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.

Foreign sellers are not yet confident about accepting payments in the form of equity in Indian companies. For them it would also amount to foreign direct investment, which brings regulatory issues. Also, in many cases, the overseas sellers are private equity funds and such sellers are reluctant to accept stock because either they are looking to cash out or are unsure about the valuation of the buying firm.

While domestic acquisitions have been funded though equity funds raised through either IPOs, private placements or rights issues, overseas acquisition financing has generally been structured as leveraged buy-outs (LBOs). For example, acquisitions have been funded through debts mobilised either in the acquiring company or in a special purpose vehicle incorporated for the acquisition. Subsequently, acquiring company has reduced gearing by mobilising funds through IPOs, private placement or rights offerings.

Typical debt instruments used for financing acquisitions have been syndicated loans, external commercial borrowings or foreign currency convertible bonds (FCCBs). Equity financing has been in the form of private placements or public issues.

Syndicated loans from banks are one of the primary sources of financing the outbound acquisitions. They are currently priced at LIBOR (London Inter-Bank Offer Rate) plus 250 - 400 basis points and the tenure can vary between three and seven years. These can be raised via ECB route if raised in India or else raised outside based on the transaction structure. Typically the key factors considered by the lenders are:

FCCBs have also been quite popular instruments, especially at times of booming stock markets. These instruments have seen trigger prices for conversion of the bonds into equity at premiums to the prevailing stock price ranging from 25% to 75%. Also, the coupon rates on these bonds were usually 150-200 basis points below the general debt coupon rates.

Raising funds (debt or equity) through public issuances has been a time consuming process. However, some of the Indian companies have taken advantage of the shorter route from government designated Qualified Institutional Buyers (QIBs) who are familiar with the Indian markets. Companies have also been opting for bridge financing from the banks to raise interim funds followed by the public issuances to repay them.

Over the last few years, private equity and hedge funds have also emerged as a major source of financing for Indian acquirers of overseas companies. Typically, they are willing to support the companies in which they have already invested. They are open to follow-on investments to help firms with acquisitions plans to go global. These funds have also altered their investment strategies from being pure equity funding to a mix of equity and debt. However, the cost of financing from these sources is higher as compared to the traditional sources of finance.

While there is no single structure that can be efficient, it depends on the acquirer and target’s country of residence. However, most of the overseas acquisitions are through multi-level structures, which can be leveraged for future acquisitions.