The M&A activity in India having leapt rapidly in the last year after its descent in 2008, is firmly set on the path to creating a new record in 2011. Lex Witness tracks the surge, mammoth earnings, facets, regulatory riddle and legal maze of India’s M&A market…
That Merger market- the global M&A intelligence service- has revealed a significant growth in India’s mergers and acquisition (M&A) market in 2010 with a year-on-year surge of 34.3 per cent in deal count and 166.5 per cent in deal value, is well-known. The buzz is that in the year 2011, inbound deals would be driven by India’s robust economy, and the outbound deals would be driven by the twin needs of securing raw materials and desire for diversification. But why is the Indian M&A market growing exponentially? There are a variety of factors that have contributed in facilitating the phenomenal rise in M&A activity in the country. These range from favorable government policies, buoyancy in economy to additional liquidity with India Inc., and above all dynamic approach of the entrepreneurs. Since the growth of the economy, both global and domestic, has a direct impact on the M&A activity, 2006 and 2007 were marked by a spate of mergers and acquisitions all over the world. The subsequent recession and debt crisis of 2008 which hit USA and European nations caused a setback to the M&A market also. If 2009 was a ‘wait and watch’ year, then in 2010 the tide turned! With the US economy beginning to recover, Europe still lagging behind, China and India becoming dominant forces, the chain of financing, consumption and the resultant M&A activity is set to create a new economic world order over the next decade.
“Mergers and acquisitions” is an open-ended term encompassing various facets. These include:
Indian corporates keen on tapping into new markets and multiplying their revenues are acquiring overseas assets with gusto. Of course, many Indian companies now also have regional and global leadership aspirations. All this has led to increased M&A outbound deals as a tool for shaping growth strategies. According to Ernst & Young (E&Y), in 2010 India witnessed outbound deals aggregating to USD 32.4 Billion. The share of outbound deals in the total M&A pie rose to 47 per cent in 2010 from a measly 6 per cent in 2009. Interestingly, the outbound deals were wide-ranging from few multi-billion dollar deals to a number of smaller deals. The activity has been spread across various sectors, including telecommunications, metals and mining, oil & gas, healthcare, biotechnology, amongst others. In terms of deal value, natural resources followed by telecom were the top two sectors, together accounting for nearly 40 per cent of aggregate deal value in 2010. In the natural resources sphere, the acquisition spree of shale gas assets in the US by Reliance Industries has been touted as the game changer in India’s energy economy. The Indian giant acquired a 40% stake in the US-based Atlas Energy for USD 1.7 billion in April 2010, besides two other small purchases.
With India’s population offering a rapidly growing market, a number of global giants have been willing to offer more for Indian companies which in turn has signaled an increase in inbound M&A investments. Inbound activity into India in 2010 was marked by purchase of Indian companies with Abbott Labs investing a staggering USD 3.72 billion for the takeover of Piramal Healthcare. Another notable transaction was USD 1 Billion deal between Japanese steel-maker JFE Holdings and JSW Steel, India’s third largest steel maker. Despite inbound deals valuing approx. USD 24.3 billion having fructified in 2010, there has been a marked decline in inbound activity owing to valuation resistance. Will the “India pull” remain? Experts believe that India is no longer an option, rather a must-have for international companies! It is expected that inbound activity will make a comeback as global conglomerates beginto focus not just on the country’s market potential, but also the long-term opportunity which India offers.
The financial crisis of 2008 had diverted the attention towards home market pursuant to which 2009 witnessed a rise in companies buying domestic assets. In 2010, however, there were fewer deals. The total deal value at USD 12.4 Billion depicted mere 3.2 per cent growth over the announced value in 2009. Recovering global economies, rise in risk-taking appetite and the valuations of domestic companies could have led to overshadowing of domestic deals. It is said that India Inc’s growing appetite for “mega outbound deals” could have also curtailed the action in the domestic market. Nonetheless, there were some noteworthy domestic deals during 2010, including GTL Infra’s USD 1.8 Billion purchase of Aircel’s tower portfolio; and merger of Reliance Natural Resources & Reliance Power for USD 1.5 Billion. Interestingly, the domestic banking space saw action with the merger of Bank of Rajasthan and ICICI, leading private sector lender, in a deal valuing Rs. 15 billion.
