M&A Report 2021: India
Harsh Pais, Clarence Anthony and Varun Agarwal, Trilegal
In spite of challenges posed by the global COVID-19 pandemic, geopolitical tensions in the Indian sub-continent and market uncertainties associated with the US presidential elections, Indian M&A deal activity remarkably prospered in certain respects during 2020.
Deal flow crossed the $82 billion mark in aggregate deal value, representing an increase of 22.9% from 2019. However, nearly a quarter of this figure is attributable to multiple big-ticket investments made in Jio Platforms, the holding company for India's largest mobile network operator Jio and other digital businesses of the Reliance group, and there was an overall 17.1% fall in total deal-count. The second quarter of 2020, in particular, saw a significant drop in transactions.
In line with global trends seen throughout 2020, the Indian technology sector stood strong amid the economic fallout. Facebook acquired approximately a 10% stake in Jio Platforms for $5.7 billion. Meanwhile, Google acquired a 7.7% stake for $4.5 billion that, together with other global investments, meant that Jio Platforms raised approximately $20 billion in the middle of the global lockdown.
In what is potentially the largest domestic deal of 2020, Reliance Industries has agreed to acquire Future Group's retail, wholesale, logistics and warehousing businesses for $3.38 billion. The completion of the acquisition has (at the time of writing) been halted by the Indian Supreme Court on account of allegations by Amazon that it violates prior contractual obligations of the Future Group towards Amazon.
Encouragingly, the M&A market has showed signs of recovery during the second half of 2020, and bodes well for continued growth in 2021.
COVID-19 and recovery plans
The COVID-19 pandemic and enforced lockdown in India suppressed overall deal count significantly, from 461 deals in 2019 to 382 in 2020. While inbound activity by value was at its highest since 2013 at $49.1 billion (a 30.3% increase over 2019), outbound M&A declined by 13% in value, to $1.76 billion.
The influence of PE funds on Indian M&A also continued to rise, and accounted for almost half of M&A by value in 2020
Moreover, changes to foreign direct investment (FDI) policy impacting investments from countries sharing a land border with India – significantly China – had a chilling effect on M&A originating from these jurisdictions.
As a result, consolidation across the domestic retail and banking sector became key as deals slowed, with public sector bank mergers notably accounting for around 25% of consolidation activity in 2020.
The influence of private equity (PE) funds on Indian M&A also continued to rise, and accounted for almost half of M&A by value in 2020. Investments by sovereign wealth funds and other PE players in Jio Platforms helped drive growth-stage PE investments to an all-time high ($15 billion). PE exits were, however, at their lowest in five years due to increased market uncertainty.
As the Indian M&A area looks to make a recovery, the sale of distressed assets are likely to increase, with disinvestment from non-core businesses also being a key driver. The new budget signals the government's intent to continue divestment in systemically important public sector companies, with significant interest apparent in potential sales of the state-owned carrier, Air India, and oil company, Bharat Petroleum. Investment prospects are likely to improve on the back of an expansive national COVID-19 vaccination programme, and supportive measures from the government.
Legislation and policy changes
The key legislation and regulations governing Indian M&A activity include:
Companies Act, 2013: Administered by the Ministry of Corporate Affairs (MCA), the Companies Act is the primary legislation governing companies and mergers.
Securities Regulations: The securities markets are regulated by the Securities and Exchange Board of India (SEBI). The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code) governs substantial stake acquisitions in publicly listed companies. The SEBI (Delisting of Equity Shares) Regulations, 2009 governs take-private transactions.
Foreign Exchange Management Act, 1999 (FEMA): Administered by the Reserve Bank of India (RBI) and the Government of India, FEMA, the rules issued by the Government of India thereunder as well as the associated RBI regulations regulate capital inflows and outflows.
Competition Act, 2002: The Competition Commission of India (CCI), the regulator established under the Competition Act, accords antitrust approvals.
Income Tax Act, 1961: Administered by the Income Tax Department, the Income Tax Act along with double tax avoidance treaties govern the tax treatments.
Insolvency and Bankruptcy Code, 2016 (IBC): Administered by the National Company Law Tribunals, the IBC regulates auction sales under a corporate insolvency resolution process.
Recent legislative changes notably includes controls to FDI from China. In order to curb opportunistic acquisitions of Indian companies during the COVID-19 pandemic, the FDI policy was amended so investors from China (and other countries sharing a land border with India) would need prior government approval before making investments.
Furthermore, a 'beneficial owner' test has been introduced to pick up indirect beneficial interest up the ownership chain. There is no clarity on how such interest would be computed, and whether there would be minimum thresholds. Market participants have practically applied minimum thresholds between 10% and 25% when applying the beneficial owner test.
