Indian M&A: what buyers need to know

Author: | Published: 15 Mar 2016
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Kotak Investment Banking’s Sourav Mallik talks deal-making in the year ahead

The continuing emergence of Asia as a global player was a consistent theme in M&A throughout 2015. Booming values and volumes coincided with major legal developments across the continent, as governments and regulators look to tackle corruption and boost transparency. Joint managing director and head of M&A at Kotak Investment Banking Sourav Mallik discusses India’s contribution to the boom, and provides invaluable advice to dealmakers eying up the rising star of the emerging markets.

Asia overtook Europe in M&A activity this year despite some economic uncertainty, with China contributing nearly 50%. What, in your opinion, has been driving that growth?

Acquisitions have risen, primarily because the companies - especially Chinese companies - are being driven by their shareholders to produce growth.

Companies are also taking advantage of low interest rates across the globe to finance their acquisitions, through bridge loans, term loans and bonds, for example. Given low prices in both crude and commodities, large corporates with large war chests are striving to consolidate their market positions.

What are buyers in your region most looking for in a seller right now?

We are seeing many wanting to gain access to the Indian domestic market to establish better geographical synergies, and this applies to both products and cost, too.

When establishing the individual seller, buyers are definitely looking for high standards of corporate governance and professionalism.

Merger control is bigger and more global than ever before. How do you navigate the web of regimes around the world?

Early analysis of possible areas of conflict during the early stages of a deal is essential. Buyers and sellers should build a rationale as to why a transaction should be approved by merger control regulators, and establish potential divestments at this early stage, too.

What issues should foreign buyers be aware of when structuring M&A deals in your region?

It’s important that foreign buyers identify the right strategy for entering India, be it through a greenfield investment or acquisition, or joint venture (JV). Greenfields are not an easy route for a multinational wanting to make inroads in India.

It is generally more suitable to enter by way of an acquisition - supported by a professional Indian management team, of course, or through a JV, though this comes with significant handholding by Indian promoters.

The buyers’ understanding of the social environment in India is also important, and there should be a good effort to familiarise oneself with it. Decision-making in many family-owned established businesses is often influenced by succession issues and family arrangements, so this must be taken into account.

Stature considerations - such as deferred exits to promoters and titles - are also an issue. At times, providing titular positions to promoters may mitigate social concerns and facilitate a smoother transition.

There are sector-specific laws and regulations that influence everything from media and telecoms to insurance and finance, as well as environmental requirements to be adhered to. A grasp on the attitude and role of the relevant competent authority is key here. An imperative to demonstrate willingness to explore, and operate under, new structures to meet local legal requirements is a good approach to take in some of the more tightly regulated markets.

Competition laws and takeover regulations can also impact the structure and timing of a deal. Takeover regulations can be an obstacle to the existing partnership strategy, for example, shareholders’ arrangements require detailed consolidation, which is highly relevant for minimum shareholdings.

Getting the transaction structure right depends on the commercial objectives of the acquirer and various other financial, tax, legal and regulatory considerations. Buyers should also establish if they want to proceed with an asset or business purchase, or a share purchase.

What are the key regulatory developments of recent times that most affect M&A activity?

One of the most significant changes has come from many sectors - including insurance, defence, banking and financial services, construction, single-brand retail, broadcasting and civil aviation - being opened to foreign direct investment. There have also been changes to tender offer regulations, including amendments to the exchange settlement mechanism.

There have been plenty of developments in the merger control space. Ranbaxy and Lafarge have tested the system in recent times, and anti-circumvention provisions (Regulation 9(5)) have had a significant impact. Non-complete clauses being restricted, and gun jumping between signing and closing, as seen in the Thomas Cook deal, have also changed the face of merger control.

The Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) have been very efficient in circulating news, particularly surrounding developments in the put and call option space. Past performance has been given weight over future prospects when it comes to return on equity benchmarking.

Sebi’s insider trading regulations, released in 2015, clarified important definitions. These included: an insider, to be determined by the scope of frequent communication; unpublished price sensitive information (UPSI), to be assessed as what is generally available; and trading - though we are unsure as to whether the creation and invocation of a pledge is included in this. We are also unsure of its position on two-step board processes, timelines and the approval process.

The Companies Act, 2013, introduced a special resolution provision for unrelated shareholders to enter into certain transactions with related shareholders, as well as carve-outs, be it on an arm’s length or ordinary course of business basis. Audit committee approval and justification for this in the board’s report is also now needed, and minority exits were granted. We are unsure of the impact minority exits may have on minimum public shareholding requirements, as well as the additional burden this could place on promoters.

Sebi has been very busy; it also made significant amendments to its listing agreements. On related party transactions, these take a broader scope than the Companies Act - for example there are no carve-outs, audit committee approval is required for all related party transactions, and special resolution with the related party is not permitted. It also requires the majority of minority approval for related party transactions.

The general anti-avoidance rule (GAAR) aimed at reducing tax avoidance has also had a significant impact. In the future, the incoming goods and services tax will also be an issue.

What impact do you see rising interest rates having on activity in 2016?

In 2006, 2007 and 2008, several Indian companies went shopping for acquisitions, within India and abroad. They completed capital projects and made significant investment decisions, but took on debt and leverage, and currently have high levels of foreign debt on their balance sheets.

Their markets, both home and overseas, did not perform well. Europe went downhill and Indian domestic business also suffered slightly. They were stuck with debt, with borrowings on the balance sheet and little in the way of revenues, so now they have too much leveraged debt on their balance sheets.

Hence they will have to either raise equity or sell something to raise money fast. In 2016, we think these companies will try to raise equity and identify companies from their subsidiaries to sell off to raise capital.

What would you say are the critical success factors in a successful transaction?

Key critical success factors for investing or undertaking a transaction in India include choosing the right partner, as well as getting the transaction structure right. This depends on the commercial objectives of the acquirer, of course, as well as relevant financial, tax, legal and regulatory issues. Also consider the extent of the stake to be acquired and the method of payment, be it cash or stock.

Tax issues in particular must be understood. The choice of acquisition vehicle - be it a local holding company, foreign parent company or intermediate holding company in a tax-favoured jurisdiction to minimise double taxation. Stamp duty may also need specific evaluation during transactions.

The nature of the transaction structure may necessitate multiple ancillary legal agreements, so ensure that these reflect one’s commercial understanding. Always endeavour to provide for possible scenarios in the foreseeable future. The style of negotiation could end up being the difference between winning a bid or coming out as a runner-up.

About the contributor
Sourav Mallik
Joint managing director and head of M&A, Kotak Investment Banking

Mumbai, India
T: +91 22 433 601 05

 Sourav Mallik is joint managing director and head of the M&A advisory practice at Kotak Investment Banking. He joined the Kotak Mahindra Group in 1999. During his career as an investment banker, he has advised a wide range of clients on their growth strategies, M&A and restructuring plans. This includes Lafarge, CRH, CIE Automotive, Hitachi, Toshiba and Kokuyo on their India entry and acquisition strategies; Owens-Illinois on restructuring of their India business; Abbott Laboratories on their India growth and consolidation strategy; Godrej Consumer, United Breweries, Mastek, Mahindra Systech and GE Shipping on restructuring and many more. Mallik’s outbound M&A expertise has been built by liaising with international investment banks across Japan, Europe, the UK and the US.

 He is a specialist in M&A advisory, deal structuring, restructuring, valuations, joint ventures and India entry services. He is also very familiar with the regulatory framework for M&A (including cross-border M&A). Mallik was a member of the Sebi’s Takeover Regulations Advisory Committee, which recommended a new set of takeover regulations for Indian listed companies in 2010.