. Several M&A and inorganic growth options are available, of which four relevant ones are outlined next.

Acquisition of a Competitor

Though this strategy provides the incumbent with control over the acquired target, effectiveness may be enhanced if the target is in possession of a significant competency in its innovations, technologies, markets, brands, distribution channels, business know-how, or talent. Additionally, this strategy bears the advantage of eliminating a degree of competition in the market, provided approval by market regulators is forthcoming.

Acquirers often fail to leverage significant value from the target as initially envisioned. Extracting value from a target company is not always easy. State-owned companies with little merger experience, in particular, face a high risk of failure. Even when a state-linked company uses M&A to move up the value curve, lack of planning and poor strategy can derail the entire exercise.

Consider the short-lived attempt of Shanghai Automotive Industry Corporation (SAIC) to run South Korean automaker SsangYong. SAIC bought a 49 percent stake in SsangYong for $500 million in 2004, outbidding global giants, including General Motors (GM).3 SsangYong had a 10 percent share of Korea’s car market and was the country’s fourth-largest automaker. The company was struggling with a large debt burden but was starting to grow exports of its sport utility vehicles (SUVs); SAIC hoped the acquisition would help boost its own development capabilities and gain entry to new global markets, including the United States.

The new joint-management team decided to swiftly expand manufacturing capabilities and launched five new models worldwide. In 2006, gas prices shot up, and Europe and the United States came out with tough, new emissions standards. Both factors hit SUV sales hard, straining relations between SAIC and SsangYong’s powerful trade unions, which went out on a seven-week strike. Chinese and Korean executives disagreed, partly because of cultural differences, on how to improve the company’s performance. The global financial crisis dealt the struggling company another blow. SsangYong’s sales fell 53 percent in December 2008 over the same month the year before.

SAIC supported its subsidiary by buying $4.5 million worth of vehicles to sell in China. Eventually, SAIC put a restructuring plan in place that cut the workforce by 36 percent and included a number of measures to improve productivity. The Korean unions refused to sign off on the plan and initiated legal action against SAIC, accusing the company of transferring designs and technology developed with Korean government funds to China, a charge SAIC denied. SsangYong eventually filed for bankruptcy protection in January 2009, prompting another round of strikes and protests. SAIC wrote off most of its investment and reduced its stake to 3.7 percent in July 2010. In the five years that SAIC controlled SsangYong, the company pumped more than $618 million into the venture and walked away with nothing.4

SAIC had the right idea but failed to extract the synergies it hoped to gain from the deal. The key in such acquisitions is to proactively develop early on a clear strategy of what value is to be captured from where and how to optimally extract that value. A good risk management plan might have helped troubleshoot some of the problems that ran the company aground. Perhaps more could have been done to incentivize workers to meet the productivity goals needed to extract value from the merger. Private or public companies that want to unlock value from a merger must create an integration strategy that covers all these bases and more. Companies should only execute acquisitions after developing a strategy instead of pursuing an opportunistic approach to acquisitions. Concrete and immediately realizable synergistic assets such as patents and distribution networks are advantages.

Partnership and Joint Venturing

Perhaps the biggest advantage of a joint venture (JV) is the benefit of maintaining ownership of its organization while gaining access to a competitor’s know-how at substantially lower costs than an acquisition. The training ground it offers allows the incumbent to develop leaner, more efficient business models, and talent can later be leveraged into the parent organization.

The difficulty in striking such deals, however, is the lack of incentive for the counterparty and the government incumbent to form the partnership. The government incumbent is typically only able to offer greater access to markets in which it dominates, and this directly risks eroding its market share, thus leading to the halfhearted pursuit of partnerships by incumbents over minuscule and meaningless projects and preventing the creation of a viable platform with sufficient critical mass to turn around its parent organization. Incumbents should seek to build open and dynamic relationships with their partners, expanding or modifying scope and partners and seizing advantages wherever possible.

