NTRODUCTION - · PDF fileINTRODUCTION Consolidation or ... funding options, regulatory framework and ... Tata Steel’s acquisition of Corus is among the largest outbound deals and

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N A T I O N A L C O N C L A V E O N E X P A N S I O N S & C O N S O L I D A T I O N S

CHAPTER I

INTRODUCTION

Consolidation or Acquisitions, by their very nature are alluring to business managements. With one stroke,multiple objectives are sought to be achieved in most acquisitions, especially those which are cross border innature. Objectives range from increase in size and market share to reduction in competition to access to othermarkets, technologies, brands, customers and valuable assets that may be scarce at the time of acquisition.

Most acquisitions also seek to gain from synergies arising out of elimination or reduction of common overheads,improved bargaining power vis-à-vis suppliers and customers and by offering complementary products andservices to established customers. Most managements and shareholders are willing to pay a premium, sometimessignificantly high premiums especially in a competitive bidding scenario, as the alternative route to achieve mostof these objectives are time consuming and expensive.

However, acquisitions have been known to have under delivered on the objectives or the gains envisaged bythe managements at the time of making the acquisition. There are several widely published studies which havecommented on erosion of shareholders value post acquisition. Key reason for under delivery has beenmanagement’s inability to integrate business operations with differing operating cultures optimally to capture thesynergy benefits and gross over-estimation of synergy benefits at the time of acquisition.

While almost all professionally managed businesses have robust evaluation systems in place to evaluateinvestments into green field projects, capacity expansion, debottle necking, R&D, advertisement spends etc. interms of project Internal Rate of Return (IRR), payback period, Return on Capital Employed (ROCE) vis-à-visWeighted Average Cost of Capital (WACC) etc. to enable them to make informed decision, most are ill equippedto handle pre and post acquisition situations. The reasons for this are not difficult to understand. The managementscan control the timing and the capital outlay on all such investment decisions as opposed to acquisition opportunitieswhich can spring up unexpectedly from unexpected quarters. Also, the size of target companies could be vastlylarger than acquiring companies own size.

This note aims to provide a broad overview of issues relevant to M&A in current scenario and gives historicalbackground of how M&A's has evolved in India terms of size of deals, funding options, regulatory framework andpre and post acquisition processes. It concludes with discussion on the way forward and the best practices thatmanagement can adopt to build a truly globally competitive enterprise.

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Source: The Asian Venture Capital Journal, Bloomberg, EY Research

CHAPTER II

CROSS BORDER MERGERS & ACQUISITIONS

In the initial years of liberalization, Indian corporates and managements focused on increasing exports, gettinginto joint ventures and technology collaborations with global players in its attempt to make a presence felt inworld market. Then the emphasis shifted to attracting FDI and portfolio investments. The outsourcing boom Indiais experiencing over last few years is a culmination of this process.

In recent years, Corporate India has steadily moved towards building globally competitive enterprise. Theincrease in both inbound and outbound M&A is indicative of this trend. From an earlier focus of just serving theglobal markets by producing domestically, Indian companies are now acquiring foreign assets, for having greatershare in the world market. Spurt in the cross border M&A activity is backed by healthy performance at home,strong management capabilities and access to competitive financing.

Indian M&A activity has tripled over the last 2 yearsThe total value of M&A deals in India has been consistently growing. The M&A market has grown at a compoundedannual growth rate of around 28% between 2002 and 2006. Most of this growth has come over the last 2 years,when the value of M&A deals increased from US$ 7.5 billion in 2004 to US$ 21.4 in 2006.

The total number of M&A deals increased from 343 in 2005 to 480 in 2006. Domestic, inbound and outbounddeals increased in the range from 36%-42%. The share of domestic, inbound and outbound deals were moreor less stable, with domestic deals having a share of 44%, inbound deals 16% and outbound deals 40%.

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Overseas M&A has been increasingThe share of overseas M&A that includes both inbound (overseas companies acquiring companies in India) andoutbound (Indian companies acquiring overseas companies) deal have been increasing. Overseas M&A accountedfor 42% of total M&A deal value in 2002 which increased to 73% in 2006.

Source: IndusView Advisors Private Limited

Source: Bloomberg, Merger Market, Mape

Source: The Asian Venture Capital Journal, Bloomberg, EY Research

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Share of outbound deals vis-à-vis inbound deals has been increasingBeginning of the century saw international buyers looking for attractive assets in India. The share of inbounddeals was around 27% in 2002, while outbound deals accounted for mere 14%. However, the trend has beenshifting with more outbound deals happening in Indian M&A space with the share of outbound deals increasingto 35% in 2006 almost equal to inbound deals.

Average outbound deals size increased though average inbound deal size declinedAverage size of outbound deals improved to $39 million in 2006 from $25 million in 2005 along with the numberof deals. However, the Average value of inbound deals declined to US$108 million in 2006 from US$142 millionin 2005.

Average deal size lower then global averageThough the M&A activity has been moving at a great pace both in terms of number and value of deal, theaverage deal size is still low as compared to global averages. The average deal size has improved both globallyand in India. However, the value of an average deal in India is half (US$ 50 million) of the global deal value(USD$ 100 million USD).

Europe and North America are key outbound deal destinationsFrom 1995 to August 2006, the largest proportion of outbound acquisitions has been in North America, accountingfor 32% of total outbound deal. This was followed by Europe that accounted for 29% of total deal. Europe is nowemerging as the prime destination for Indian companies making acquisitions abroad.

Source: Thomson Financial, Accenture, EY research


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Products accounted for 40% of cross border M&ACross border M&A activity has been fairly well spread across industries, though Consumer goods and services,pharmaceuticals & healthcare and automotive were the key sectors.

Pharma companies have been particularly aggressive in scouting for opportunities abroad, going to the top ofM&A league with total deal of a little over $2.2 billion. Key drivers for these acquisitions have been access tocomplementary products and molecules and access to expanding markets. The pharmaceutical industry saw thelargest inbound deal in 2006; the acquisition of 51.5% stake in Matrix Labs by Mylan Labs of US at a cost ofUS$736 million. Other large deals include Dr Reddy’s takeover of Betapharm, Germany’s fourth-largest genericdrug maker for 480 million Euros and Ranbaxy’s acquisition of the Romanian Terapia for US$ 324 million.

In the energy sector, ONGC’s acquisition of equity stakes in a couple of oil blocks in Columbia and Brazil asalso Suzlon Energy’s acquisition of Hansen led the M&A deals. With India’s oil companies striking out abroadto acquire equity in oil-fields, refineries and pipelines, the oil and gas sector, is likely to see more M&A activity.

In recent times the Indian cement industry has seen entry of global player, Holcim through acquisition ofcontrolling stake in ACC and Gujarat Ambuja.

Similarly another inbound M&A involving R. R. Donnelly’s acquisition of equity stake in Office Tiger, the unlistedChennai-based BPO company, was among the biggest deal in the IT sector. The deal was valued at US$250million. Other key M&A in this sector were Aditya Birla Nuvo’s acquisition of Canadian BPO Company andMinacs Worldwide Inc acquisition of Azure Solutions by Subex.

Medium sized players such as United Phosphorus has been very active on the M&A front was and has beeninvolved in six of the eight major deals in the chemicals industry during recent years.

As a business group Tata has been fairly aggressive in cross border M&A deals across sectors. Few of the majordeals announced by the group in the recent past are:

• Tata Tea’s acquisition of 30% in US’ Glaceau (Energy Brands) in August 2006 for $677 million


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• Tata Tea bought 33 per cent in South African tea company Joekels through its subsidiary Tetley Group

• Tata Tea acquired US-based Eight’O clock coffee company for $220 million in June 2006

• Taj Hotels acquired 100% stake in Ritz- Boston for US$170

• Tata Chemicals picked 63.5 per cent in UK’s Brunner Mond Group for Rs 508 crore in December 2005

• Tata Steel acquired Millennium Steel of Thailand in December 2005 for $404 million

• TCS acquired Chilean BPO firm Comicorn for $23 million in November 2005

M&A in India moves to higher level in 2007The M&A activity in 2007 started with a bang with Tata Steel acquiring Anglo dutch steel maker Corus at a priceof US$12.1 billion. Even before the discussions on this deal could settle down, Hindalco announced the acquisitionof Novelis for $6 billion.

Over the course of February, Vodafone struck a $11.1-billion deal for Hutchison’s stake in telecom operatorHutchison-Essar.

In addition, a string of other possible billion dollar-plus acquisitions could be in the pipeline. These include

• Reliance Energy, Tata Power and Lanco evincing interest in the assets of global power company Globeleq.The valuations is being pegged at about US$2 billion

• Ranbaxy and Cipla are said to be in the race for Merck’s generic business unit, which is again expected tobe valued at around US$5.2 billion

• Possible acquisition of liquor giant Whyte & Mackay, which is being wooed by United Breweries in a dealclose to US$1 billion

• Tata Power is interested in coal assets in Indonesia which could again cost about US$1 billion

• Suzlon’s hunt for Germany’s RE power, which could cost about $1.3 billion

Indian ‘Davids’ targeting global ‘Goliaths’Another notable trend in Indian outbound M&A is acquisition of global companies that are much larger in sizethan themselves. Tata specifically has been the pioneer in this. In February 2001, Tata Tea acquired Tetley, UK.Tata Coffee’s acquisition of the US-based Eight O’Clock, which is around 2.5 times the size of the former, isanother such example. Tata Steel’s acquisition of Corus is among the largest outbound deals and also a perfectexample of use of leveraged funding for acquisition. Other key large acquisition was by Subex Systems which

Break down of India’s cross-border M&A activity by Industry group


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acquire Azure Systems (UK), a company larger than itself (Azure has a turnover of $ 31million against Subex’srevenues of $26 million).

These acquisitions reflect positive change in the mindset of Indian companies that has come about as a resultof greater domestic fundamentals and increased competitiveness. As companies have successfully faced thechallenges of competing on foreign turf, they have matured and grown in self-confidence. The risk takingcapabilities of the companies has also increased.

Key enablers in facilitating spurt in outbound acquisitionsWhile Indian management have developed management capability and confidence to acquire global assets andenterprise, significant credit is also due to external factors. Key enablers include evolution GoI policies towardsoutbound M&A and increase in financing options available to Indian Companies.

Liberalization of government policies towards outward investmentThe government policy on overseas investment policy has evolved with time. The ceiling on the quantum ofoverseas investment has been revised upwards in phased manner over time. In 2000 FEMA was introducedwhich changed the perspective of overseas investments. Annual investments up to US$ 100 million were madeavailable without any profitability condition. Companies were allowed to invest 100 per cent of the proceeds oftheir ADR/GDR issues for acquisitions of foreign companies and direct investments in Joint ventures and whollyowned subsidiaries. The policies were further liberalized post 2003 wherein the clearance through automaticroute allowed Indian Companies to fund to the extent of 100% of their net worth, which was later increased to 200%.

