The Indian merger and acquisition (M&A) space, over the last couple of years, has seen a bevy of regulatory refinements driven by policy aimed at ease of business as well as industry consolidation. Reforms like time-bound insolvency regime, changes to the primary company legislation, and the replacement of a dated and convoluted foreign investment regime with a new one, among others, have encouraged strategic M&A activity in the country.
The last financial year saw deals valued upwards of $80 billion, thanks to landmark activity in telecom, technology, financial services and energy sectors – almost 30% more than the year before. We explore below, in brief, the key facets of this dynamic trend.
Insolvency and Bankruptcy Code (IBC), 2016
While there are no official statistics available, we have observed a significant increase in M&A activity in the stressed assets’ space. The IBC 2016 creates a conducive environment for healthy companies to look for inorganic growth opportunities in entities undergoing insolvency resolution. The acquisition of these entities with haircuts, and exemption from the open-offer requirement by the Securities and Exchange Board of India (SEBI) have made stressed asset M&As attractive. While steel and pharmaceutical sectors account for a significant portion of strategic mergers under resolution plans, cement and allied sectors are also getting noticed by market players. Industry body Associated Chambers of Commerce and Industry (Assocham) predicts almost $50 billion worth of deals on the back of stressed assets in 2018. In 2017, Assocham said 944 transactions (664 domestic and 280 cross-border) worth $46.5 billion ($13.1 billion domestic and $33.4 billion cross-border) took place.
Cross-border M&A framework
Under the erstwhile Companies Act, 1956 only inbound mergers were permitted. The Companies Act, 2013 provides for outbound mergers as well, and its provisions were notified in 2017. To that extent, the Reserve Bank of India (RBI) recently issued Foreign Exchange Management (Cross Border Merger) Regulations, 2018 in March this year, to provide a definite and liberalised framework for cross-border mergers. The regulations put in place a deemed-approval status from RBI upon fulfilling certain conditions instead of a logistically intensive and cumbersome in-principle approval on a case-to-case basis. While the regulations are expected to drive up merger volumes, certain ambiguities still need to be cleared.
For instance, de-mergers, for one, have not been provided for. No tax-neutral treatment has been given to outbound mergers so far. Furthermore, there is no provision for fast-track mergers, which are available for domestic companies.
However, as the regulations came recently, market dynamics may prompt certain developments.
Almost all relevant regulations in India have been revamped in the last few years, be it the takeover rules, delisting and accounting guidelines, anti-monopoly laws, etc. More recently, in November 2017, the FEMA (Transfer or Issue of Securities to Persons Resident Outside India) Regulations, 2003 – the primary legislation governing foreign investment in India – was replaced by a simpler and streamlined successor. The institution of the Goods and Service Tax regime is another step towards a simpler tax environment. On the policy front, several sectors have been liberalised and brought under the automatic route over the last year – single-brand retail, manufacturing, and aviation being among them. There is also a proposal for the simplification and consolidation of industrial and labour laws. The proposal is to condense the 44 laws into four broad codes on wages, social security, safety regulations and trade unions. Another area that could witness simplification and overhaul is the direct tax regime. While these changes could just be seen as an organic development – in our view, they are focused efforts towards making India a friendlier jurisdiction for M&A activities.
Even as the M&A regulatory and policy framework in India keeps evolving, some challenges remain. One, for example, would be SEBI’s low threshold of 25% to make open offers under the takeover regime, for listed companies.
Acquirers typically shy away as it involves significant costs and expenses. Further, delisting a company after merger is not an easy exercise. Another problem is varying stamp duty rates across states, which have in the past made inter-state M&As unattractive propositions at times. Furthermore, from a non-regulatory point of view, the market is still young and lacks sophisticated support from third-party intermediaries like warranty and indemnity insurers as well as directors and officers (D&O) liability insurers.
Also, procedural bottlenecks like multiple approvals from courts and sectoral regulators as well as a long compliance list pose a challenge. Given time and the spate of reforms, however, we feel most of these irregularities should get ironed out sooner than later.
M&As are market-driven processes – not only dependent upon the overall economy but also upon external forces like market sentiment and regulatory developments. As such, M&A volumes are likely to grow further in the next year, based on the conditions generated by IBC and other regulatory reforms. We may witness further consolidation across sectors as companies divest their distressed assets to reduce debt. Also, corporates with stronger balance sheets will be seen deploying funds towards acquisitions and consolidation of their market positions.
We do, however, suggest exercising caution before taking a commercial call. Buying a distressed company, although tempting, needs in-depth due diligence. Sector-wise, technology, infrastructure and financial services should see most activity. Outbound investments should continue to be led by the oil and gas sector, driven by India’s quest to secure supplies of natural resources, and aided by the government taking steps to encourage Indian players to acquire oil, gas and coal abroad.
The trend, in the simplest of terms, could be described as cautious optimism – lower volume, but higher value in deals. With continuing political stability, economic reforms at a fast pace and macro-economic factors looking positive, 2018 will perhaps be one of the best years for M&A with transaction activity, closing at an even higher level than that achieved in 2017.
Rajesh Begur is managing partner at Ara Law. Views are his own.