Inbound deal value has increased from 9.9 billion USD in 2015 to 21.4 billion USD in 2016, reporting 115% increase y-o-y. There were a lot of pent-up demands in India for investments. Several large international companies, which are sitting on a huge pile of cash, are looking at opportunities to deploy their capital in India.
The New Era of Indian Business
The inflow of foreign direct investments (FDI) to India has dramatically increased since the latter half of the 1990s. There has been a significant elevation in value and number of cross-border acquisitions in India.
Inbound deal value has increased from USD 9.9 billion in 2015 to USD 21.4 billion in 2016, reporting 115 percent increase YoY. There were a lot of pent-up demand in India for investments. Several large international companies, which are sitting on a huge pile of cash, are looking at opportunities to deploy their capital in India.
Hence, mergers & acquisitions (M&A) will continue to sustain as the most favoured route for investing in India through FDI channel in the coming years also. Some factors that will drive M&A in India are reasonable valuation, diversifications, improved sentiments (due to GST & demonetization) and a large growing market.
Further, the government of India has announced many radical changes in the FDI policy in November 2015 as well as in June 2016, placing most of the capital-intensive sectors like real estate, defence and civil aviation under the automatic approval route, thereby creating scope for entry of foreign capital in these sectors. Several other policy initiatives by the government, such as the ‘Make in India’ campaign, ‘Smart City’ development and ‘Digital India’ provide a favourable outlook for inbound investments into the country.Now the big questions are -
- Why the Indian market and where to find opportunities in it?
- What are the entry strategies towards the Indian market?
- Whether your business requires breaking into the Indian market?
- What is the risk of investing in Indian market?
Let’s deal with each of these questions in detail here.
Why Indian market?
On the development front, India has high probability of becoming the third largest economy in the world by 2030, making it one of the biggest markets all over the world. FDI in India has shown a marked increase of 29 percent during the period of October 2014 to December 2015 (after the launch of ‘Make in India’ campaign). India also ranked highest internationally in terms of consumer confidence for the quarter October-December, 2015. Further, in the Indian market, the scope of cost minimization and benefit maximization is huge, owing to economic inefficiency and higher NPA in Indian banking sector (due to mounting pressure from lenders, debt-ridden companies sell their assets at a cheaper price).
Therefore, one can expect foreign companies to actively look for opportunities to enter the Indian market. Sectors such as information technology, pharma, E-commerce, power, NBFC and manufacturing are expected to be some of the preferred choices for cross-border deals in India.
Indian market is for long-term perspective.
Developed countries such as US and UK are in a matured stage whereas developing countries like India are in the emerging states of development. Hence, Indian companies are low-cost commodity players whereas the companies from developed economies are value-added branded products.
Hence, from the investment perspective, one has to look at the Indian market with a long-term view. Though, the short-term objectives appear uncertain, their long-term vision for acquisition should be clear to achieve managerial experience, financial strengths and healthy establishments with strong performance. The clearly spelt out a long-term vision which ought to be supported in attaining their goals. Since India is the largest market in the world, the focus of investment should be directed towards transfer of technologies, managerial capabilities and better market access through sales affiliates.
Whether your business requires to break into the Indian market
Before dealing with Indian market entry strategies, one has to understand the objectives and type of M&As to be adopted. The most common goals of M&A are to increase market share, diversify products and services and cost reduction, entering into new markets, technology transfer and financial viability (low cost capital).
Hence, calculating synergies or determining share exchange ratio, when two companies merge is always challenging. The premium paid by the buyers depends on the synergies. Thus, premium represents their company's future prospects from sellers’ point of view. Hence, during a synergy, the value of two companies combined should be greater than the sum of separate individual parts.
Calculating the potential benefit achieved by merging companies becomes paramount. Again, calculation and identification of the right synergies and value drivers are difficult to measure as they occur in various forms such as cost synergies, revenue synergies, financial synergies, operation synergies and market synergies. Synergies depend greatly on the intention of the investor. For instance, if the objective of the buyer or investor is cost reduction post acquisition, then it belongs to horizontal merger. The goals of horizontal M&A are to achieve economies of scale, cross-selling, maximization of market share, entering into new markets & improvement in post acquisitions operating performance. Domino’s capturing the German market through acquisition of German Pizza by paying USD 86 million during late 2015 sets a perfect example for this case (Source: BBC News).