As per RBI, the total value of Indian direct investments abroad was USD 2.7 billion in 2005-061, mainly accountedfor by the manufacturing sector. As per a report on the emerging multinationals by Boston Consulting Group(BCG) there were 21 Indian companies among the top 100 such multinationals.

1 Key note address by Smt. Shyamala Gopinath, Deputy Governor, Reserve Bank of India on January 19, 2007

Source: IMF annual reports on Exchange arrangement and exchange restricts, 1996-2005

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Increase in financing options for Indian companiesThe Indian companies are finding it easy to raise financing from various sources. As per Bloomberg, Rs 2,349billion was raised in 2006 via debt and equity in domestic and overseas market. This was 66% higher than thefunds raised in 2005. With the sustained growth of the domestic market it is becoming easier for Indian companiesto raise funds for overseas acquisitions without over-stretching their balance-sheets. Apart from traditional bankfunding and domestic IPO’s, Indian companies have explored the foreign markets for raising funds. These areboth in the nature of equity funding through listing in NYSE, AIM or other markets and debt though FCCB issues.These sources of funding are also cheaper due to interest differentials.

Most of the Indian companies have raised money from foreign markets and using this money for both organicand inorganic growth. Most Indian companies are sitting on large cash reserves; a legacy of FCCB/GDR’s raisedin 2005-06. This coupled with existing internal accruals and a surfeit of PE funding, is likely to be the driver forfuture M&A activity.

Alignment of interest rates and duties with global economiesAligning of interest rates with global rates and lowering of import barriers have also spurred the internationalforay by Indian companies. The need for a cross border deal also arises from an urge to expand capacities, enternew markets, and acquire global customer base, technology and IPR. Competition with multinationals in domesticmarket due to opening up of the Indian economy has also driven the outbound M&A activity.

Key Cross border M&A deals

Tata Steel acquired Corus to become 5th largest steel makerThe TATA Group bought Corus in February, 2007 for $ 13.12 billion - the largest M&A deal by an Indian businessgroup, becoming the 5th largest steelmaker in the world. The deal is the 2nd biggest acquisition in steel. Thecombined capacity will be 22 million tonnes, adding 18 million TPA to Tata Steel’s installed capacity. The mergerof the two entities is expected to bring synergies worth US$315 millions every year. The merger is expected toprovide Corus access to low-cost slabs from Tata Steel. The merger is also an answer to ‘make’ or ‘buy’decision. The acquisition is at a valuation of $710 per tonne, lower than the cost of setting up a new greenfieldplant whose cost is estimated to be US$ 1,200-US$ 1,300 per tonne.

The acquisition of Corus was done in a competitive bidding scenario wherein Tata was bidding along with CSN,Brazil. Tata finally paid price paid of 608p per share which was at a 33.6% premium to the original bid.

Vodafone acquires 67% stake in Hutchison EssarVodafone acquired 67% interest in Hutch Essar from Hutchison Telecom International for a cash considerationof $11.1 billion. The transaction implies an enterprise value of $18.8 billion for Hutch Essar. The acquisition willprovide direct entry into fast growing Indian telecom market.

Tata Tea’s acquisition of Energy Brands Inc.Tata Tea acquired a 30% stake in US based Energy Brands Inc. (EBI) for a consideration of US$667 million.Tata Tea and Tata Sons made the investment jointly to buyout the stake of TSG Consumer Partners. The dealstructure is based on an equity infusion of US$ 192 million from Tata Tea and US$58 million from Tata Sonsrouted through Tata Tea (GB), the special purpose vehicle, with the balance US$427 million raised through debt.The acquisition of EBI was to tap the fast growing health and energy drinks market. EBI is expected to growat a CAGR of over 70% over the next 3 to 5 years. As a result of the acquisition Tata Tea also gains accessto its EBI’s distribution network, in over 45 states of the US, which could be utilized for promoting the Tetleybrand.

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EDS acquiring stake in MphasiS BFL LimitedIn April 2006, Electronic Data Systems (EDS) of the U.S. made a conditional offer to buy 83 million shares ofMphasiS BPL Limited. This translated into a majority stake of 52 per cent in the company. The offer made ata price of Rs 204.5 per share in all cash form was fully accepted by shareholders. The transaction which wasworth $380 million was among the largest transactions in the Indian software services sector.

Key challenges in cross border transactionsAs more companies adopt outbound M&A as a key element of their growth strategy, it is imperative that theresults of previous M&A and possible pitfalls also be kept in context. According to EIU’s Global M&A Survey in2006, only half the respondents said that their deals achieved expected revenue synergies, while even less thanhalf believed that expected cost-saving synergies would be achieved.

Accordingly, Indian companies should not lose sight of the need for clearly defined objectives and strategy topursue a deal and the need for diligent planning during deal negotiations, execution and post deal integration.Often this means that companies need to take a step back during the process and evaluate objectively whetherthe transaction would still give them the desired leverage and results.

Local nuances, regulatory environments, issues of management and cultural integration need to be assessedcarefully to achieve the desired results. Careful attention to these elements will ensure that just the urge to closea deal or win a bid is sustainable and that the deal proves to be ‘value accretive’ in the long run.

Source: Indian Meets the World, Accenture; September 2006

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CHAPTER III

LEVERAGED BUYOUTS FINANCING FOR ACQUISITION

Expansion in funding options available to Indian corporates has played a big part in providing impetus tooutbound cross border acquisition. In the past, traditional funding sources have relied invariably on the acquirer’sbalance sheet strength, thus limiting the size of overseas acquisition any Indian corporate could look at. Restrictionplaced by Government on size of overseas investment also limited the number and value of deal size in IndianM&A space.

The high risk premium attached by global investors and players while investing in Indian companies alsoprevented large scale M&A. While the financial system in India was more comfortable with financing new andexpansion projects, acquisition funding remained constrained. All this has steadily changed and continues toevolve further as India gets more integrated with the world economy.

Financing options available to Indian CorporateSourcing funds for any project is no longer a difficult task as it was before. Earlier only large corporate hadfinancial muscles to arrange funds for their growth. Now even small and mid cap companies backed by a suitablebusiness idea are able to garner money for their projects. As per Bloomberg, Rs 2,349 billion was raised in 2006via debt and equity in domestic and overseas market. This was 66% higher then funds raised in 2005. The typeof funding option has also evolved over the period. There has been a shift from the traditional debt equity mixto innovative financial engineering to suit each transaction. Some of the options available with the finance headsare private equity, mezzanines capital, convertible debt instruments, structured finance, leveraged buyouts etc.

Equity based options

Private Equity activity in IndiaSource: The Asian Venture Capital Journal, Bloomberg, EY Research

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Encouraged by the rapidly growing economy and the performance put in by Indian companies, venture capitalists,private equity firms, hedge funds and buy out funds all took greater interest in India in 2005-06. In 2006 therewere 276 private equity transactions worth Rs. 345 billion ($7.6 billion)2. This accounted for 40 per cent of thetotal deal value. About 35 per cent of all PE deals were in listed Indian companies. Private equity funds investedaround US$ 7.6 billion3 in India in 2005-06 which was three times the amount invested in 2004-05. Of the totaldeals, 36% were late stage investments, 20% were early stage investments and the rest were mid stageinvestments.

Foreign ListingMore and more Indian companies are looking to raise money from international investors to finance theirincreasing ambitions. Along with establishing a global footprint, Indian companies are looking to list their shareson international stock exchanges. The New York Stock Exchange and the Nasdaq already have a number ofwell known Indian companies on board such as Wipro, ICICI, HDFC Bank, VSNL, Infosys, Rediff, Sify and WNSHoldings.

In recent times Indian companies have been exploring exchanges such as the Alternative Investment Market(AIM) of LSE, Kosdaq of South Korea, TSX of Toronto, Sesdaq of Singapore and the Euronext as stringent andcostly corporate governance regulations have made listing in the US increasingly unattractive. Liberal listingnorms, a quicker listing process and better valuations received from international investors are some of thereasons that are making Indian companies turn to these exchanges for raising capital. Investors in overseasfloats are high net worth individuals and they understand companies and markets better. This is helping companiesreceive higher valuations. Indian companies are expected to raise at least £ 2-3 billion from AIM alone4. Withalmost 60% of the investors in the market being long term investors willing to invest in long gestation projects,AIM is likely to emerge as the preferred market for Indian companies to raise capital.

Internal accrualsDespite the availability of an increasing variety of funding options, internal accruals remain one of the most usedfunding options for companies. As per a Mckinsey study, internal accruals accounted for four-fifth of the US$204 billion raised by Indian companies during the period 2000-05 with debt and equity contributing the rest. Ina developed economy like the US, the reliance on internal accruals is matched by that on debt with equitycontributing 6% of the total funding pie.

Domestic debtIndian companies continue to turn to traditional funding sources like Indian banks and corporate bonds. Indianbanks are estimated to have lent around Rs 1,730 billion5 in 2005-06 to Indian companies including those in thesmall and medium heavy industries, trade, real estate and services. Even though bank credit was the largestsource of funding for Indian companies in 2005-06, reliance of bigger companies (> US$ 1 billion) on bank creditwas at a much lower level than by smaller companies, clearly indicating a shift in sourcing preferences. Bankcredit is also constrained by the incapacity of banks to lend against shares and fund companies or projects ofspecific nature.

The corporate bond market also showed a decline with the volume of corporate bonds traded on the NationalStock Exchange falling from US$ 3.8 billion in 2004-05 to US$ 2.4 billion in 2005-066.

2 Venture Intelligence as quoted by The Financial Express3 Venture Intelligence as quoted by The Financial Express4 Hindu Business Line5 The Financial Express6 The Financial Express

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Overseas borrowingIndian companies raised Rs 525 billion7 through overseas issues in 2006. Debt, raised through Foreign CurrencyConvertible Bonds (FCCBs) and other bonds, accounted for 83% of the total funds raised as against 60% in2004-05.

Acquisition financing in IndiaAcquisition financing options are still in nascent stage in India. However, with sophisticated investors backingdeals, the role of structured finance in transaction is becoming important. Leveraged buyouts are becoming anattractive option for funding acquisitions. Tata Steel’s acquisition of Corus in February 2007 and Kohlberg KravisRoberts & Co. buyouts of Flextronics in April 2006 are recent examples of leveraged transactions in India.

