Explained | Why common ownership in companies by private equity funds has caught the fancy of CCI

The Boston Consulting Group once studied more than 50,000 deals over a period of nearly four decades and arrived at the following conclusion – deals struck during an economic downturn create more value.

Cash-rich private equity funds with an eye on the Indian market seem to be swearing by that conclusion. Many of them missed out during the global financial crisis of 2007-2008 and are now tumbling over each other in the Covid-19 era to sign term sheets.

Not surprisingly, private equity investments in India hit a record high of $28.66 billion at the end of September, according to a study by Refinitiv. That’s sharply over the $16.27 billion invested in the whole of 2019. The year promises to end with a bang as PE’s are chasing transactions in sectors ranging from pharma to consumer to financial services. In the process, they are not just edging out, but completely side-lining strategic suitors, the natural aggressive buyers of the past.

And without doubt, the country’s anti-monopoly watchdog, the Competition Commission of India (CCI) is keeping a close eye on these winds of change in the world of mergers and acquisitions.

Last week, some believe the CCI chairman set the cat amongst the pigeons , to use a British idiom, by suggesting a closer scrutiny of private equity investments in corporate India. Some of these funds are now a nervous lot.

So, is their anxiety justified or are the fears blown out of proportion and the regulator is merely looking to embrace global best practices ?

Let us try and understand the scenario –

"In order to understand the trends and patterns of common ownership by PE investors across sectors in India, the Commission is shortly going to conduct a market study,” said Ashok Kumar Gupta. He was speaking at the annual conference on competition law and practice, organised by the CII.

According to the regulator, since many of these PE investments are in multiple firms of the same industry, leading to product-market overlaps, the issue of common ownership by minority shareholders across firms and its impact on competition needs to be understood. For instance, at one point, Carlyle held a minority stake in Metropolis Healthcare (now it has exited the firm) as well as Medanta Medicity, both investments in the healthcare segment.

The regulator believes the study would help in identifying the kind of shareholding rights available to common shareholders (read PE Funds), the type of influence these rights provide, whether these rights can translate into an ability to influence the decision of a firm, consequently impacting competition and the available safeguards in a company’s policies for mitigating competition concerns, if any.

Sure. Basically, it appears the CCI wants to ensure that private equity funds are not “actively” influencing competition or aspects relating to competition in the garb of “passive investors.”

The regulator has been examining sub-10 per cent investments in target enterprises by PE investors where they even have a board seat in the target enterprises. In fact in one (un)popular case earlier this year, a private equity firm with sub 10 percent stake in one firm , was asked to give up its board seat in another firm in the same sector, where it also held less than 10 per cent stake. However, the order was withdrawn by the CCI and is not in public domain.

If a private equity firm does not have a board seat OR rights ordinary shareholders don’t have , then a sub 10 per cent stake does not require a filing and is exempt from CCI approval. In general , private equity firms are not particularly thrilled about approvals from the CCI. They believe awaiting regulatory nods might interfere with deal completion timelines they have in mind.

Nisha Kaur Oberoi, Partner and National Head (Competition), Trilegal says it’s common for private equity funds to invest in multiple companies in the same sector. She outlines the considerations of the CCI when private equity funds notify their minority investments -

(i) The investor protection rights under the transaction documents being considered as conferment of ‘control’ by the CCI,

and/ or

(ii) (ii) the fact that the private equity investor is getting a board seat,

and/ or

(iii) (iii) the transactions being repeat investment in the same sector and therefore being considered as ‘strategic ’ investment by the CCI.

To be sure, the CCI looks at multiple aspects like the budget, business plan & bunch of rights to determine “control.”

The subject of common ownership by PE funds has already been examined 2-3 years back by the US, DoJ (Department of Justice) and the OECD (Organisation For Economic Co-Operation and Development) .

It started as an academic debate but has now clearly caught the attention of competition authorities. More recently, this view has been called into question by various competition authorities including the European Commission (EC) and US antitrust authorities as recent studies have linked common ownership with competition concerns.

“(Globally), it has been theorized that PE investors with holdings in multiple competing firms may have the incentive to reduce competition, either by facilitating cartels or by encouraging unilateral business decisions that may benefit some portfolio firms at the expense of others,” says Vaibhav Choukse, Partner (Competition Law) at J Sagar Associates.

In fact , the European Commission took common ownership into account in two recent high-profile merger cases, namely Dow / DuPont (2017) and Bayer / Monsanto (2018). Further, in December 2018, the US Federal Trade Commission held a hearing on common ownership which led to strong reactions from investors and index providers.

Experts believe the CCI’s interest in this study could be driven by the recent interest shown by its peers on this topic and the complaints it had received on this issue, including the one against Ola/Uber. Japan’s SoftBank was the common investor.

“The CCI’s apprehension could be that the common shareholdings may lead to a reduction in the incentives for competition between those businesses and that a common shareholder may have access to competitively-sensitive confidential information relating to two competing businesses and could facilitate information sharing, which may lead to a cartel-like situation,” elaborates Choukse.

Typically, a cartel refers to a situation wherein a group of separate companies agree to increase profits by fixing prices and not competing with each other.

GR Bhatia , Partner and Head (Competition Law) at L&L Partners believes the CCI’s consistent approach has been to facilitate benign conditions for investments. He feels that in order to rebound, the Indian economy needs private equity investments.

“PE funds should take this in the positive spirit and in no way is it intrusive. They are expected to watch this study curiously and as I see, they would need to reassess their investment strategy and nothing beyond this,” he says and adds the regulator wants to evolve strategic solutions to ensure a win-win for all.

“Minority investments by a private equity fund, even if accompanied by a board seat, do not provide the fund the ability to control the affairs of the portfolio company. As such, the presence of board nominees across competing portfolio companies does not automatically imply that the common shareholder can effectively influence outcomes, given that there are substantial checks and balances in the form of presence of the other shareholders/ board nominees and strong corporate governance measures,” adds Uberoi.

Moneycontrol got diametrically opposite reactions when it contacted executives at two leading private equity funds. One based in the US, and the other of Asian origin and both spoke on the condition of anonymity.

“ It makes sense for them (CCI) to get comfortable on minority stakes in multiples companies,” said one of them. “ This could slow down PE investing. They already have thresholds and hence don’t see the need for this,” said the other!

Sections 5 and 6 of the Competition Act , which deals with the regulation of mergers and acquisitions have been in force since June 1, 2011. In the backdrop of this study on PE investments, experts feel it will be crucial to observe the extent to which common ownership may arise as a concern in the context of merger control proceedings.

In the past, the CCI has asked for details of shareholders’ stake in other corporations operating in the same sector. Thus, many observers believe one should expect this trend to continue, particularly in sectors characterised by higher levels of concentration and common ownership. Net-Net, the study represents an empirical analysis of common ownership, and for the time being, regulatory or legislative changes do not appear imminent.