Consider the petrochemical joint ventures formed by Malaysia’s state-owned oil company, Petronas. Facing depleting oil reserves in the 1980s, Petronas needed to diversify into other sources of income. It chose to build petrochemical capability by engaging with established players who were looking to build a base in the region. Petronas, which largely focused on refining crudes for domestic consumption before the 1990s, is the largest and most diversified petrochemical producer in the region. In 2009, Petronas took over the independent operation of its three most advanced petrochemical JVs after it paid around $700 million for the shares of its JV partners, including Dow Chemical Company’s Union Carbide Corporation. That move was a testament to Petronas’ success at building capability.

Malaysia’s state-owned investment agency, Khazanah, took a particularly bold step in August 2011, when it engineered a share swap between the ailing, state-controlled flag carrier, Malaysia Airlines (MAS), and upstart rival AirAsia, Asia’s first and most successful low-cost carrier. The $364 million deal created an alliance between the two adversaries and put AirAsia’s outspoken, entrepreneurial founder in a position to make real changes at Malaysia Airlines.

This is a fine example of a state-linked company creating an alliance with the clear intention of bringing private sector expertise on board to breathe new life into its operation. Under the agreement, AirAsia founder Tony Fernandes and his partner Kamarudin Meranun, who hold about 30 percent of AirAsia through their holding company, Tune Air, will sell a 10 percent stake in AirAsia to Khazanah, which owns 69 percent of MAS. In return, Tune Air will get a 20.5 percent stake in MAS. As part of the planned collaboration, the airlines aim to realize savings and increase revenues in key areas, including aircraft purchasing, engineering, ground support services, cargo services, catering, and training. The two airlines compete head-on on numerous domestic routes, and analysts widely expect the deal could lead to a more profitable route rationalization.

MAS has plenty to learn from AirAsia, which has grown routes, services, and profits at a time when MAS has struggled, paring routes and firing staff to avoid bankruptcy.5 In the quarter ended March 31, 2011, MAS had an operating loss of RM267.4 million ($86 million) on revenue of RM3.14 billion ($1 billion). AirAsia had an operating profit of RM241.72 million ($77.4 million) on RM1.05 billion ($336 million) revenue.

The deal will end a bitter rivalry between the two airlines and put one of Southeast Asia’s most colorful, market-oriented entrepreneurs in the cockpit of one of the region’s stodgier, more troubled state-owned companies. In 2001, Mr. Fernandes, the former head of Warner Music’s Southeast Asian operations, bought AirAsia—then a small, two-plane operation owned by an automotive conglomerate—for 27 cents, plus an agreement to assume the $10 million debt the airline carried. He revamped the airline into a low-cost carrier and, within three years, turned AirAsia into a regional budget carrier. A slew of budget carriers and Asian government-linked airlines scrambled to copy his formula, giving birth to a new segment of Asia’s airline industry.6

AirAsia had to fight MAS and Malaysia’s regulators tooth and nail during the early years. The Malaysian government balked at giving AirAsia the domestic routes it requested for fear of hurting the incumbent state carrier. The country’s chief airline regulator, who approved routes, was a member of MAS’s board. Mr. Fernandes had to lobby senior government officials hard to win new routes. He even crashed a tony cocktail party to get a moment with the transport minister. When customers rushed to snap up AirAsia’s low fares, MAS responded with a price war, slashing many domestic fares by half. AirAsia accused MAS of using government money to push it out of business. Mr. Fernandes wrote then–Prime Minister Mahathir Mohamad a blistering letter, accusing MAS of “state-sponsored economic terrorism.” MAS denied it had started a fare war and told the Wall Street Journal that it had extended “promotional fares” to a host of groups, including senior citizens, students, police, armed forces personnel, families, and people who fly at night.

Malaysia’s move to put the man whom local aviation officials once eyed warily onto the board of its troubled flag carrier indicates how serious the government is about revitalizing MAS. Shortly after the share swap, Khazanah announced a management revamp, replacing MAS’s chairman and managing director and appointing two new businessmen to the board, besides AirAsia’s duo.7 Equity research analysts, who welcomed the deal, are watching to see how much room the airline gives Mr. Fernandes to maneuver.