A further change has permitted FDI in the defence sector up to 74% under the automatic route, from the 49% previously allowed. The FDI policy has also been changed to permit 100% FDI for insurance intermediaries.
Exits aggregated $5.15 billion in 2020 – a 28.2% decline from 2019 figures
The IBC was also amended to provide immunity to corporate debtors and their assets from any liability regarding offences committed prior to or during corporate insolvency resolution proceedings. Additionally, considering the COVID-19 pandemic, defaults in payment of debts arising between March 25 2020 to March 31 2021 have been excluded from the ambit of the IBC.
Going forward, there are a few proposed legislative and regulatory changes that may impact M&A activity in India. Notably, the Companies Act was amended in September 2020 to allow unlisted public companies to be directly listed in certain foreign jurisdictions, with this move being in line with the gradual maturing of the Indian stock market. A detailed framework is expected later in 2021.
The SEBI has also looked to initiate changes and may ease norms concerning the re-classification of promoters by allowing parties with up to 15% stake, instead of the previous 10% limit, to opt out of promoter-classification.
Labour reform is also planned, with the government of India notifying three other labour codes in September 2020 – the Industrial Relations Code, the Code on Social Security and the Occupational Safety, Health and Working Conditions Code. While not yet operational, these codes seek to facilitate ease of doing business.
A key misconception of foreign investors in the Indian market concerns scepticism over the Indian judicial system.
Transacting parties often opt for foreign law-governed transaction documents based on the belief that choosing Indian law may expose a transaction to uncertainties. However, the Indian government has actively taken steps to encourage international commercial arbitration, including by way of amendments to Indian arbitration law and by promoting Mumbai as a hub for international commercial arbitration. The government have also worked to revamp the court system and ease the enforcement of foreign arbitral awards. Transaction parties also often ignore the fact that Indian courts can provide interim relief to parties in foreign-seated arbitrations.
Further common mistakes made by investors dealing with the Indian M&A market are: (i) the failure to undertake detailed due diligence, especially in highly regulated sectors; (ii) inadequate mapping of expectations (commercial or legal) in transaction documents, specifically with respect to governance structures given the prevalence of promoter-dominated businesses; and (iii) disengaging advisors at the end of the negotiation stage, thereby exposing investors to closing and post-closing compliance complications.
Legal advice should be sought at the outset to identify regulatory hurdles and approval processes, including under antitrust and exchange control regimes. Information exchanged should be within the bounds of antitrust law especially for deals between competitors. Handling of unpublished price sensitive information in case of listed targets also continues to be a major pain-point.
While India is still at the early stages of embracing technology-led deal making, the forced remote-working during the COVID-19 pandemic has accelerated adoption of such tools. In the future, data analytics and document automation tools coupled with artificial intelligence (AI) are expected slash timelines for completing due diligence. Digital technology could also be a game changer for post-merger integrations, especially on matters concerning workforce, operations, and corporate processes.
An acquirer can choose two ways to secure control in a publicly listed company in India, by triggering either a voluntary or mandatory tender offer. Under the Takeover Code, barring certain exemptions, an agreement for the acquisition of 25% or more voting rights or control of a publicly listed company requires the buyer to tender a public offer to further acquire at least an additional 26% of target shares. Acquirers should also ensure that minimum public float (prescribed at 25%) is maintained, unless the target is delisted pursuant to the transaction.
The Indian government has actively taken steps to encourage international commercial arbitration
Delisting has proved to be challenging in India and is undertaken through a reverse book-building process to determine offer price, yielding a significant premium. If the discovered price is unacceptable, an acquirer may make a counter-offer that must not be lesser than the book value (which comes with its own set of challenges).
Historically, hostile takeovers of publicly listed entities in India have been scarce. However, 2019 witnessed India's first hostile takeover in the IT space when Larsen & Toubro successfully launched a bid to take over Mindtree.
Public takeovers may require mandatory regulatory approvals, including from sector-specific regulators and antitrust approvals. These regulatory approvals may be conditional or may prescribe additional compliance. While there is limited scope to attach specific conditions in a public tender offer, the Takeover Code permits offers to be conditional upon a minimum level of acceptance (subject to deposit of the offer amount in an escrow), and acquirers may also make takeovers subject to receipt of statutory approvals.
In light of the COVID-19 pandemic, SEBI has raised the annual creeping acquisition limit for promoters from 5% to 10% until March 31 2021.
While completion accounts mechanism is commonly used for price adjustments in private M&A transactions in India, there has been a clear increase in the use of locked-box pricing mechanisms in recent years. Post-closing price adjustment mechanisms, such as earn-out and escrow structures, may also gain traction post-pandemic due to market volatility. However, in case of cross-border deals, exchange control regulations impose certain time and quantum limitations on such structures, compelling parties to adopt tranched acquisition structures.