In my view, apart from the due diligence exercises, the acquirer should be cognisant of the postmerger integration challenges. I would recommend to all acquirers to actually undertake a “premerger integration simulation” to identify the gaps and how some of them could become incompatible. The speed with which a transaction is concluded is often indicative of the delayed shocks in store. The target may be an eager bride but if the acquirer is not properly groomed, the honeymoon can turn into a nightmare. Identifying good advisors is critical. Also penny pinching in a multi-million Pound transaction is hardly a respectable attribute. Most importantly, the question to be asked is whether an acquisition is a strategic move or born out of a desire to be part of a transient euphoria. There is nothing called a “cheap acquisition”. Each one is a value proposition to the stakeholders all around. If you acquire a target that is going cheap you should be prepared for some costly consequences. Be even more careful when the acquisition is unrelated to the existing business. The challenges of managing a new business and making itself sustained can be very daunting if the acquisition is not carefully planned and the existing management and technical talent is not retained.
The trend is encouraging and must be given an impetus. Corporate India can claim much credit as the Government has hardly done anything to take India to the outside world. Some of the “all cash deals” are an indication of the shopping abilities of the Indian corporates. They all tell a story of consolidation and creation of new footprints. Indian employers have overcome cultural barriers and have built bridges with the overseas work force by effective and sustained communication. I think the trend is sustainable.
There are no doubts about that! Indian corporates are on a consolidation path. The mergers and acquisitions within the country are a perpetual feature of corporate growth in India. Unlocking value is the bipartite mantra. Both the acquirer and the target are looking towards value realisation. There is a desire to create a “win-win” situation. I would say Jai Ho.
“Financing is the key driver and determinant for large M&As”, say experts. Traditionally, the financing options for M&A deals have been internal cash flows, equity funding, external debt, to name a few. With time other financing routes have emerged, mainly to control the escalating costs of fructifying the transaction. We take a quick look at two of the financing mechanisms which made an impact in 2010.
Globally, private equity (PE) investments have played a significant role in fueling the growth of the M&A market. In India too, PE investors are primary players in the M&A segment owing to the increasing appetite of India Inc. to align with financial investors for funding, innovation and strategic partnerships. Since the hitherto popular instruments like Foreign Currency Convertible Bonds (FCCBs) and Global Depository Receipts (GDRs) are no longer in vogue for financing, the equity market has emerged as a major source of growth capital for India Inc. However, with the setting in ofthe European debt crisis, PE buyers are lagging behind corporate buyers in the size of M&A deals fructifying in the West. In India, although PE-backed M&A volumes are far short of the mega deals witnessed in 2006-2007, both PE investments and M&A transactions witnessed consistent growth in 2010. According to Venture Intelligence, the total value of M&A transactions providing exits to PE-investors during 2010 was approx. USD 5.3 Billion. This shows that the PE backed M&A deals in the year gone by culminated into substantial profits!
One of the primary purposes of syndicated finance is to fund M&A activity, specifically “leveraged buyouts” where the buyer uses the debt markets to acquire the acquisition target’s equity. Studies indicate that in Asia Pacific (except Japan), the syndicated loans for M&A surged 153 per cent to USD 24.35 billion in 2010, although the figures are below the record of USD 80.8 billion achieved in 2007. In India, the major deal which pushed up the value of syndicated deals in 2010 was that of BhartiAirtel which raised USD 7.5 billion through a group of 13 lenders for funding its acquisition of the African assets of Kuwait-based Zain Telecom. Going forward, bankers anticipate increased requirement for syndicated loans for M&A activity in 2011 from Indian corporates targeting overseas assets, particularly in mining, oil and gas in Australia, Indonesia and South America, as well as food-related assets in Australia and New Zealand.