Leveraged Buy OutsA leverage buyout or an LBO is a strategy involving acquisition of another company using significant amountof borrowed funds. The assets of the company being acquired are used as collateral for raising funds. The debtcomponent in a leveraged buyout has typically been around 70% with 30% equity. Because of the large amountof debt relative to equity in new corporation, the debt instruments are rated below investment grade and are oftenseems as high yield bonds or junk bonds.

The equity component of the purchase consideration is contributed by pool of private equity investors. Thesefinancial sponsor gain control of the majority of target Company’s equity and might also take the companyprivate. Advent of LBOs has allowed corporates to evaluate and acquire assets/ businesses much larger theirexisting balance sheet size, hitherto impossible earlier. LBOs have features, which make them attractive for allthe stakeholders involved.

LBO provides higher equity return and increase firm’s value through tax shield1. The main attractiveness of an LBO transaction is higher equity return due to leveraging available in the

transaction. By paying 30%-40% of the purchase price, the equity holders gain control of the target company.Also, in any LBO, the debt holders are locked into for a fixed return while equity holders receive all thebenefits from capital gains.

2. The interest paid on borrowed funds provides tax shield to the company. This tax shield increases firm’svalue.

3. Large debt and interest payment leads to forced efficiency improvement for the Management. This ‘disciplineof debt’ and performance pressures leads to cost cuttings, downsizing, investment in technological upgradesand other such tools. These changes, if sustainable, create immense shareholder value.

Non-regulated manufacturing industry with low financing cost, conducive for LBOHistorically, LBO has prominently been taking place in manufacturing industries which are basic and have beentypically least regulated in terms of restriction investments and pricing. The presence of considerable tangibleassets in the target company is also conducive for LBO. These tangible assets provide collateral for the debtraised. This is why LBOs have been relatively less popular for high tech companies which carry higher businessrisk and have fewer assets that can be leveraged.

Low financing costs is also a pre requisite for a successful LBO. High cost of debt has negative impact on cashflows and future debt servicing ratio. The management is faced with burden of cost reduction and operatingperformances to produce equity returns. Any LBO deal should ideally be undertaken when the interest costs arelow and the inflation is high as this makes assets more valuable.

7 The Financial Express

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In addition to the two factors mentioned above, a target Company with strong business potential and marketposition with steady and predictable cash flow makes it an ideal candidate for an LBO financing. The companyshould have strong balance sheet with low debt equity ratio. Typically the company should have twice as muchcash flow as required for debt repayment. There should be synergistic opportunities after buyout which can alsoprovide potential for expense reduction. There should be minimum future capital requirement in the short tomedium term so as to avoid further pressures on funding. Track record and reputation of management is acritical element for a successful LBO.

LBO success require clear exit strategyIn addition to enabling management’s to acquire businesses without putting their existing balance sheet undertoo much strain, the main motive behind LBO structuring has been higher equity returns. Thus, LBO successrequires a clear exit strategy in place. The potential exit strategy for an LBO fund could be outright sale, publiclisting through IPO or recapitalization.

The sale of the company to a strategic buyer or another financial investor is the simplest structure to exit anLBO. Financial investors to an LBO can also take an IPO route to realize partial gain on investment. The moneyraised through initial public offering could be further used to reduce existing debt burden, if any. This makesvaluations attractive and financial sponsors can divest the remaining stake.

However, not everything about LBO is positive. There have been several debates on the negatives of LBOs andtheir impact on businesses.

Concerns for LBOLBO’s have generated a lot of negative publicity after the 1980’s when corporate took over other companies withthe help of low quality debt and then sold off the acquired companies for their profits. It is widely believed thatleveraged buyouts affect the operations of the acquiring company in the long run. The acquiring firms are notable to replace the operating assets of the target company as the cash flows are dedicated to servicing theinterest on debt. The company also has to cut down on the repair & maintenance costs affecting the life of assetsfurther. Also the research & development expenses take a hit as a result of which all, the future growth prospectsof these firms may be significantly reduced. It is also said that LBO transactions have a negative impact on theother stakeholders of the firm. In many cases, LBO’s might lead to downsizing of operations, and employeesmay lose their jobs.

An LBO transaction might show immediate gain to the stockholders, through the premium that equity holdersget over the market price. However, these could only be short term gain as these equity holders are loosing onthe ‘true value’ that the firm has got. It’s this ‘true value’ of the firm that has attracted the financial investortowards an LBO transaction. These concerns are higher in case of a Management buy out’s where the existingmanagement takes over the company. Under an MBO structure, the possibility of under reporting of financialperformance and hiding of future prospects cannot be ruled out.

There is always a wealth loss to the original bondholders which is said to be as a result of the increase in defaultrisk caused by the incremental leverage buyout debt financing. However, some academicians also believe thatthe debt holders become better off as operational efficiencies lead to higher cash flow available for servicingdebt.

There is a considerable amount of tax savings associated with leveraged buyouts. These tax savings are mainlyon account of incremental interest deductions due to the debt taken during the financing and also due to theincreased depreciation deductions. Though on one hand it might sound beneficial for a firm, one needs to alsoconsider the capital gain on the shares for equity holders and taxes on interest earned for bondholders.

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Source: PE Week Wire

LBO has been prominent in matured markets

LBO in US marketThe LBO market in US has gone through several cycles. Started in 1970’s, in less than ten years it became hottopic among M&A community and business media. The LBO was at its boom in late 1980’s post which, therewas a bust in the market during early 1990’s. Post which it was making a comeback with LBO deals reaching$24.2 billion in 19968. The high yielding bond market didn’t perform well in late 1998 and this has direct impacton the LBO transactions. During 1999 and 2000, the acquisition multiples remained high and this made LBOoperators more cautious about risk.

With the overall market turning bullish, 2004 was the comeback year for LBO activity with 126 deals and a valueof $94 billion.

8 http://www.oycf.org, Leveraged Buyouts: Inception, Evolution, and Future Trends

During the past three years, the LBO activity has further picked up. The total value LBO deal in US was closeto US$200 billion during 2006.

Source: Standard & Poor's

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The key LBO transactions in US have been:

LBO in EuropeIn Europe, the deal volume was up 37 per cent, with US$1.2 trillion in announced deals9. Increased private equityactivity in Europe led to leveraged market accounting for 23 per cent of loan market volumes in 2005, asopposed to only 12 per cent in 200010. The average leveraged buyout deal size increased to US$664m in 200511.Spain registered increase of 179% in total loan volumes since 2004 with Telefonica’s US$40bn takeover of O2,and Gas Natural’s US$10bn takeover of Endesa.

LBO in AsiaThe last two decades saw growth in LBO activities in developed western markets of US and Europe. However,economic boom in India and China and the recovery of the Japanese economy are attracting buyout firmsincluding Kohlberg Kravis Roberts, Blackstone Group, Citigroup, Goldman Sachs Group among others to startoperations in Asia. Though the value of Asian buyouts is still a fraction of those in the United States and Europe,the rapid growth in the regions is attracting the international banks. “Every bank is trying to chip in on these dealsto tap the high returns and growth potential of the buyout industry,” said Alan Hirakawa, managing director forAsian leveraged finance at Citigroup in Hong Kong.

Private equity deals as a percentage of GDP was 1.6% in US, 1.4% in Europe and only 0.2% in Asia. Also, theprivate equity deals as a percentage of M&A deals were 17% in US, 19% in Europe and only 6% in Asia12. Thisgap in Asia hints towards for international banks for increased PE operations in Asia.

Japan has been leading the buyout boom in Asia. In Asia’s biggest-ever leveraged buyout deal, Softbank ofJapan purchased Vodafone Group’s Japanese unit in April 06 for ¥1.8 trillion with debt funding of ¥1.28 trillion.Though Chinese economy is reportedly growing at fastest pace, the buyout activities are not attractive as thelenders have no legal guarantee to seize the assets in case of default.

Source: www.simpsonthacher.com

9Thomson Financial10www.gtnews.com, Trends in European Loan Market11www.gtnews.com, Trends in European Loan Market12AVCJ; Thomson Financial; EIU

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Key global deals structured as LBOKKR’s RJR Nabisco deal of 1989 at $31 billion was one the largest leveraged buyout. KKR started bidding forRJR’s share at a price of $75 per share when RJR’s share was trading at $56. The deal was struck at a priceof $ 109 per share out of which $ 81 was in cash, convertible subordinated debentures valued at $10, and PIKpreferred shares valued at $ 18. The rival bid of Johnson was at $112 in cash and securities. RJR board choseKKR although Johnson’s group had offered $3 per share more as its security valuations were viewed as “softer”and perhaps overstated.

The beginning of 2007 marked one of the largest buyout deals wherein Blackstone bought America’s biggestoffice landlord for nearly $ 40 billion. This again was an example of takeover battle with Vornado making an offerof US$ 56 per share. This was US$0.5 above Blackstone’s offer of US$ 55.5.

Leveraged Buy Outs in IndiaThere have been very few deals in Indian M&A space that have an LBO. The key among these are:

Tata Tea acquisition of Tetley, UKTata Tea’s acquisition of Tetley Tea UK in February 2001 was the first ever leveraged buy out by an Indiancompany. Tata purchased Tetley for £ 271 million. Of this £ 60 million was brought in by Tata Tea and £ 10million by Tata Tea USA, a wholly owned subsidiary of Tata Tea. The equity investment was made into TataTea UK which was a Special Purpose Vehicle (SPV) set up for the acquisition.

The debt component include, £ 20 million of subordinate vendor loan notes and the balance was arranged bythe investment bank backing the deal. With only £ 70 million been invested as equity, leveraged financing in thetransaction was around 74%. Further, Tata Tea itself has raised £ 45 million through GDR’s to help meet itscontribution to equity. Thus, the effective internal accrual utilized to fund acquisition was £ 25 million i.e. mere9% of the purchase price13.

NewBridge Capital acquired stake in Shriram HoldingsNewbridge Capital acquired a 49% stake in Shriram Holdings (Madras) Limited in September 2005. Newbridgeused the LBO structure to fund its US$ 100 million purchase of 49% stake in Shriram Holdings which owns stakein three truck finance companies - Shriram Transport Finance Company Limited (STFC), Shriram InvestmentCompany Limited (SIL) and Shriram Overseas Finance Limited (SOFL).

KKR Flextronics DealKohlberg Kravis Roberts & Co. (KKR), the world’s leading buyout fund, acquired Flextronics Software Systems(FSS) in April 2006 for US$ 900 million. KKR acquired an 85% stake with Flextronics International, the originalowner of FSS, continuing to hold the remaining 15%. The transaction was the largest LBO deal in India.Flextronics International received US$ 600 million in cash and the remaining amount through a seller’s note thatmatures in eight years. KKR financed the deal with fully underwritten debt facilities.