Warranty and indemnity (W&I) insurance is not very common in India and both enforcement timelines and premiums on insurance coverage are substantially higher than in matured markets. However, due to an increase in cross-border transactions, difficulties in estimating litigation durations, and buyers seeking seller credit-risk mitigation, the market for such insurance products is growing rapidly. Where possible, parties tend to opt for foreign law governed transaction documents when seeking W&I insurance. Uncertainties regarding protections under India's tax treaties, and adverse tax rulings in big-ticket M&A transactions has led to greater demand for tax warranties insurance.
Break fee provisions are at a nascent stage in India. Payments of break fee and reverse break fee do not have an origin in the legal framework but can be contracted upon. Lack of legal backing may impose regulatory hurdles such as a requirement of prior approvals from the RBI and SEBI. Rising uncertainty caused by the pandemic has resulted in increased appetite for such arrangements.
There is no practice of private takeover offers in India, as private companies are required to impose restrictions on the transfer of shares. Transactions involving the exercise of contractual rights such as tag-drag and sale of pledged shares by lenders, are notable exceptions. The MCA in February 2020 also notified rules enabling shareholders having a 75% or more stake in a company to buyout the minority subject to certain conditions, including compliance with specified pricing norms.
Indian law usually governs private M&A transactions – however, cross-border transaction documents for dispute resolution generally provide for foreign-seated arbitration in Singapore, New York or London.
COVID-19 also had a detrimental impact on the exit environment in India. Exits aggregated $5.15 billion in 2020 – a 28.2% decline from 2019 figures, with market uncertainty resulting in several other exit plans being shelved. The technology sector saw most exits, but the transport and construction sectors contributed the most in value terms.
In the primary capital markets space, the $507 million IPO of Brookfield Asset Management's real estate investment trust (REIT), Brookfield India Real Estate Trust was a major recent highlight. It became the third REIT to be publicly listed in the last two years – and was oversubscribed eight times, further validating the viability of innovative structures like REITs.
Although COVID-19 and a global lockdown certainly caused a slowdown, the Indian government's business friendly regulatory reforms have brought liquidity and revived core market sectors to some extent.
The government's target of 450 gigawatts of renewable energy by 2030 is likely to keep the renewables sector thriving. India's fast-growing position as an alternative for manufacturing to China will also drive investments as Indian companies look to shore up production capabilities. The electric vehicles (EVs) market could witness substantial growth, with government policies incentivising the manufacture and sale of EVs.
The government's continued disinvestment strategy, along with a glut of distressed assets likely to go on the block (once the IBC suspension is lifted), also portend a healthy M&A environment in 2021.
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Harsh Pais heads Trilegal's corporate practice and focuses on M&A and PE matters. He advises extensively on cross-border acquisitions – involving public and private targets – and joint ventures.
Harsh provides strategic counsel to clients on matters involving change of control transactions, corporate governance, securities laws, troubled joint ventures and crisis management. He is also experienced in providing transactional and regulatory advice to clients in highly regulated industries, including telecom media and technology, retail, financial services and infrastructure.
Harsh is an alumnus of Columbia Law School and the National Law School of India. He has experience at a major international law firm in New York and is additionally qualified in the UK and New York. He is ranked by legal publications and rated highly by clients.
T: +91 95 6005 9977
Clarence Anthony is a partner at Trilegal. He focuses on M&A, joint ventures and PE matters. H has led a number of inbound joint ventures, strategic acquisitions and exits, including in contentious situations and in regulated sectors such as fintech, gaming, telecom, renewable power, asset management and insurance.
Clarence recently advised Stillfront on its acquisition of Moonfrog Labs and Metaloop Innovation on raising a round of funding from Elevation Partners and existing investors.
Clarence is an alumnus of Government Law College, Mumbai. He is a Bombay solicitor and is additionally qualified in the UK. He also headed the legal and compliance functions at Embassy Office Parks REIT, India's first real estate investment trust (REIT), for close to a year.
T: +91 95 6044 0500
Varun Agarwal is a part of the corporate practice group at Trilegal. His primary focus is public and private M&A, joint ventures and PE transactions.
Varun advises funds, development finance institutions and multinational corporations such as Ontario Teachers' Pension Plan Board, DEG, FMO, Actis, LGT Lightstone Aspada, Kois Invest and Franklin Templeton on their India-facing transactions, operations and regulatory matters.
Varun has previously founded, scaled and exited from an award-winning fintech start-up. He is an alumnus of NALSAR University of Law, Hyderabad, and a member of the Bar Council of Maharashtra and Goa, India.