The first two months of 2011 have witnessed a decline in the number of inbound deals, especially large ones despite the robust growth in economy. Reasons are varied and range from inflation, regulatory uncertainties, corruption and scandals in certain sectors like telecom and realty, mixed signals from government on approvals to large projects and deals. Year 2010 ended on a high note, but certain important markers like weakening of the Rupee, stock market slide, to name a few, may indicate a more cautious outlook at least for the first half of the year.
Money chases opportunities and knows no geography or color, but the trend certainly seems to indicate that the next frontier is Africa. Other emerging economies in Asia are also attracting attention compared to USA or Europe, which have not recovered fully from the recession.
The telecommunications sector in India is in a state of turmoil with hyper competition (having largest number of players in the world), low and almost unsustainable tariffs, huge regulatory uncertainties and marred by corruption and scandals. The dust needs to settle, transparency, fairness and trust needs to be established as the first priority
The life cycle of an M&A transaction has at least two sub life cycles. The first one that starts with the intention of a buyer to acquire or that of a seller to sell and ends with the closure of the legal documents and the fulfillment of the conditions precedent effectuating the acquisition. The second sub life cycle commences with the completion of the first and is an ongoing process of integration till the point a seamless synergy is achieved. A variety of factors in both these sub life cycles would be critical for the transaction to fructify or be successful. Some sort of an alignment in the reasons for the acquirer as well as the to-be-acquired for contemplating the transaction on their part, coupled with perceivable absence of intractable incompatibility would very well be the bedrock on which a successful transaction could be built. Subsequently, meticulous dealing of the operational aspects such as due diligence, disclosures, enabling and facilitative as opposed to obstructionist advisers, right deal structuring and agreement on acquisition mode, proper consideration of employee issues or competition or taxation related matters (if relevant) clear, succinct and unambiguous drafting of legal documents and increasing appreciation of each other’s positions, more in a win-win model for both parties as against adversarial attitudes, would serve to fructify the first sub life cycle of the transaction. The challenges really begin because most of the times the mere integration of physical elements like systems and assets and branding, etc., are the cosmetic components of the integration process and the kernel of that process is a coming together of minds and hearts. So, commonality of values, similar respect and appreciation for certain behaviours and common deprecation of certain other kinds of values, alignment on post acquisition vision and goals are cardinal factors that shape the success of the integration process. It would definitely be helpful to and supportive of success in this phase if there was agreement on some key post acquisition scenarios even during the first sub life cycle; and the human resource teams are seasoned with prior integration experience that allows them to improve the integration process from the last time and detect early and solve timely any issues opposed to reaching the point of “seamless synergy”. (Q) What is the likelihood of the current trend of Indian companies aggressively pursuing cross-border acquisition deals sustaining in the times to come? Indian companies are looking for scaling up operations and all of that cannot be done organically. Hence, inorganic growth makes sense. Also, as these companies scale up, they need newer markets, additional resources, etc., all of which may not be available in India so we have seen acquisitions overseas by Indian companies. My reading of the present situation is that the Indian economy is going to go from strength to strength and we will see a sustained spree of cross- border acquisitions by Indian companies.
The action on the domestic front will also continue. The strong economic situation has resulted in a lot of entrepreneurial activity fuelled by interest shown in Indian ventures by PE firms, angel investors etc, and as a result a lot of start-up companies have spawned even in areas where there are large players already at work. In the days to come, there will be a drive towards consolidation as in due course only a few players will be able to make their business profitable. And, that consolidation process will see a lot of M&A transactions happening in India.