Mergers with Peer Government Companies

This avenue offers the typical revenue and cost synergies that accrue from a merger. More importantly for the government incumbents, a large-scale merger provides management with a platform for reform and transformation. It allows management an opportunity to intensify the pace of change and precipitate a “step-change” through actions it would otherwise find difficult to take, such as capacity reduction, workforce rationalization, and divestment of non-productive assets. In other words, it presents management with an opportunity to address legacy issues, start with a clean slate, and go forward with a performance-oriented culture more suited to the increasingly competitive industry.

This strategy comes with the typical merger challenges. A well-publicized A.T. Kearney study found that fewer than 50 percent of mergers create value. The top attributing factors in merger failure were identified as lack of stake-holder buy-in, loss of momentum, and an organization structure that is too compromised. These factors would be magnified in the merger of government companies, where cultural, legacy, and political complications are undoubtedly more intense than in private sector mergers. To navigate through a merger, the company must rigorously commit to synergy realization. It needs to integrate synergy realization into top management key performance indicators (KPIs), create an empowered project management office to run the integration, put in place measures to motivate employees, and have continuous change management interventions.

The worst move a government can make is to order two state-owned companies to merge without having a highly detailed road map and change management team in place, as with the disastrous merger of Air India and Indian Airlines. This is a classic example of a merger of GLCs that was deeply resisted and poorly implemented. In 1986, India’s government began talking about merging Indian Airlines, the main domestic carrier, with Air India, the country’s flagship international airline. Rajiv Gandhi, then prime minister, appointed a committee to draw up a merger plan with an eye to improving service; making more efficient use of staff, fleet, and maintenance operations; and increasing the odds that the state-backed airlines would achieve long-term self-sufficiency.8 The airlines and their internal unions resisted the merger, concerned about job cuts and rollbacks. Over the next two decades, the government proposed variations of the deal, from creating a holding company that would oversee the two airlines, which would be left intact, to creating closer cooperation between common units, such as engineering and ground handling. They met resistance at every step.

Finally, in 2007, India’s government pushed ahead and merged the two airlines. The results have been nothing short of dismal. Air India, the merged entity, has not turned a profit since 2007 and was expected to report a pretax loss of 70 billion rupees in 2011. The airline failed to synergize operations, trim unprofitable flights, pare high debt costs, and tackle an inflated wage bill that plagued both operations.

Air India, saddled with a cumbersome and bureaucratic structure, unyielding unions, and a host of operational efficiencies, has struggled in the face of growing competition from the more nimble private sector. Air India has the largest fleet in India, yet it holds a 15 percent market share, well behind private competitors such as Jet, Kingfishers, and IndiGo.9 Competing airlines have their aircraft in the air for up to 14 hours a day; Air India’s fleet is airborne for fewer than 10 hours. The state-owned carrier has about 250 employees per aircraft, over one-third more than the industry norm. IndiGo, in contrast, has 102 employees per aircraft. Powerful unions and local laws that make it tough to fire workers are part of the problem, but a poorly planned integration is also to blame. The government had two decades’ worth of warning that resistance would run deep, and more could have been done to map out synergies, create incentives to motivate staff, and mitigate the highly visible risks that have cramped the merger.

The government response has continued to lack speed and decisiveness. In 2009, India’s Prime Minister Manmohan Singh promised to create a turnaround plan for the airline, which is only now being finalized. Critics say this particular plan focuses only on restructuring debt, not on fixing the problems in operations. “Hardware is not an issue. Air India has the best fleet,” Jitender Bhargava, a former executive director of the airline, told Singapore’s The Straits Times. “But it is the software that needs to be fixed.”10

In August 2011, the government appointed Civil Aviation Secretary Nasim Zaidi as chairman and Rohit Nandan, a joint secretary at the Ministry of Civil Aviation, as managing director, as part of a management shakeup. “Government will not allow Air India to fail because the political repercussions would be too severe,” said Madhavan Nambiar, a former aviation secretary. “But my worry is that too little is being done too late.”11

