Mergers & Acquisitions (M&A) activity worldwide has seen a year-on-year rise due to many factors including relaxed regulatory scrutiny, reduced operating costs and beneficial tax regimes. The disruption caused by the COVID-19 pandemic led to a rise in protectionist measures in several jurisdictions, including India (see our update here), which, combined with rising inflation, increased taxes and disruptions in existing supply chain models, posed a significant economic threat globally.
However, the liquidity unleashed by central banks globally in the last couple of years has resulted in stock markets rising to unprecedented highs, and M&A and investment activity smashing all previous records last year in terms of value and volume of deals.
This update highlights the key trends from 2021, analyzes the factors impacting deal-making activity and summarizes our outlook for M&A in 2022.
As per Big-4 accounting firm PricewaterhouseCoopers, 2021 saw publicly disclosed deal values reach an all-time high of US$5.1 trillion, approximately 20% higher than the previous record of US$4.2 trillion achieved in 2007. Moreover, a significant number of deals had a value greater than US$5 billion, as corporates made up for the time lost in 2020 with renewed vigour and fuelled growth through acquisitions.
In India, the M&A frenzy was driven by first-time buyers, industry disrupting start-ups and incumbent behemoths across multiple sectors. 2021 saw the number of unicorns in the country triple due to the attractiveness of India as the last major untapped technology and e-commerce market, and the significant amount of capital available with international funds and companies. As a result of low interest rates globally (enabling easy leverage), strong cash reserves and the de-leveraging of manufacturing from China, there were more than 80 strategic acquisitions of Indian companies through the foreign direct investment (FDI) route, valued at over US$75 million each.
Between January and December 2021, total FDI inflows aggregated to approximately US$73.68 billion as per the data collated by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India. In line with previous years, the services sector along with the computer software and hardware sector continued to attract the highest FDI, and Maharashtra, Gujarat and Karnataka were the top three states attracting FDI. The US was the top investing country after Mauritius and Singapore, which are commonly used as intermediary jurisdictions from a tax standpoint.
In 2021, the Indian government increased the FDI limit for the insurance sector from 49% to 74%. This was a welcome move, as India has one of the lowest insurance penetration rates in the world, and the only way to improve things is to attract more FDI in this sector. In line with this, the Indian government notified new rules for FDI in the insurance sector and scrapped the erstwhile requirement for Indian promoters of insurance joint ventures to nominate a majority of the board of directors. However, the rules also provided that a majority of the board of directors and key managerial personnel should be resident Indian citizens, and least one executive position, namely, the chairperson of the board, the managing director or the chief executive officer should be a resident Indian citizen. These changes are likely to spur foreign investment in a sector which is traditionally very capital-intensive and requires a long gestation period for a return on investments.
The e-commerce sector in India has been growing at a tremendous rate in recent years. With India’s large consumer market available to be serviced, major international players such as Amazon and Walmart have dramatically increased their Indian investments, alongside Indian majors like Reliance and the Tata Group (the latter acquired online grocery provider Big Basket in May 2021 to enter the e-commerce space and pit its might against the other entrenched players). This spate of recent acquisitions has taken place against the backdrop of complaints raised by aggrieved consumers, local traders, associations and regulators in respect of the allegedly unfair trade practices prevalent in the e-commerce sector in India.
India’s foreign exchange regulations permit 100% FDI in the e-commerce sector under the automatic route for entities following a marketplace model, but subject to compliance with several sectoral conditions. A major source of concern has been the adoption of complex ownership structures by e-commerce players which are allegedly aimed at circumventing the applicable sectoral conditions. In this context, the Indian government notified the Consumer Protection (E-Commerce) Rules, 2020.
Subsequently, in June 2021, the Indian government proposed amendments to these rules to curb the unfair practices prevalent in the sector. We have discussed the proposed amendments in detail in our update available here and while the amendments are yet to be notified, they are consumer-focused and aimed at creating a level-playing field for participants in the e-commerce market in India. At the same time, the proposed amendments will significantly increase the compliance burden for e-commerce entities, and therefore, players in this space should keep a track of these amendments.
As per data released by the Ministry of Commerce and Industry, Government of India, India’s fintech adoption rate is an impressive 87% as against the global average of 64%. The rapid digitization of payment gateways, increase in availability of cheap smartphones, and other enabling measures introduced by the Indian government have provided a major boost to this sector. Consequently, many start-ups offering lending, neobanking and such other products, have emerged and have attracted significant funding. Amazon, Airtel and WhatsApp have all entered the payments space as a complimentary addition to their existing businesses and to provide an alternative to banks, which have traditionally dominated the payments space.
With the rise in investment and market penetration, a key concern has been the protection of financial information and payment data. To address this concern and to regulate the outsourcing of operations by payment service providers, in August 2021, the Reserve Bank of India issued a new framework on outsourcing of payment and settlement-related activities by non-bank payment system operations. The new framework which has been analyzed in our update available here introduces, inter alia, data localization requirements and several onerous compliance obligations. As the sector continues to explode, it remains a sensitive one, and investors will likely have to navigate several such regulatory challenges in the future.