The M&A market in India has more than emerged from the shadows in the aftermath of the global economic downturn of 2008. The statistics say it all! Year 2010 has been the most active year in the history of the Indian M&A market with the fructification of deals valuing USD 51 billion. Among the different sectors that have resorted to cross-border mergers and acquisitions in recent times,the telecom sector, industrial sector (particularly steel and automobile industry) and pharmaceutical sector are particularly worth mentioning.
Not surprisingly the telecommunication sector was a significant driver of M&A in the year 2010 with 16 transactions amounting to USD 19.6 Billion (representing 38.4% of all Indian deals in value). Bharti Airtel Ltd’s acquisition of Zain Afria CV was India’s largest announced deal of 2010 contributing USD 10.7 billion to the sector’s total deal value. Another noteworthy industry deal was Bharti’s USD 300 Million investment in Warid Telecom International, the fourth largest mobile company in Bangladesh. Experts point out that the hectic M&A activity in the telecom space is primarily because domestic players are now looking at foreign funds to finance their expansion plans. At the same time, the international operators are exploring emerging markets like India since their home markets are fast reaching saturation.
The Indian steel companies now resemble their foreign counterparts in size as well as scale, and M&As have been a compelling part of this success story. In early 2007, Tata Steel, the Indian steel giant, purchased a 100% stake in the Corus Group, the Anglo-Dutch steelmaker, in an all cash deal valued at USD 12.04 billion. The deal is the largest Indian takeover of a foreign company and is a classic case of bringing together the apparent synergies between a low cost steel producer in fast developing region of the world and a high value product manufacturer of the developed world! The metals industry saw another big deal in the year 2007 with Aditya Birla Group’s Hindalco acquiring Canadian company Novelis Inc. in an all cash transaction for nearly USD 6 billion. The combination of Hindalco and Novelis has established a global integrated aluminium producer.
One of the most talked about and keenly watched deal in the automobile market was Tata Motors’ acquisition of Ford’s Jaguar and Land Rover (JLR) in 2008 for an estimated value of USD 2.5 billion. The acquisition gave Tata the opportunity to expand its presence in the automobile market beyond India and the necessary clout to compete with international players. More recently, Mahindra & Mahindra took one of their biggest steps in building themselves as a global brand by acquiring a 70% controlling stake in Ssangyong Motor Company, South Korean auto maker, for USD 463 Million. The deal which is expected to be concluded by March 2011 combining Mahindra’s competence in sourcing with Ssangyong’s technological capabilities, will give rise to a globally competitive auto player.
The sheer number of Indian pharmaceutical companies picking up stakes in other companies demonstrates that the pharmaceutical industry is now a force to reckon with as far as the M&A segment is concerned. If Nicholas Piramal India Ltd., recently acquired stake in Biosyntech, a major pharmaceutical packing organization in Canada, then Torrent Pharmaceuticals Ltd., acquired Heumann Pharma, German company and formerly a subsidiary of Pfizer. The list goes on! On the other end of the spectrum, some of the largest Indian drug companies have lately gone into the hands of foreign pharmaceutical giants. These include the buy-out of majority stake in domestic major Ranbaxy for over USD 4.5 billion by the Japanese drug major Daiichi Sankyo; and the acquisition of India-based Piramal Healthcare Solutions by the US drug major Abbott Laboratories for USD 3.7 billion.
To state the obvious, mergers and acquisitions are indicative of a robust and growing economy. Therefore, it is only fair that the regulatory environment for corporate restructuring be liberal andfacilitative. In India, the regulatory framework for M&A activity is extensive, varied, and depends upon a host of factors. These include, inter alia, the sector in which the target company functions; mode of acquisition; financing route; nature of the acquirer and the target company; etc. From a regulatory perspective, in a transaction involving foreign companies/persons, the FDI Policy of the Government of India together with the Foreign Exchange and Management Act 1999 is applicable. These norms prescribe the maximum percentage of shareholding that a foreign entity/person may hold in an Indian company engaged in a relevant sector. While currently in most sectors, foreign investment is allowed up to 100 per cent, in certain other sectors like defence, retail, insurance, lesser percentages of holding is permitted. In addition, the Reserve Bank of India has prescribed certain pricing guidelines which stipulate that the shares of an Indian company cannot be acquired by a foreign investor for a price less than the price determined in accordance with these guidelines. To add to the regulatory riddle, there are various other sector specific regulatory compliances which are required to be complied with. For instance, in the telecom sector, the Department of Telecom has stipulated limits for the combined market share of any merged entity in a particular service area and a minimum number of service providers, post-merger in a particular service area.