13www.tata.com

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Tata Steel acquired Corus, UK to become 5th largest steel playerIn a major M&A battle with CSN, Brazil, Tata Steel finally emerged as the highest bidder for Corus with a finalbid price of 608 pence per share. This implies a market capitalization of US$ 12.1 billion and an enterprise valueof US$ 13.7 billion for Corus. After completion of the deal, Corus will be a wholly owned subsidiary of Tata SteelUK Limited which in turn is 100% held by Tata’s Singapore based subsidiary, Tata Steel Asia Holding PteLimited.

The deal, as per Tata’s Management would be financed by a combination of internal accruals and debt. Tatawould raise debt to the tune of US$ 8 billion by leveraging cash flows from Corus. This accounts for leveragingto the tune of 66% of the total purchase price paid. The remaining US$ 4.1 billion is the equity contribution ofTata Steel and the Singapore subsidiary in to Tata Steel UK. Of this Tata will fund US$ 2.3 billion through internalaccruals while the remaining US$ 1.8 billion will be funded either through long term debt or fresh equity infusion.

Road blocks to LBOs in IndiaThe above mentioned examples, notwithstanding, there have not been many instances of LBO structuring inIndia. Though the M&A activity is growing, the average deal size in India is not attractive enough for global LBOfunds. The stand of regulatory authorities and support of Indian banking system for leveraged transactions isneeds further clarity. Historically, leveraged buyouts have worked when the assets are available cheap. Theglobal investors have their own concerns for over heating enterprise valuation of Indian companies. Also, given thehigh enterprise valuations and increased funding costs, LBO structure in India might not be attractive to enter into.

Smaller average deal sizeIn 2005, the average deal size in an LBO was US$972 million14 in US and US$664 million in Europe. Theaverage deal value of M&A deal in India was US$ 32 million in 200515. This gives an indication of low deal valuein Indian market. These small deal sizes might not be lucrative for large global buy out funds. Though there areexamples of Indian corporate looking for overseas assets larger than its own size, deals amenable to LBO arefew and far apart.

Family firm’s hesitance to share ownership is major deterrent for LBO’sFamily owned business forms a large chunk of Indian corporate structure. These firms are typically reluctant topart with ownership. Negotiations with company founders or family owners are particularly sensitive with issuesof control and management. Also, there are cultural resistances by these businesses towards institutionalizingthemselves.

Higher valuation concernsThough there are reasons to believe that the Indian growth story would remain strong, there are concerns, atleast among some sections of global investors, on high stock valuation vis-à-vis other emerging markets. Theaverage PE multiple of India was around 21 in 2006. This was way ahead other emerging markets PE.

From an investor’s perspective high equity valuation is a concern.

Pressure of domestic expansion restrict over leveraging for acquisitionIndian companies having large domestic market share have stiff in house competitions. These companies havetheir own capital requirement to fund expansion in the local market. The companies that are already highlygeared will not get cheap finances for such domestic expansion. Under such scenarios, LBO’s would provideadvantage of gearing the acquirer company’s balance sheet. For example, in the recent Tata Corus deal, thefinancial gearing is not done at Tata Steel’s balance sheet and this still gives it space for raising fresh loans tofund its domestic expansion.14 Standard & Poor’s Q4 2005 Leveraged Buyout Review.15 How Indian Companies Fund Their Overseas Acquisitions, India Knowledge, Wharton

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LBO financing cost higher than cost of traditional debtToday, Indian companies are finding it less difficult to raise loans for overseas acquisitions. Most of the fundsraised are through external borrowing and these are directly secured by the acquiring company’s balance sheet.These loans are typically 2% lower than the prime lending rates. However, leveraged financing comes at ahigher cost due to increased financial risks. Also, the leveraging is secured by the balance sheet of the targetcompany. Indian companies find it more lucrative to borrow cheaper funds in there own books rather then goingfor leveraged financing options. The typical example of this is when Tata Motors acquired Daewoo’s Koreantruck business; it had the option of going in for leveraged finance with a non-recourse debt on Daewoo whichwould have cost 3% over the Libor. However, Tata Motors chose to raise a loan on its own balance sheet at0.5% over Libor to fund acquisition16.

Lack of historical transactionThe Indian M&A history provides few examples of leveraged transactions. Under such scenario, the lenders arestuck with a decision of taking such high default risk. Historically, public sector banks have largely avoided thiskind of funding. Only the foreign banks with global expertise and experience have moved ahead with suchstructuring.

Key policy framework required for an LBODue to lack of clear guidelines relating to leveraged funding for acquisitions in India, the Indian banks have neverbeen active in providing leveraged financing. During the disinvestment phase, Indian banks had lent money tocorporate to buy stakes in PSU up for sale. However, this was more in nature of balance sheet financing ratherthen a leveraged buyout transaction.

The guideline for overseas acquisition is considered under External commercial borrowing and financing byIndian banks. The existing guidelines allow for overseas funding up to US$ 500 under automatic route. Theoverall remittance from India should not exceed more then 200 per cent of net worth. However, the banks areallowed to fund acquisitions that are in the nature of strategic investment, in terms of board approved policy dulyincorporated in loan policy of the bank.

The government regulatory authorities need to draft definitive policies that guide banks about actions to taketowards funding acquisition through leveraging the acquired company’s balance sheet. The guidelines are to bemade after considering the implications of such leveraged transactions on overall economy. The Australiancentral bank has recently raised concerns about the rising leveraged buyouts in Australia. As per a newspaperarticle, “the leveraged buyouts typically resulted in a significant increase in the target’s debt to equity ratio,making it more vulnerable to rising interest rates or deterioration in economic conditions”.

Source: Deutsche Bank

16 TMC net news

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CHAPTER IV:

DUE DILIGENCE IN M&A –BOTTLENECK OR VALUE ADDITION

Following the motto “Concentrate on your central competencies, reach your critical size and you will be successful”companies are buying, selling and merging. Capital is available in abundance and is increasing with investmentflows from abroad and growing profits of domestic companies contributing to the booming M&A market.

Due to the increase in M&A activity in India over last few years, investments in well managed public companiesare nearing saturation. Investors, including private equity investors, hedge funds etc. are forced to look deeperfor identifying value investments which in most circumstances translates into investments in growing privatecompanies owned and managed by a ‘family promoter group’. Such organizations usually function in a lessstructured environment than a listed entity and the business environment that they function in is radically differentfrom enterprises in western economies and larger domestic corporations. As a result, parallel to the growth inmergers and acquisitions as well as equity participation, there is a growing demand for special advisory servicescalled “Due Diligence” in this market.

Process hurdle or risk reductionIn a period, where there is increasingly more money chasing fewer and fewer lucrative investment opportunities,it is not uncommon that due diligence is often viewed as a formality or even a process hurdle. Presently, theabundance of capital usually results in multiple suitors for a single target. This brings in elements of timeconstraints and competition to the deal table frequently resulting in either complete avoidance or dilution to thedue diligence process. However, a closer look reiterates the fact that a due diligence is a critical step, not onlyfor risk reduction but also contributes significantly to the completion and success of a transaction. Besides, animproperly conducted due diligence can lead to investors and managements taking irreversible drastic decisions.

Dynegy came very close to acquiring Enron in 2001, just before the Enron fiasco was unearthed and it collapsed.Dynegy had done the due diligence of Enron but soon realized that the financial situation of Enron was muchworse than what was disclosed in the public domain. Though the deal fell through, it clearly indicates how hidingof necessary information or improperly conducted due diligence can lead to drastic results.

(Source: http://www.thestreet.com/markets/detox/10003860.html)

The primary objective of due diligence is to confirm the reliability of the information provided. To put it simply,are you buying what you think you are buying? Any change in these preliminary assumptions may have asignificant impact on the pricing, or may even question whether to proceed at all.

Set out below, are some of the illustrative issues, which often arise from financial due diligence and contributein reaching a final ‘go/no-go’ decision on a transaction. While global private equity firms are great votaries ofgoing through a proper due diligence process, some of the other investors/ managements are increasinglyfinding merit and value in making due diligence process an integral part of their M&A decision making process.

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Inputs for structuring a transaction – Asset Purchase vs Equity PurchaseAcquisitions are structured as either as asset purchase or equity purchase. Both structures present their ownbenefits and pitfalls:

When buying the assets of a business, not only does acquirer benefit from tax deduction, the buyer does nothave to assume the hidden contingent liabilities of the business. On the other hand, purchasing the company’sstock means inheriting outstanding tax liabilities, undisclosed debts, overstated earnings, poor employee relations,overvalued inventory and pending lawsuits. At first glance, it might seem more attractive to buy assets only;however, certain contracts are not assignable when purchasing only the assets. Another benefit from purchasingthe stock is the tax-favoured capital gains treatment received with this type of purchase. In general, sellers preferto sell stock, buyers prefer to purchase assets. A proper due diligence process helps identify relevant issues toenable optimum structuring of any transaction. For e.g. a due diligence can determine whether the company’scontracts are assignable and whether they will continue after the stock or asset purchase.

Inputs for pricing a transaction – Non sustainable historical earningsAudited financial statements are usually the starting point in any transaction negotiations. Due diligence processis aimed at providing greater understanding on quality of earnings through an in-depth review of the businessand management accounts. Adjustments to audited financial statements are identified to reflect the targetbusiness as it currently stands. Common adjustments include stripping out the impact of one-off events, lostcustomers, discontinued products, changes in cost structure and accounting errors. Traditionally, while valuinga business, focus was placed only on evaluating cash flows and maintainable earnings. A rigorous due diligenceprocess attaches importance to evaluation of non-financial information which impact the sustainability of historicalearnings such as the quality of risk management, the quality of management, corporate governance and thesocial and environmental performance of the company.

Inputs for seeking indemnity from sellerA rigorous due diligence process identifies areas where a buyer should ask for protection by way of warrantiesand indemnities.

Usually, these include liabilities, penalties and exposures pertaining to past period, which are likely to materializeor crystallize in future.

While buying a business carved out from a company or one which uses services of group companies/ Groupcorporate office, it is imperative to understand the nature and extent of related party transactions. Such transactionsare often conducted under special pricing terms. It is common to find that certain infrastructure, such as businesssupport services, have not been charged by its parent or group company to the target business at all. A duediligence process helps identify all such related party transactions and assesses their impact on the businessdue a change in ownership structure. Identifying all the related party transactions in a business may not bestraightforward as it is not uncommon, especially in mid sized or smaller private companies, for key managementto have undisclosed competing business interests.

