India outbound M&A financing: why corporates should look beyond LBOs

Author: Ashley Lee | Published: 17 Jul 2012
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Participants in IFLR’s India Outbound Investment Forum  said that they are looking towards new methods of financing beyond traditional LBOs. Here’s what they recommend.

The most straightforward investment method was mentioned by Ranbir Hunjan, a partner at Clifford Chance’s London office. A recent trend had been developing, he said, for joint venture (JV) partnerships or transactions using cash reserves.

But if a JV is not possible or a company is not stockpiling cash, LBOs remain an option. The panel had mixed views about LBOs, however, which have fallen out of favour with the Reserve Bank of India (RBI). Some companies have received notice to collapse structures or to use operating company structures.

But Hunjan remained positive. He said that dollar borrowing by Indian companies will be subject to European Central Bank guidelines. In addition any dividends from the target to the Indian company will be subject to taxation and there is only so much taxation that can be sheltered by the deductions from the interest on the financing. "An LBO model with an offshore holding company will mitigate these concerns," he said.

He added that deals have been done by on a non recourse basis to the Indian parent. Although there are complications and price implications, it keeps the deal outside of the Indian regulations as it is offshore and there is no Indian parent guarantee.

Indian banks are not directly involved in the acquisition financing. But they do have an integral role in establishing the credibility of Indian companies.

Mohit Saraf, senior partner of Luthra & Luthra, said when foreign banks think of supporting Indian companies on an acquisition finance transaction, they often require an Indian bank to stand behind the guarantee of the Indian acquirer in the form of a letter of credit, largely because foreign banks don’t have a relationship with most Indian promoters.

"On the other hand, though Indian promoters can invest 400 times their net worth under the automatic route, often they may not have ready cash available," said Saraf. "Therefore Indian banks (including State Bank of India) have a significant role to play in providing investment up to 400 times the net worth, which essentially forms the corpus for a LBO model."

For SMEs

While LBOs are controversial, they best suit large transactions. Gaurav Khungar, Religare Capital Markets’ managing director and corporate finance in India, said that raising capital for outbound M&A by mid-sizeunlisted companies was relatively challenging.

Khungar encouraged Indian corporates to look towards private equity as an untapped source of capital. "In 2011, 28 percent of the funds invested by private equity were in companies which were formed in the last three years," he said. "This indicates a scarcity of quality assets that meet funding criterion. This trend cannot be ignored as these companies will prospectively look at becoming global and will need outbound investment funding."

Rajiv Nayar, managing director and head of capital markets origination, India at Citigroup, added that private equity investments prove a company’s legitimacy. "For small and medium businesses not well-known outside of India, including private equity in the funding mix adds credibility and even sometimes makes debt raising in places like the US easier," he said.

Although Hunjan had observed a shrinkage of the debt market, Nayar encouraged companies to look to the US bond market, which he said was the world’s deepest source of liquidity. He believed Indian corporates had not used this to the extent that corporates elsewhere in the world had. "It has become more available," he said.

He had a bullish outlook for companies utilising the debt capital markets to raise funds, and said that the environment for raising debt in the US market has never been better. He observed that investors at the retail and institutional levels moving capital from equity to debt.

More from IFLR’s India Outbound Investment Forum:

Indian natural resources M&A: what lawyers want to see

How Indian corporates can benefit from the euro crisis