Done properly, a merger of GLCs can unlock massive value. A prime example of such success is the three-way merger of Sime Darby, Golden Hope, and Kumpulan Guthrie to create the world’s largest palm plantation company and Malaysia’s largest market capitalization firm. State-owned fund manager PNB, which controlled the three groups, initiated the deal: The goal was to use the merger as a transformation platform to achieve competitive leadership in the palm oil industry. However, they were aware that mergers often fail to create value, let alone be a platform for change. To avoid such an outcome, they set forth numerous top-line and bottom-line improvement initiatives, committed to the projected synergy numbers, and appointed a program management office (PMO) with a direct reporting line to manage the initiatives. The plantation operations reported a 139 percent increase in operating profit the year after. Notwithstanding the increase in global palm oil prices, significant productivity and cost improvements contributed to this increase. Since the merger, the company has always exceeded its annual revenue and profit targets. Although, in recent years, some have called for the company to spin off its palm oil group from other non-palm oil related ventures such as engineering, utilities, and automotive, the rationale for consolidation of the three palm oil companies has never been questioned.

Self-Initiated Sale to a Nonhostile Party

This strategy provides management with a platform for transformation to a greater degree than a merger because reduction or elimination of government ownership will reduce legacy and public service constraints. Although this avenue is typically controversial politically, it is a better option than a privatization out of the incumbent’s control. For the management, it provides a more suitable platform for transformation than if the company is privatized through a public offering. New owners can provide financial and know-how support. During the turnaround phase, management is often afforded greater flexibility in taking unpopular or short-term loss-making decisions for the eventual turnaround if a sympathetic owner backs them.

Even though the key challenges of fit issues and finding a non-hostile buyer might seem to make this an improbable option, consider the case of Skoda. After the Velvet Revolution, the Czech government sought to divest the business, seeking to turn it into a viable contemporary car producer rather than dismantling the business. Skoda was a healthy business at this point. Despite its dated image, Skoda has remained a common sight in Western Europe. Volkswagen (VW) was selected to be the eventual purchaser, primarily because it committed to technology transfer and producing high-value models in Czech factories. Since its acquisition, Skoda sales volume has quadrupled. More impressively, its revenue has increased over 20 times, a fivefold increase in the value of its cars and a testament to its successful modernization.

A BETTER WAY TO ACHIEVE TRANSFORMATION

As government incumbents embark on these journeys of regaining supremacy through M&A, a successful deal involves the right partner and terms and the execution of the integration process. Transformation involves envisioning a clear, consistent view of the end state, generating and maintaining momentum for change, and maintaining agility to adapt to new information and shifting circumstances. These can be difficult for government incumbents as they are the weaknesses that bred in them in the first place. But what better time to start the process of turning over a new leaf than with the coming together of two companies?

ACKNOWLEDGMENTS

The following A.T. Kearney white paper was used as background material in writing this chapter: “Turning Over a New Leaf: Transforming Government-Linked Companies through M&A,” by Vikram Chakravarty, Karambir Anand, Navin Nathani, and Rizal Paramarta.

Notes

1. Carlos D. Ramirez and Ling Hui Tan, “Singapore Inc. Versus the Private Sector: Are Government-Linked Companies Different?” International Monetary Fund Working Paper WP/03/156, July 2003, www.imf.org/external/pubs/ft/wp/2003/wp03156.pdf.

2. John Burton, “Malaysia’s CIMB to be Delisted in Bank Revamp,” Financial Times, June 6, 2005, www.ft.com.

3. Anand P. Raman and Peter J. Williamson, “How China Reset Its Global Acquisition Agenda,” Harvard Business Review, April 2011, 109.

4. Ibid.

5. M. Jegathesan, “Malaysian Airline Tie-Up Hailed as a Win Win,” Agence France Presse, August 10, 2011.

6. S. Jayasankaran and Cris Prystay, “Fare Fight: Discount Airlines Proliferate Across Asia, Despite Red Tape — Former Malaysia Music Man Leads Parade of Carriers Offering Low-Cost Tickets,” Wall Street Journal Asia, July 20, 2004, 1.

7. Leslie Lopez, “Major Overhaul of Malaysia’s Airline Sector,” The Straits Times, August 10, 2011.

8. Joseph P. Manguno, “India Considers a Proposal to Combine its Growing Domestic, Overseas Airlines,” Wall Street Journal, August 13, 1986.

9. Ravi Velloor, “India’s National Airline Flying on Empty,” The Straits Times, August 13, 2011.

10. Ibid.

11. Ibid.