Inputs for identifying investments required in improving management information systemManagement information systems in unlisted companies are usually unstructured and may not provide highquality timely information that most investors seek. It becomes critical, therefore, to invest in improvement ofmanagement reporting systems. Also, in such companies it becomes important to lock in the experiencedpersonnel with the business till such time that systems are institutionalized.

Due Diligence Process – Practice in India vs US & EuropeConducting a due diligence exercise in India is significantly different from diligence exercises undertaken in theUS and Europe. The quality of financial statements, financial infra structure and business process are less

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developed in India than western investors are accustomed to, resulting in the need to explore more risk areasand take more time for due diligence.

The table below highlights some key areas wherein there are differences in Indian and western world, thusnecessitating customizing the due diligence process to suit Indian scenario:

Western Countries India

1. Level of transparency in financial High Low - mediuminformation

2. Normal duration of duediligence 1-8 weeks 3-10+ weeks

3. Preparation time requiredby target Minimal May require extensive assistancecompany beforedue diligence

4. Basis of financial statements US GAAP or IFRS Indian GAAP

5. Audited financial statements By reputable standards Typically reliable but need a re-lookfrom a US GAAP or IFRS perspective

6. Extent of related partytransactions Varies, typically fully disclosed Usually extensive; inadequatedisclosure

7. Disclosure of contingentliabilities Usually transparent High risk area and minimal disclosure

8. Reliance on computerized Typical Evolving; dependenceon manualaccounting systems processes

9. Reliability of Normally reliable Untestedrepresentationsand warranties

10. Enforceability of indemnification claims Strong; backed by courts Untested

Due diligence encompasses more than just the financial numbers

Legal due diligenceThe market is dynamic and brings with it complexities of varied nature. Therefore basing acquisition decisiononly financial due diligence, especially in case of inbound or domestic M&A may be inadequate and fraught withrisk. Legal due diligence has gained increasing importance given the multiplicity of regulations and complexstructure of corporate laws in India.

Legal due diligence covers contractual documentation, litigation, ownership of movable, fixed and intangibleassets like IPR, etc. It also looks at any contracts on which there could be onerous covenants or which maybecome infructuous by reason of change in control of the target following the acquisition. All these aspects couldsignificantly impact the valuation of the target company.

The importance of a legal due diligence can be further stressed by understanding the structuring required insome recently concluded inbound acquisitions such as: Heidelberg’s purchase of 51 per cent stake in MysoreCements, EDS Corp’s acquisition of 52 per cent stake of MphasiS BFL, Kohlberg Kravis Roberts (KKR) buyingup Indian software unit Flextronics, and Holcim taking up stake in Gujarat Ambuja Cement. These transactionsrequired significant thought on structuring to achieve multiple objectives of being tax-efficient, compliant withSEBI (Securities and Exchange Board of India), FDI (Foreign Direct Investment) regulations and so forth.Heidelberg’s acquisition in the BIFR-reported (Board of Industrial and Financial Reconstruction) Mysore Cementstriggered off the SEBI takeover code. Heidelberg had to then make an open offer for 22.15 per cent stake ata price higher than their acquisition price.

Thus an understanding of the prevailing laws in India and their applicability to the transaction is of paramountimportance. Further, in the Heidelberg deal the acquisition of 51 per cent stake was made on a preferential basissubject to the approval of the shareholders in their extraordinary general meeting. Thus, corporate law provisionscome in to full play in M&A deals, making the role of a due diligence process more important.

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The EDS Corp deal was subject to the approval of the Bombay and Karnataka High Courts. Also required weresanctions of the stock exchanges, shareholders, creditors, and regulatory authorities.

In contrast, KKR’s acquisition of 85 per cent of Flextronics did not trigger the takeover code, because the Indianentity had applied for voluntary delisting and been de listed from BSE and NSE in 2005, prior to KKR’sacquisition.

Tax due diligenceIn case of cross border M&A transactions tax structuring has assumed great significance. Presence of taxtreaties between India and some jurisdictions have enabled managements to make acquisitions tax efficient. Keyareas which require attention from a tax perspective include ‘substance’ test, tax outflow, capital gains, dividend,interest and royalty, withholding taxes and elimination of double taxation.

Failure to plan and structure transactions in the most tax efficient manner diminishes or destroys anticipatedincreases in shareholder value and can lead to tax leakage and loss in management and staff incentives. It mayalso result in opportunities for optimizing the new group’s tax position being missed and delayed integration.

Environmental and HR due diligenceA certain level of environmental diligence and human resource evaluation are also forming part of transactions,albeit in very few transactions. These issues gain more importance in case of cross border M&A ignoringenvironmental issues and work cultures may impact post integration efforts significantly. The failure of some highprofile mergers due to differences in work cultures are cited below:

AT&T and NCRThe merger of AT&T and NCR—two similar organizations—failed partially because of the combination of disparatecorporate cultures. AT&T was unionized, whereas NCR was not. NCR had a “conservative” corporate culturewhereas AT&T was more “politically correct.” Thus, the two companies did not gel well together.

Source: http://appanet.org/files/PDFs/APPAreportPost-MergerExperience.pdf

Daimler ChryslerDaimler Chrysler merger is an example of how difference in culture can be one of the reasons of merger failure.The merger was expected to bring in lots of synergies and help creating one of the leading automobilemanufacturers in the world. However, 3 years post merger, the DaimlerChrysler’s market cap stood at $ 44billion, roughly equal to the value of Daimler Benz before the merger.

Source : http://business.timesonline.co.uk/tol/business/columnists/article1386969.ece

The process of M&A is usually a long drawn one, with due diligence being just one of the activity involved. Themerging companies have to go through a series of regulatory approvals once it decides to go ahead with themerger plan. Many a times, these regulations become a bottleneck in the complete M&A transaction. Theregulatory environment has evolved in India over last decade with regulatory authorities taking active measuresto minimize hurdles in the complete process.

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CHAPTER IV

REGULATORY ENVIRONMENT – PLAYING AN

ENABLER’S ROLE

India is becoming a preferred investment destination globally due to its growing economy as well as changesin regulations which are getting more conducive to attracting investments. The M&A scenario in India has seenradical changes with year 2007 expected to clock deals worth USD 50 billion as compared to just USD 16.3billion two years ago17.

In the pre-liberalization regime, India was characterized by stringent regulations, restrictive labour laws, inefficienciesin the judicial system, protection to domestic industry. In last decade, series of steps have been taken to makethe environment more conducive to doing business like expediting judicial systems, rationalization of import andexport duties, slashing of corporate tax rates, industrial policy reforms, capital markets development etc. whichhave provided impetus to companies to consider India as a serious investment destination.

Every M&A transaction in India has to ensure compliance with various regulations like Competition Act 2002,Companies Act 1956, FEMA regulations, SEBI Takeover Code, Stock exchange regulations, sector regulators,exchange control regulations etc. These regulations become even more in case of cross border transactions.Though the list seems to be long, the regulatory scenario has improved over the years and regulatory authoritieshave taken steps to promote M&A in India.

FDI norms

FDI inflows in India have been increasing over the last few years, mainly due to the opening up of various sectorsby the Government for foreign participation. The chart below highlights the movement in FDI inflow in India over aperiod of last 7 years:

17 http://economictimes.indiatimes.com/News/Economy/Indicators/India_Inc_scorches_Street_MA/articleshow/1606910.cms

Source: http://dipp.nic.in/fdi_statistics/india_fdi_nov_2006.pdf* Figures for 2006-07 are for April 2006 to November 2006

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The country has witnessed a series of M&A activities in India with foreign companies acquiring stakes in Indiancompanies as well as substantial investments coming from PE funds.

Some of the key investments made by MNC’s in India are as follows:

1. Vodafone acquisition of 67% stake in Hutchison Essar

2. KKR’s acquisition of 85% stake in Flextronics Software System

3. Holcim’s acquisition of 14.8% stake in Gujarat Ambuja

4. Mylan Laboratories acquisition of 72% stake in Matrix Laboratories

Two sectors, which have seen a lot of discussion revolving around the FDI norms, are Real Estate and Retail.Real estate sector has shown tremendous growth in last couple of years with significant amount of foreign moneyflowing into the sector. Retail industry has, on the other hand, faced stiff political and domestic industry pressurewith the government unable to liberalize FDI norms further which would have facilitated large scale investmentsby overseas investor in this industry.

FDI in real estateReal estate sector has seen unprecedented growth in last couple of years, with opening up of FDI norms beingone of the key contributors. Prior to opening of the FDI regulations in Real estate sector, only Non-ResidentIndians (NRIs) and Persons of Indian Origin (PIOs) were permitted to invest in the housing and the real estatesectors. Foreign investors other than NRIs were allowed to invest only in development of integrated townshipsand settlements either through a wholly owned subsidiary or through a joint venture company in India along witha local partner18.

However, in February 2006, Government opened up the construction and development sector and allowed 100%FDI under the automatic route to facilitate foreign players participate in the real estate growth story. Therelaxation of norms saw players like Emmar Properties, one of the leading real estate developer in the world,tying up with MGF Developments for setting up various projects.

Presently 100% FDI is permitted in Real estate sector under automatic route in urban infrastructure projects andin project involving development of integrated townships, including housing, commercial buildings, hotels, resorts,etc. However, these are subject to certain conditions pertaining to size of area to be developed, investmentcriterion, time frame for development etc.

FDI in retailIn retail sector, 51% FDI is permitted only in single product retailing provided the products should be one whichare sold under single brand name internationally and are branded during manufacturing. As a result of thisrestriction, not many global brands have shown keen interest in investing in retail in India. Wal-Mart has tied upwith Bharti Enterprises for their retail foray but it will not be a direct front end retail business. The key rationalegiven against opening up of FDI in retail is shrinking of job opportunities and loss of livelihood of millions ofpeople thriving on local “mom and pop” stores.

Another key development which supported the government’s focus on creating an equal environment for foreignplayers in India was replacement of Press Note 18 with Press Note 1.

Press note 1, 2005 (Guardian Modi case)19

Press Note 18, issued in 1998, was scrapped in early 2005 which further smoothened the flow of FDI into India.Press Note 18 made it mandatory for any foreign company having a joint venture in India to obtain a No-Objection-Certificate from the Indian JV partner before setting up a new business in India in same or allied fields.

18 http://www.ficci.com/surveys/fdi-survey-real.pdf19 http://www.blonnet.com/2006/11/08/stories/2006110804680100.htm

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Press Note 1 replaced Press Note 18 and stipulated that future ventures should include conflict of interest clausein their agreement to protect the interest of the concerned parties. This has removed a restrictive covenant whichwas acting as a roadblock for the Multi National Companies to set up their operations in India.