Depending upon the nature of the entities involved in an M&A deal, various legislations come into play. Partnerships involving shareholder arrangements are key components of any M&A activity andsuch arrangements are usually subject to a wide-array of laws, viz., company law, securities laws and foreign exchange laws. For starters, every deal involving acquisition of shares or any other security of an Indian company would have to comply with the provisions of Companies Act, 1956. The Companies Act is also applicable to every transaction involving a merger of two or more companies and prescribes a series of compliances for the same. Moving on, in transactions involving the acquisition of securities of Indian listed companies, compliance with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997 or the Takeover Code is imperative. Further, in conducting due diligence of a listed target company the restrictions laid down in the SEBI (Prohibition of Insider Trading) Regulations 1992 become applicable. Additionally, while consummating an M&A transaction, indirect tax implications (including stamp duty) and direct tax implications (including Indian tax legislations and applicable Double Tax Avoidance Treaties) also merit due consideration.
The country’s complex legal and regulatory regime is highlighted in a recent memorandum submitted by Confederation of Indian Industry (CII) to the Government stating that the growth of the Indian multinationals is severely restricted by the regulatory framework for cross-border transactions and that there is an urgent need to bring out regulations that would facilitate overseas aquisition!
The M&A market burgeoned in India in 2010, thanks to several large marquee transactions and is poised to scale even greater heights this year, thanks to the increased ambitions of India Inc., which ishigh on capital and looking to grow, and certain regulatory changes such as proposed amendments in the Takeover Code which will support such ventures. The role of law firms as transaction engineers and solution providers in M&A transactions is undeniable. It is imperative for a law firm that is advising on an M&A transaction to understand the business drivers and objectives underpinning an M&A transaction. It is only after having internalised the commercial derivers and dynamics of the transaction that the law firm can appropriately structure, document and negotiate an M&A transaction on behalf of its client. M&A transactions are increasing cross-border and in order to advise effectively on such transactions, a law firm must have a keen awareness of the international legal and regulatory environment that is likely to affect the transaction; especially the complex interplay and possible tensions between the laws and regulators of the multiple jurisdictions where such transactions may be playing out. Even in domestic M&A transactions, within the same jurisdiction there is a multitude of regulators which may lead to competing pressures and conflicting priorities that need to be resolved. The Central Bank, the Securities Regulator, Stock Exchanges, the Company Registry, the Competition Commission, sectoral regulators (such as TRAI, IRDA, MIB or the DGCA) all have a stake in M&A transactions and it is incumbent on a law firm to be fully cognizant of the requirements of each of these to ensure that the transaction is fully compliant with the requirements of each of these regulators. While M&A transactions typically separately have tax advisors, the lawyers need to work closely with tax advisors, understand tax regimes and treaties in order to structure transactions in a tax effective manner and to also balance commercial, tax and legal & regulatory imperatives.
India has several laws and regulations that govern human resources and employee welfare and courts typically interpret such laws in favor of employees and workmen. Some such laws have provisions which govern the manner in which the employees should be treated in the event of a merger or restructuring of the company or a change of its ownership and management. Employee relations must be skillfully managed in case of an M&A transaction since worker issues are potentially politically sensitive.