On the other hand, if the objective of the investor or buyer is to get more control over its supporting steps of supply chain (supplier or raw material provider), it comes under vertical M&A. The objectives of the vertical M&A are cost reduction, control market power of supplier, increase entry barriers, improve capacity utilizations and ease backward and forward integrations. Acquisition of Paypal by Ebay during 2002 illustrates vertical Merger perfectly. Ebay being an E-commerce company has acquired PayPal, an online money transfer company, to support its customers’ electronic payment service.
Apart from the reasons listed above, acquisitions can depend on mixed or pure market strategies such as friendly, hostile or diversified only. For example, Facebook has acquired WhatsApp at approximately USD 19-20 billion. At the time of acquisition, WhatsApp had charged 1 USD from a few countries. However, that does not justify the valuation of USD 20 billion. Facebook had not paid WhatsApp for its revenue model but for its more than 600 million active users in Asia, Europe and Latin America at the time of acquisition. Further, in the initial years of its operation, WhatsApp had grown faster than Skype, Twitter, Facebook and LinkedIn.
In the past, a couple of international players like Vodafone-Hutchison Essar had made a successful entry into the Indian market. In the 2007, Vodafone had acquired controlling stake in Hutchison Essar to enter the high growing telecom market in India.
The risk of investing in Indian market
Whether it is Indian market or a developed economy, the investor may have far-reaching consequences post-acquisition. However, history suggests that 90 percent of M&A fails (do not achieve the planned synergies), probably due to high valuations, lack of well-understood value drivers and cultural misfit.
Ranbaxy-Daiichi Sankyo deal can be quoted as an example. In 2008, Daiichi Sankyo entered into a joint venture agreement with the largest pharmaceutical company in India, Ranbaxy Laboratories. However, during 2012-13, the company made an indirect exit from Ranbaxy. The Japanese drug maker exited at a more discounted price than it had paid to buy Ranbaxy. Hence, one should understand that emerging economy differs from the developed economy in a couple of areas such as taxes, transaction costs, liquidity, accounting transparency and governance.
From the perspective of investors, it is always better to understand the value driver prior to investing. Snapdeal in the Indian E-commerce market can be illustrated as an example.
Snapdeal as a local player has failed, but foreign players like Amazon, E-bay and Alibaba funded Paytm E-commerce is doing reasonably well. Snapdeal showed a good initial start in terms of funding, sales and gained vertical growth by making couple of acquisitions, but at the end of the day, Snapdeal has lost its battle with Flipkart, Amazon and Paytm. Even during demonetisation, Snapdeal investee company Freecharge has failed to capitalize the market but Paytm utilised the opportunity very well.
Undoubtedly, India is most likely to remain the highly favoured destination for M&A for its attractive climate among MNCs in terms of stable policies, cheap labour, unexplored markets and availability of natural resources. However, before investing in India, it is necessary to gain knowledge on Indian institutional laws-regulatory-financial system, accounting and tax provisions, investor protection clause, geographical, political and cultural factors. For instance, Indian laws are very rigid. In India, according to the notification issued by the Reserve Bank of India (RBI), valuation certificates are required to be submitted along with other relevant documents in case of inbound (FDI Valuation) and outbound (ODI Valuation) transactions.
Moreover in the case of overseas direct investment transactions exceeding USD 5 million, only a SEBI registered (Cat-I) merchant banker is authorized to do the valuations. Further, as per clause 24(h) of the listing agreement, in the case of a listed company getting merged, it is required to obtain a "fairness opinion" on the valuation done by valuers from an independent SEBI Registered (Cat-I) merchant banker.(Gaurav Barick, is an Investment Banker & Venture Capitalist and is Mentor with Finshore Management Service Limited, a SEBI Registered Merchant Banker. He is reachable at email@example.com).