Recently in November 2006, Foreign Investment Promotion Board (FIPB) ruled in favour of a foreign JV partnerGuardian International to set up a separate subsidiary for manufacturing similar products. In this case, GujaratGuardian Limited was a JV between Guardian International (having 50% stake in JV) and Modi Rubber (Having22.41% stake in JV) for manufacturing float glass. Guardian International wanted to set up a wholly ownedsubsidiary in India to manufacture similar products but the Modi group refused to grant no objection certificateto Guardian International. Guardian International clarified that the new plant will be at a different location andaround 70% of the new plant production will consist of items not presently manufactured by Gujarat GuardianLimited. FIPB gave approval to the new venture thus setting a precedence that restrictive policies are on theirway out.

Investment by Indian companies abroadIndian companies have made substantial inroads in the international scenario with various big ticket acquisitionsabroad. Tata’s acquisition of Corus, Hindalco’s expected acquisition of Novelis, Dr Reddy’s acquisition ofBetapharm, Aban Lloyd’s acquisition of Sinvest etc are some of the deals which have increased India’s presencein the international market. The liberalization of government policies allowing Indian companies to commit alarger sum of money for their international forays has been a booster to their plans.

The chart below depicts how the policy pertaining to investment by Indian companies abroad has evolved overa period of time:

Source: http://www.bis.org/review/r070122c.pdf

It may be noted that the limits mentioned came with some additional conditions in respective years. Also thelimits mentioned above are the amount of investment allowed under the automatic route (except for the year1969).

The present policy framework stands as follows20:

• Proposals for investment overseas by Indian companies/registered partnership firms upto 200 per cent oftheir net worth as per the last audited balance sheet, in any bona fide business activity are permitted byAuthorised Dealers (AD) irrespective of the export/exchange earnings of the entity concerned. Within this

20 http://www.bis.org/review/r070122c.pdf

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limit, loans and guarantees by the parent company and associates are also permitted. The condition regardingdividend balancing has been dispensed with.

• No prior approval of RBI is required for opening offices abroad. For initial expenses, AD have been permittedto allow remittance upto 15 per cent of the average annual sales/income or turnover during last two financialyears or up to 25 per cent of the net worth, whichever is higher. For recurring expenses, remittance upto 10per cent of the average annual sales/income or turnover during last two financial years is allowed. Withinthese limits, AD can allow remittance by a company even to acquire immovable property outside India forits business and for residential purpose of its staff.

• Partnership firms registered under the Indian Partnership Act, 1932 and having a good track record arepermitted to make direct investments outside India in any bona fide activity upto 200 per cent of their networth under the automatic route.

Income Tax Act, 1961Income tax Act 1961 provides for specific provisions pertaining to Mergers and Amalgamations. The provisionsrelating to M&A are covered under various sections like:

• Sections 2(1B) defines amalgamation

• Section 19 (AA) defines demerger

• Section 42 (C) defines slump sale

• Sections 47 (vi)/ 47(vii) explains provisions of capital gains in case of amalgamations

• Section 50(B) talks about capital gains provision in case of slump sale

• Section 72A talks about various conditions to be fulfilled for the merging companies to avail of benefits ofbusiness losses and unabsorbed depreciation carried forward

Besides laying down clear provisions to facilitate M&A, the corporate tax rates have also been rationalized.Corporate tax rates for domestic companies have been reduced from 55% in 1991 to 30% (plus surcharge andcess) for the year ending March 31, 2007. Foreign companies, which were taxed at a rate of 65% in 1991, arenow taxed at 40%, excluding the surcharge and education cess.

Foreign banks in IndiaIn February 2005, RBI announced a road map for the presence of foreign banks in India. During the first phasebetween March 2005 and March 2009, foreign banks are permitted to set up wholly owned subsidiaries in India.During the second phase, from April 2009, RBI proposes to accord full national treatment to wholly ownedsubsidiaries of foreign banks, dilution of stake in wholly owned subsidiaries and mergers and acquisitions of anyprivate sector bank in India. RBI also announced norms for the ownership of foreign banks in Indian privatesector banks.

Prior to these guidelines, there were several restrictions on foreign banks with respect to the expansion of branchnetwork, location of new branches, acquisition of shareholding in Indian bank’s etc.

As per the new guidelines, initially entry of foreign banks will be permitted only in private sector banks that areidentified by RBI for restructuring. In such banks, foreign banks would be allowed to acquire a controlling stakein a phased manner. Besides, foreign banks are allowed to open 20 branches in a year as against the limit of 12earlier. However, it will be contingent on RBI’s policy that new branches should preferably be in under banked areas.

ECB guidelinesThe Reserve Bank of India (RBI) has eased the norms for raising funds through external commercial borrowing(ECB) route progressively over a period of time. ECB limits exist for individual corporates as well as the total

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amount that can be raised under ECB route during a financial year. The total ECB limits are usually fixedannually. Till December 2006, the total amount raised through ECB’s was $14.3 billion. Since the total limit fixedfor the current fiscal was USD 18 billion, the government is planning to raise the total limit to USD 22 billion21.

As regards individual borrowers, RBI came up with a last notification in December 2006. As per this notification,an additional limit of USD 250 million with an average maturity of more than 10 years under the approval route wassanctioned, over and above the existing limit of USD 500 million, in a financial year. However, other ECB criteriasuch as end-use, all-in-cost ceiling, recognised lender, etc. need to be complied with as earlier. Also, it wasmentioned that Prepayment and call/put options, would not be permissible for such ECB up to a period of 10 years.

In order to facilitate companies flexibility in their borrowing schedule and manage their interest cost, prepaymentof ECB up to USD 300 million, as against the existing limit of USD 200 million, will be allowed by AD Category- I banks without prior approval of the Reserve Bank subject to compliance with the minimum average maturityperiod as applicable to the loan.

Regulations – Issues & ProblemsWhile the regulatory framework in India has evolved to M&A activities in India, there are still some issues whichneed to be sorted out.

Multiple ClearancesIn the process of any M&A deal, multiple bodies in India like the Reserve bank of India, Foreign Investmentpromotion board, Securities and exchange board of India, stock exchanges, Company law board, High courtsetc need to be dealt with during the various phases of acquisitions and post acquisition integration. Whileauthorities like Reserve Bank of India have been more supportive in terms of easing some regulations foracquisitions by Indian companies abroad, bodies like the tax authorities are yet to deal with a number of issueswhich the companies face while making acquisitions and during the post acquisition integration.

Bank financing for acquisitionsBank financing for acquisition purposes is still not a developed market in India. RBI governs the exposure normsfor all the banks in India. Acquisition by a company in India by mode of acquiring shares of another Indiancompany is viewed as a capital market transaction even in a case if such an acquisition is for strategic businesspurpose. There is no bifurcation between a strategic investment and a financial investment by the RBI.

RBI regulations require that promoters’ contribution towards the equity capital of a company should come fromtheir own resources and banks should not normally grant advances to take up shares of other companies Oneof the exceptions listed in the said circular provides that loans can be sanctioned for meeting promoterscontribution towards equity of a company upto a limit of 5% of the total outstanding advances of the bank ason the previous year ending date. However as a practice banks in the country do not lend for acquiring sharesof other companies.

Further proceeds from External commercial borrowings are not permitted for investment in capital markets oracquiring a company (or a part thereof) in India.

Income Tax Act, 1961Though specific sections have been defined in Income Tax Act, 1961 to deal with M&A, industry experts believethat there are number of grey areas, which needs to be worked out to make the system transparent and optimal.Some such issues, as highlighted by experts from time to time, are encapsulated below:

• A number of acquisitions are done by way of special purpose vehicles (“SPV”). SPV is funded through equityand quite often with a significant portion of debt. Deductibility of interest payable on such debt against theincome of the invested entity or the dividend receipts from the invested entity is under question. For instance

21 http://economictimes.indiatimes.com/articleshow/1233730.cms

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in case an Indian company creates a SPV to acquire 100% stake in another company, the interest paid bysuch SPV will not be a deductible expense for the SPV, the invested entity or the parent company in whichthe accounts the SPV will be consolidated. Quite often innovative structures across various regimes areplanned to deal with such tax issues.

For instance Welspun India, which in June 2006 bought British towel brand Christy for £15.6 million ($30 million).Welspun India created a 100% subsidiary in Cyprus tax haven) which in turn has a 100% subsidiary in the U.K.called Welspun Home Textiles U.K. The British subsidiary borrowed £10 million from Bank of India. WelspunIndia paid £5 million to the Cyprus entity, which passed that on to its Welspun U.K. for payment to CHT Holdings,which was Christy’s seller. The loans were to be repaid by the dividends from Christy paid to Welspun U.K. Taxrules allow the consolidation of accounts of Welspun U.K. and Christy, Accordingly, the interest will be expensedagainst the earnings of Christy, thereby reducing the overall tax liability of Welspun U.K. and Christy.

• Dividends earned from foreign subsidiaries when repatriated back into India are taxed in the hands of theIndian parent company at a notional tax rate of 33.66% under the Indian IT Act. There is an absence ofunderlying tax credit system except for countries namely Mauritius & Singapore. Underlying tax credit systemmeans credits for the taxes borne by the subsidiary are available to the parent company.

• Similarly, there is absence of group relief and tax consolidation provisions which permit losses of onesubsidiary to be offset against the profits of other companies within the same group.

• Section 47 of the Indian IT Act provides for capital gains tax exemption to foreign shareholders for transferof shares in Indian company pursuant to a merger or a de merger provided certain conditions are satisfied.However Transfer of shares in a foreign company by the Indian shareholder consequent to a foreign mergeror restructuring should also be eligible to get similar exemption from capital gains tax. There is no provisionin Section 47 in this regard to promote tax neutrality for Indian shareholders.

• Section 79 is yet another provision which has to be looked into while working out cross-border transactions.Carry forward of losses and their set off is not allowed under the Section in the case of a closely-heldcompany, unless on the last day of the previous year the shares of the company carrying not less than 51per cent of the voting power are beneficially held by the same persons as on the last day of the previousyear in which the loss was incurred. This requirement of Section 79 will not apply in cases where theshareholding changes in an Indian subsidiary on account of merger or demerger of a foreign company. It isnecessary that this relaxation be provided to Indian holding companies too. Section 79 should be madeapplicable to all cases of mergers and demergers.

In a nutshell, though Indian regulations have come a long way in making environment conducive to M&A, thereis still some way to go before things fully smoothen out.

