Overseas acquisitions ride on new financing options

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India has come a long way since the pre-liberalisation regime where it was characterised by stringent regulations, restrictive labour laws and inefficiencies in the judicial system and protection to domestic industry. Today the Indian industry is steadily moving towards building globally competitive enterprises. This spurt in the cross border M&A activity is backed by healthy performance at home, strong management capabilities, buoyant stock markets and access to competitive financing.

India’s regulatory environment for overseas acquisitions has facilitated overseas acquisitions through a relaxed regime. In a move that has catalysed the growth of outbound foreign investment, the Indian government in January 2005 removed the cap of $100 million on foreign investments by Indian companies and raised it to the level of net worth of the acquiring Indian firms. In March 2006, the Reserve Bank of India (RBI) eased many of the regulations relating to overseas investment by Indian companies.

While Corporate India is rapidly marching towards global presence, overseas acquisition- financing options by domestic players are still limited, primarily on account of regulatory constraints on the traditional domestic fund providers. Indian banks are unable to directly participate in the acquisition financing and they look at funding the transaction through their overseas subsidiaries. However, foreign investors, private equity and hedge funds through their overseas branches are betting on and aggressively backing Indian companies in the latter’s foreign acquisitions.

However, unlike most international M&A transactions that typically feature stock swaps, Indian acquirers have for the most part paid cash for their targets, mobilised through a combination of internal resources and borrowings. Share swaps have not yet emerged as a favoured payment option in India for overseas acquisitions because of the domestic regulatory impediments (subsidiaries not permitted to hold shares of its holding companies).

The other possible reason why most transactions have been executed through cash payments is that many Indian companies have high promoter holdings, and promoters also comprise the management. According to some private fund insiders, overseas sellers are often hesitant to invest through stock swaps in firms they perceive are primarily promoter “owned and managed”.

Moreover, while the Indian capital markets are far deeper today, they are still small and are susceptible to liquidity constraints when compared with markets in other developed economies.