In terms of section 25FF of the Industrial Disputes Act, 1948 (“IDA”), a transfer of ownership or management of an undertaking from the employer to a new employer results in a deemed retrenchment of every “workman” who has been in continuous service for not less than one year, unless certain conditions are fulfilled (“Section 25FF Conditions”). The parties would have to determine the nature of the services provided by employees in order to ascertain whether the provisions of the IDA would apply to them. Section 25FF Conditions are: (i) the service of the workman is not interrupted by such a transfer; (ii) the workman’s terms and conditions of service are no less favourable to the workman post transfer, in comparison with the terms and conditions prevailing prior to the transfer; and (iii) the transferee is, under the terms of such transfer or otherwise, legally liable to compensate the workman, in the event of his (future) retrenchment, on the basis that the workman’s service has been continuous and uninterrupted by the transfer i.e., seniority benefits for past period of employment of the workman are preserved post transfer. Accordingly, if workmen are being transferred into a transferee company on account of an M&A transaction, it must be assured that the transfer will not be on terms less favourable than the ones applicable prior to the transfer and shall be on a continuity of service basis. In case the Section 25FF conditions are not met and the employees of the transferor company proposed to be transferred to the transferee company are considered as “workmen” as defined under the IDA, they will be entitled to compensation and notice of one month in writing or wages for the period of the notice (in lieu of such notice) as per Section 25F of the IDA. The compensation has to be paid as condition precedent to the retrenchment. Courts in India have held that the claim for compensation of the workmen can only be raised against the transferor, and not against the transferee of the undertaking in question.
Further, to ensure the continuity in services of the employees of the transferor company, the transferee company will have to establish appropriate funds to which the accumulations of the employees under the existing schemes of the transferor can be transferred. This would apply to all employee benefit funds presently with the transferor company, including provident funds and pension plans. These transfers would require the approval of the appropriate authorities. In case of provident funds, the transferee company will either have to establish a separate fund and apply for exemption of the fund under section 17 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 or register itself with the Regional Provident Fund Commissioner and render contributions to the Regional Provident Fund. In addition, the Payment of Gratuity Act, 1972 prescribes compulsory gratuity payable by all establishments employing 10 or more persons to every employee who has rendered continuous service for 5 years or more. Gratuity is payable to an employee on the termination of his employment at the rate of 15 days salary/wages for every completed year of services or part thereof in excess of six months subject to a maximum of Rs. 3,50,000. This should be kept in mind in the context of payments that may need to be made to the employees of the transferor company in the case of termination of their services if contemplated.
In addition to compliance with legal provisions, there are several softer issues that must be borne in mind to ensure a smooth transition and to make use of the synergies arising from the transaction. Post a merger or an acquisition of a company, cultural differences of the companies must be addressed, such that the best of both companies is consciously retained and preserved. Cultural issues are best addressed by way of constant communication with the employees and other important stakeholders of the company. As was appropriately said by Kevin J. Dooley, “A merger is like a marriage – seemingly insignificant communication gaps can become crucial.”
Undoubtedly over the last few years, the average “ticket size” of M&A deals of India Inc. has grown considerably. Besides highlighting corporate India’s growing hunger for bigger and better assets, it also underlines high confidence and risk-taking appetite. And going by the advice of the industry watchers, this is just the beginning of M&A action in India. The Capital Confidence Barometer Survey conducted by E&Y in late 2010 showed that Indian companies continue to remain optimistic about the prospects of their economy. But, will this optimism translate into bigger deals and higher deal volumes? The answer would depend on the availability of “right assets” at the “right price”. While identifying the right assets is not an easy task, it is the latter involving valuation of companies which often proves to be the stumbling block. But, perhaps it would be fair to quote Arnold H. Glasgow, “Success is simple. Do what’s right, the right way, at the right time”, to describe the success story of M&A in India. When it comes to corporate restructuring, cross-border as well as domestic, Indian corporates are well on their way to surpassing their foreign counterparts.
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