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CHAPTER VI

M&A IN INDIA - FUTURE TRENDS

With the continued strength of the Indian economy and stock markets, India is likely to participate fully in theanticipated global M&A bull market in 2007. Indian companies are likely to take ever larger steps globally,particularly into the US and Europe, while the scale of domestic Indian companies will continue to attract bothstrategic and private equity interest, the latter fuelled by the growing funds raised from Western investors seekinghigh returns. Growth through inorganic route has become an integral part of companies’ strategy and there isa clear drive to gain in scale and size.

Significant deal activity is expected to continue in IT/ ITeS, telecom, pharmaceuticals, energy and banking andfinancial services sector. Other sectors which are expected to witness increase in deal activity include realestate, retail and entertainment and media.

According to a recent study by IndusView, one of Europe’s M&Aadvisory firms, bilateral trade between India and Europe is likely totouch $ 100 billion, by 2010, driven mainly by feverish outboundM&A activities by India Inc.

Increasingly the main drivers for Indian companies making overseasinvestments are acquisition of new markets, accessing newtechnologies, improving efficiencies and becoming global leadersin their respective fields. They are also being compelled to activelyconsider cross border acquisitions to maintain their growthmomentum, take on global competition and to acquire globalvisibility and international brands.

Several billion dollar deals are in pipeline which might result inyear 2007 being a landmark year in Indian M&A market. These include Reliance Energy, Tata Power and Lancoevincing interest in the assets of global power company Globeleq. The valuation is being pegged at about $2billion. Similarly, Ranbaxy and Cipla are said to be in the race for Merck’s generic business unit, which is againexpected to be valued at around $5.2 billion. Then there is Tata Power - which is interested in coal assets inIndonesia - that could again cost about $1 billion and Suzlon’s hunt for Germany’s REpower, which could costabout $1.3 billion.

One of key enablers for future M&A would be availability of structured financing options. High growth in economyhas left Indian companies flush with surplus funds. Besides Indian companies are already exploring exchangessuch as the Alternative Investment Market (AIM) of LSE, Kosdaq of South Korea, TSX of Toronto, Sesdaq ofSingapore and the Euronext to take advantage of liberal listing norms, a quicker listing process and bettervaluations from wider range of international investors. Indian companies are expected to raise at least £2-3billion from AIM alone22. With almost 60% of the investors in the market being long term investors willing to investin long gestation projects, AIM is likely to emerge as the preferred market for Indian companies to raise capital.

The regulatory bodies are expected to contribute further in facilitating the companies in their endeavour to goglobal. RBI is now planning to relax the prevailing lending norms to ease funding situation for Indian corporateswho are forced to borrow heavily from international markets due to stringent norms. RBI plans to allow corporates

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to lend 200% of their net worth to overseas step down subsidiaries, ventures promoted by holding company ofthe India subsidiary. At present, Indian firms are allowed to remit funds for overseas acquisitions to a directsubsidiary but not to a group subsidiary where it holds no shares. RBI’s move will enable the step-downsubsidiary to not only leverage the balance sheet of the holding company but also the Indian corporates. Thisshall also open avenues of more business for Indian banks23.

Several companies float SPVs that are subsidiaries of the acquiring firm. The step-down subsidiary acts as anarm of the holding company, which can be used for future acquisitions by the corporate group. The step-downsubsidiary resorts to funding largely from overseas firms since Indian lenders do not finance acquisitions in abig way. By allowing the step-down subsidiary to raise funds on the strength of the Indian corporates balance-sheet, more Indian money would be available for buyouts.

Moving toward best practicesAs India moves towards global scale of M&A activity in terms of numbers and size, it would also have its ownshare of acquisitions which go wrong or under deliver.

Researches have time and again indicated that not many mergers create value and reasons for the same varylike overestimation of synergy gains, cultural misfit, inability to discover hidden liabilities etc. According to EIU’sGlobal M&A Survey in 2006, only half the respondents said that their deals achieved expected revenue synergies,while even less than half believed that expected cost-saving synergies would be achieved.

This would prompt investors to demand stricter adherence to due diligence process to identify pre and postmerger issues upfront. Acquisitions would be preceded by a well planned out strategy covering the first step frominception of the deal till post merger integration to minimize post merger failure. Managements would lay downclearly defined objectives and strategy to pursue a deal and processes to be followed during deal negotiations,execution and post deal integration. Just like the companies have yardsticks for analyzing a Greenfield project,they would have framework or benchmarks for acquisitions also, non compliance of which should be an indicatorof scrapping the deal.

In the recent transaction of Vodafone bidding for Hutch, Arun Sarin, CEO Vodafone, time and again stressedthat the price it shall bid for Hutch will be as per the internal investment guidelines and the required IRR (internalrate of return) to be considered before investment stipulated by Vodafone internal standards.

As such there is no rule book or standard checks which can guarantee success for any merger. However,following a structured approach and certain practices can tremendously increase the probability of a mergerachieving its desired objectives.

A study24 on leading in-house M&A practices has revealed that certain steps, if taken, can improve the odds ofM&A success. These include a set of practices like:

• Impart structure to the deal process – It is necessary to have sequential committees which keep a check onresources being committed for the work and through transaction document process.

• Leverage resources – Placing resources on the basis of their capabilities and sharing responsibilities amonginternal channels facilitates M&A

• Rotate Staff between department: M&A groups that rotate staff between business units are more likely toachieve deal success than those that don’t promote such rotations

• Synergies matter: Companies that use their corporate development groups to help quantify synergies andintegration costs stand a greater chance of achieving those objectives than those relying solely on theexpectations of their business units.

22 Hindu Business Line23 Business Today – February 11, 200724 Bank of America Business Capital bi-monthly e-newsletter on leveraged finance

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• Source deal from outside and inside - According to the study, 75% of transaction opportunities originate fromoutside the corporate development group

• Train, Equip and Track – It is necessary to monitor closely whether synergies are actually been realized,activities are going on as planned, operating metrics are being reached etc.

• Utilize Advisors – External advisors can provide an independent view on various aspects of the deal, be itthe validation of key assumptions or due diligence etc.

• Separate due diligence activities: Creating separate investigations and work streams for assessment of thetarget company, the market and the integration itself improves focus and makes the due diligence processreplicable and improves the likelihood of success.

• Seek Independent review of findings: Whether via internal committees or third-party advisers, companiesshould always validate key deal assumptions and diligence findings.

Besides the practices mentioned above, there are certain other steps, which would increasingly find favouramongst Indian companies as they go global.

Pre Deal AnalysisThe investor needs to formulate a staged approach to an M&A transaction in India. A staged approach wouldrequire the investor to do some pre deal analysis to ensure that the target meets atleast some broad parametersbefore considerable amount of resources are invested on the deal. A typical starting point would be to definecertain tasks which could include, among others, the following:

Possible tasks Objectives

Screen historical auditor’s report Understand key business drivers, quality of earnings and related issues,working capital requirements, etc

Evaluate key accounting policies Identify potential risky/sensitive areas that need additional attention in duediligence, valuation and structuring.

Perform high level overall analytical review Assess integrity and quality of financial data.

Review internal management reports Identify useful business statistics that are instrumental to in-depth analysis.

Understand the work culture, regulatory Analyse how it differs from domestic market and whether it will be possibleenvironment and market of target company to gel the two

These preliminary checks can help the acquirer in determining whether there is any possibility of getting synergiesout of this transaction and will it be worthwhile to committed valuable resources further to the deal.

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Post merger integrationAn important area, which would find more favour amongst management, is to develop framework to achieve postmerger integration. Post Merger integration (PMI) forms an integral part of any M&A deal. Thinking that the workis over once the agreement has been signed and purchase consideration paid off can be a misnomer and canlead to serious post merger issues.

PMI is not a process which starts post closure of the deal, but it’s considered a good practice to think about theissues like cultural fit, employee transition etc right at the outset when the deal is being planned and lay downthe action plan for the deal accordingly.

Key areas in which PMI plays a major role are25:

1. Employee Transitiona. Culture integrationb. Communication of severance programme, if any

c. Role and designation fittingd. Management of perceptions and expectationse. Compensation structure clarity

2. IT transitiona. Integration of IT infrastructure

b. Restructuring of IT department with operations and support team

3. Finance and Accounting integrationa. Aligning accounting systems and methodologies

b. Aligning internal control systems

4. Sales and Marketing integrationa. Sales force integration

b. Product offeringsc. Customer retention

Global best practices on ensuring that the PMI is effectively carried out include:1. Planning for PMI at the outset of the deal2. Designated team for PMI

3. PMI leader effectively communicating with the employees, key stakeholders, creditors etc at regular interval

The presence of a PMI team can ensure that the process of integration is carried out in a structured way. Theleader of the PMI team needs to be a part of the deal right from the beginning so as to have an idea of theculture of both the merging entities and how effective steps can be taken to ensure smooth transitioning ofpeople from one organization to another.

Presence of PMI team also ensures that other managers concentrate of their routine activities and does not getdistracted by the post merger issues. The managers otherwise may end up spending considerable time inmerger activities, thereby hampering their ability to work towards the long term goals of the company.

25 SG Capital – Post Merger Integration

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CHAPTER 7:

SMALL COMPANIES PILOT GLOBAL DRIVE

It may be the Tata Group, Videocon, UB and Ranbaxy that inspired us to trumpet about India Inc’s globaltakeover spree, but this M&A drive is being navigated by a bunch of small and medium companies. And, mindyou, these young entrepreneurs, with no history behind them to brag about, had a much tougher time convincingtarget companies and financiers about their intentions and abilities.

Late in 2005, when Subex Systems founder and chairman Subhash Menon approached Toronto-based Syndesiswith a takeover proposal, he was not taken seriously. After all Subex was one-third the size of the $45 millionSyndesis, a leading provider of telecom operations support software (OSS) solutions. Earlier, a leading investmentbanker in Mumbai too had turned its back on Menon’s overseas ambitions. But Menon refused to give up hisdream of making Subex a $100 million by 2007. In April last Subex acquired UK based Azure Solutions in astock deal exceeding $140 million. Six months later, Syndesis approached Menon and in December Subexacquired Syndesis for $164.5 million in the largest overseas acquisition by an Indian IT company.

“We have always harboured significant ambitions, our problem is that people did not believe us,” says Menon,the new poster boy of the Indian IT sector.

And Menon is not alone. Several small and mid-sized Indian companies have acquired companies overseas,which are either the same size or bigger than them. BPO firm TransWorks acquired Minacs Worldwide in Junelast for $125 million.

The Canadian BPO had a revenue of $260 million against TransWork’s 35 million. After the acquisition, TransworksMinacs with a revenue of $300 million became the second-largest BPO company in India, second only toGenpact. Together, these entrepreneurs seems to have changed the image of India Inc. Today, global companiesare much more willing to be taken over by Indian firms. And the trend globesetting is picking up. “Recently, aclient with a turnover or Rs 40 crore came to me and said he wanted to do an IPO,” says Shyam Shenthar, MDOzone Capital. He felt the company’s turnover was too small for an IPO.”A few days later the owner came tome with a list of potential targets abroad, which were roughly the same size as his business, wanting to knowif we could help him acquire any of those companies. “An acquisition with a same sized company would easilyput him in the Rs 100 crore bracket, a decent size for an IPO.

Shenthar’s client may be an exteme example, but it is not an isolated one. According to a report by GrantThornton, the number of crooos-border deals from India in 2006 grew much faster than domestic deals. Therewere 480 M&A deals in India last year with a total value of about $20.3 billion. Of these, more than half, or 266,were cross-border deals (value $15.3 billion). In 2004, the number of cross-border deals was only 60.

Of the 480 M&A deals, only 40 had a deal value of over $100 million. The average deal size was $42 million,which clearly shows that the “majority of transactions whether domestic or cross-border, is being done by mid-sized companies,” says the report. In a clear indication that companies are acquiring targets much bigger in size,the relative size of acquisition have also grown. “The size of acquisition to the size of acquirer (market capitalization)used to be about 10% in 2004 and is now approximately 25%. We are seeing a number of transaction wherethe relative size is close to or exceeding 100%,” says the report.

Ambition and scaleClearly it is the ambition and confidence of the Indian entrepreneurs that is driving this deal frenzy. Companiesused to wait years before thinking of entering global markets; now an entrepreneur with a turnover of $15-30million wants to take his business global. And he does not want to wait for an organic entry.

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Four months ago, Gaurav Deepak, the EVP and Founder of Avendus, an investment bank that offers privateequity syndication and M&A advisory to corporates, closed a deal for Manugraph India, the largest manufacturerof web offset printing machines in India. Manugraph, with a turnover of about $70 million, wanted to set up asales and distribution network in the US. “They could have taken the organic route but it would have taken themat least 2-3 years to set up an office in the US. Then there was the risk whether the move would have workedor not,” says Deepak. The company decided that the acquisition route would work much faster.

Avendus started scouting the US market. “What is surprising is that we were cold calling companies that weren’teven looking for a sellout, but when they heard that it was an Indian company, they were immediately interested.This would not have happened two or three years ago. “In November last Manugraph acquired Dauphin GraphicMachines Inc (DGM), a $70 million Pennsylvania-based manufacturer or web offsent machines, for a cashconsideration of $ 19.2 million. Manugraph DGM is now the largest manufacturer of single width press in theworld.

While the Indian companies ambition is certainly driving the M&As, there is greater opportunity to acquire todaythan ever before, Lower margins and very high cost of operations are making it difficult for the foreign companiesto raise capital and grow business. Azure, the company that Subex acquired, did not ever make any profits whileSubex at a margin of 40% was highly profitable. Minacs was operating with a margin of barely 1-2% whileTransoworks had a much higher profit margin of 18%. The capital structure of Syndesis was in such a mess(the company had seven different classes of shareholders) that even though the company was burning cash itwas difficult for it to raise capital. Manugraph’s EBIDTA before the deal were in the range of 20-25% where asDGM was operating in the 5% range.

Indian companies are also enjoying a bull run on the stock markets and are in a far better position to raisecapital. At a valuation of 5-6 times EBIDTA, Indian companies are easily able to afford these acquisitions. Mostof the funding is coming through IPO money, GDR issue, FCCBs or even internal accruals. There is no dearthof PE money available for acquisitions as well.

“The writing on the walls is clear,” says Shenthar, “If you are in manufacturing then you will have to sell to eitherthe Chinese or the Indian.” Adds Harish HV, partner and head, south India, Grant Thornton, “India is on the listof every company abroad that is trying to sell.”

In many cases, Indian companies are even buying out the companies they were supplying to or partnering with.Some are even bailing out their partners in distress. In June 2006, Allcargo Movers India, a Chenai basedlogistics company, acquired Belgium-based ECU Line Group (revenues e180 million)a leading global player inair, sea and road transportation. For over a decade, Allcargo had used ECU’s network for carrying goods todestinations across the world. The acquisition gives Allcargo access to the high-margin markets of Europe, LatinAmerica and Africa as well as the high-volume markets of the US and China.

Will these acquisitions work?While it may be euphoric to acquire companies overseas, Indian companies have their task cut out as fas asintegrating the companies go. They will also have to be extremely careful to not saddle their operations with thehigher costs that the overseas companies bring. Subex has seen its margins drop from 40% to 22% afteracquiring Azure. The company is rationalizing these costs by moving some of the jobs from high cost locationsoverseas to India. “Once the global delivery model kicks in, the costs automatically get aligned” says AtulKanwar, CEO, Transworks Minacs. Kanwar says the company is lowly increasing its pie with large customerssuch as General Motors by picking up processes that can be delivered offshore, which Minacs couldn’t do.

Another worry is retaining some of the key employees abroad as the customer contacts is what the Indiancompanies are interested in. when Subex acquired Azure, it made the costly mistake of not making key employeessign employment contracts, and ended up losing key employees. With Syndesis the company is careful of notmaking that mistake. With most acquisitions not even a year old, the work is far from done.

ABN AMRO commenced its mergers and acquisitions (M&A) advisory business in India in 1998. We have comea long way since then, having been ranked #2 in India on the basis of several landmark M&A transactionscompleted in the calendar year 2006.

We have advised on transactions where we have taken our clients to new markets (advising the shareholdersof Tata Steel on the acquisition of 100% equity stake in Corus Group Plc for US$10.1b, advising RanbaxyLaboratories Limited on the acquisition of 100% equity stake in Terapia SA for US$324m) and / or to enterrelated businesses where synergies exist or for acquiring new technologies.

We have advised on transactions which have been driven by defensive reasons such as contracting markets,falling product prices (advising the shareholders of Matrix Laboratories Limited on the divestment of 71% equitystake to Mylan Laboratories Inc for US$750m), excess capacity, the uncertainties of technological change or thesoaring costs of research, when the imperative has been to consolidate and improve efficiencies.

We have also advised our clients on transactions aimed at achieving their desire to restructure their investmentportfolio (advising the shareholders of the Nirula’s Group on the divestment of 100% equity stake to fundsadvised by Navis Capital Partners) or induct a strategic partner to achieve global best practice (advising theAirports Authority of India (AAI) on the restructuring and modernization of Mumbai and Delhi Airports which isexpected to yield about US$2.4b by way of concession fees to the AAI over the first 20 years of the concessionperiod).

As financial advisors, the most important service ABN AMRO renders its clients is to be crystal clear about thestrategic rationale for any transaction and offer end-to-end solutions including advisory, structuring, financing,hedging, etc. to achieve success. Adrenaline, vanity and greed are poor reasons for pursuing an M&A strategy,as are copycat mergers and acquisitions driven by the fear of looking foolish or being left behind when all ofone’s competitors are pursuing such a strategy. Sometimes M&A activity is also driven by the fact that achievingorganic growth in a mature market can be grindingly slow, while pursuing an acquisition is much more exhilarating.

In any transaction we pay the utmost emphasis on ascertaining the strategic fit and rationale. Our endeavouris to focus on the appropriateness of an opportunity rather than mere availability. We believe in creatingtransactions rather than merely executing a trade in an auction process. ABN AMRO’s vast network and footprintacross a number of geographies including Europe, the Americas and Asia-Pacific means that we can providea one-stop shop for our clients’ requirements for cross border acquisition advisory services. When doing so, weaim to maximize the likelihood of success as well as of subsequent value creation. The significant volumes ofrepeat business given to us by our clients bears testimony to the fact that they consider engaging us to be avalue accretive investment. We wouldn’t advise them to hire us if it wasn’t!

Ernst & Young, a global leader in professional services, is committed to restoring the public’s trust in professionalservices firms and in the quality of financial reporting. Its 114,000 people in 140 countries pursue the highestlevels of integrity, quality, and professionalism in providing a range of sophisticated services centered on ourcore competencies of auditing, accounting, tax, and transactions.

Ernst & Young operates from 7 cities* in India (www.ey.com/india) with a work force of over 2400 people, whowork towards the firm’s vision of being the trusted business advisor that contributes most to the success ofpeople and clients by creating value and confidence. Global Tax Advisory Services, Risk and Business Solutionsand Transaction Advisory Services are the core services offered by the firm. Transaction Advisory Services hasfour service lines - Lead Advisory, Valuation and Business Modeling and Business Advisory Services.

The Lead Advisory (LA) Practice has been consistently ranked as the No. 1 M&A practice in India. With over100 dedicated professionals in our Lead Advisory business, we offer a comprehensive, integrated solution to allM&A requirements. The practice advises a number of companies by offering teams attuned to the marketsegment in question. These are professionals who understand the nuances of smaller companies, the uniquenessof mid-size companies, as well as the operating environment of larger organizations.

The strength of the LA practice rests in its diversified professional group, with experience beyond just traditionallead advisory – with hands-on experts working on complex deals and bringing that collective experience ontothe next transaction. The team also consists of specialists who have a deep understanding of capital marketsand its trends in India.

The Valuations practice at Ernst & Young has one of the largest teams of professionals dedicated to providingquality valuation and business modeling services in India. The team consists of personnel with varied skill setsand educational backgrounds including chartered accountants, management post graduates and engineers.

High process discipline and uniform application of consistent valuation principles and practices across assignmentsis one of strengths of the Valuations practice. The team also provides a detailed analytical reporting of professionalvalue recommendation. Being part of the Ernst & Young’s global valuation and business modeling network,enables the India practice to leverage on global expertise and knowledge.

The Transaction Support (TS) services provides accounting, financial, tax, and information technology duediligence assistance to investors and companies in all forms of transactions. It seeks to maximize the benefitsof a contemplated transaction, and identify exposures and risks that need to be managed.

Business Advisory Services (BAS) extends Ernst & Young services to assisting clients in charting their strategyand aligning operational processes in order to create shareholder value. Our analysis provides a fact basedperspective for resource deployment and process alignment to optimize value. Our extensive experience acrossindustries and organizations further helps us respond effectively to your specific needs. This service line effectivelycomplements the other services provided by Transaction Advisory Services.

* Ernst & Young has offices in New Delhi, Mumbai, Chennai, Kolkata, Hyderabad, Bangalore and Pune.

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NTRODUCTION - · PDF fileINTRODUCTION Consolidation or ... funding options, regulatory framework and ... Tata Steel’s acquisition of Corus is among the largest outbound deals and