Clamping down on investment from China
April 2020 saw India clamp down on predatory investments from neighbouring countries, especially from China, as the Indian government issued Press Note 3 of 2020, which mandated obtaining government approvals for all investments originating from countries sharing a land border with India. 2021 saw the impact of this move, as investments from China, Hong Kong and other border sharing countries dried up against the backdrop of regulatory uncertainty.
For a large part of 2021, approvals for such investments remained pending as the Indian government kept its policy on such investments in abeyance. However, press reports suggest that the second half of 2021 saw the Indian government ease its stance and grant approval to a large number of proposals while also contemplating a threshold of 25% beneficial ownership for such approvals. Nevertheless, at this stage, none of the approvals are available in the public domain, and there is continued uncertainty among market participants as the Indian government is yet to formally announce the applicable thresholds.
Amazon v. Future case
In 2019, Amazon was granted approval by the Competition Commission of India (CCI) for its proposal to acquire a stake in Future Coupons, a member of Indian retail conglomerate, the Future Group. Pursuant to the approval, Amazon acquired a 49% stake in Future Coupons, which itself held a 9.82% stake in Future Retail, thereby giving Amazon an indirect 4.9% stake in Future Retail. In August 2020, the relationship between Amazon and the Future Group turned sour, as the latter struck a deal with Reliance Industries Limited for the sale of its retail business. As Amazon approached various judicial forums in India to challenge the foregoing deal on the ground that it violated the terms of its 2019 investment in Future Coupons and indirect acquisition of Future Retail, it became clear that Amazon was keenly interested in taking over the Future Group’s retail business.
The events that followed were unprecedented. In June 2021, CCI accused Amazon of concealing facts and making false representations about its plans relating to the Future Coupons acquisition. December 2021 saw the CCI retrospectively suspending its 2019 approval and slap a hefty fine on Amazon for misleading the regulator. The CCI’s retrospective suspension of its approval will create uncertainty and sets a worrying precedent for investors. Amazon has challenged the CCI suspension order while continuing to litigate against the Reliance-Future Group deal. The result of this litigation will be keenly awaited by foreign investors.
Foreign investors can adopt a variety of transaction structures based on the requirements of the transaction and the issues thrown up in the target’s due diligence. A share purchase is the most common mode of acquisition in India. However, as successor liability cannot be ring-fenced, a share purchase often requires a deep dive diligence into the target’s prior compliances, especially, corporate, employment, anti-corruption and environment laws. On the other hand, successor liability can be ring-fenced if acquirers opt for either an asset transfer or business transfer. While from the acquirer’s perspective, these structures are fairly similar, a business transfer (categorized as a slump sale) may be preferred by the seller to avail certain tax benefits under Indian law. Other than the broad structure, acquirers should also consider factors like sector sensitivity and regulation, acquiring a minority or equal stake initially and full ownership on a staggered basis, as well as the use of debt financing.
Unlike businesses in the US or Europe, privately owned businesses in India are typically family-run businesses which may not always be professionally managed. Aligning compliance expectations against this backdrop is recommended, as investors are likely to encounter lower compliance levels. Additionally, timelines are typically treated as indicative and may not always be met. Foreign acquirers should also understand that business structures in India are often hierarchically arranged, and therefore, key negotiations should only be conducted with top-level management or senior family owners. Even when negotiating with top-level management, it is important to appreciate the difference in communication styles, as often a “yes” may only represent the seller’s tendency to be polite. Typically, family-owned enterprises and successful start-ups expect a premium. In addition, individual promoters may want to retain key employment positions post acquisition, especially if a part of the pay-out is linked to an earn-out.
As the direct impact of the pandemic and government-enforced lockdowns is gradually receding, several sectors in India such as aviation, leisure and tourism, shipping, and automotive continue to face significant financial pressures. India’s insolvency regime, which was overhauled in 2016, provides comfort to acquirers as strict timelines and established processes provide certainty in respect of the acquisition process and value retention of the distressed asset. The key features of India’s insolvency regime include time-bound resolutions, creditor control over assets and business operations, and strict scrutiny of value-eroding transactions.
Adequate planning at the negotiation and acquisition stage is important to avoid potential pitfalls leading to lengthy litigation at a later stage. For instance, 2021 saw a major dispute between two players engaged in the tech-enabled accommodation management and booking business in India on the enforceability of a non-binding term sheet. While the dispute continues to be litigated before Indian courts and the arbitral award granted in the dispute does not have precedent value, the dispute has shed light on the interpretation of term sheets (see our update here). In its award, the arbitral tribunal held that a term sheet executed between parties can be binding in nature despite the express declaration in the preamble of the term sheet stating that it was non-binding and merely exploratory. Therefore, parties should exercise prudence and not rely on the mere use of the phrase, “non-binding”, to determine the risk of their exposure. Instead, parties must ensure that the document as a whole conveys the intention of the parties to not create any binding purchase obligations, and in addition, their actions should also show this intent.
Another important aspect in negotiations is the choice of law and forum governing the transaction documents. India follows a reciprocal regime for enforcement of foreign judgments, and judicial rulings from several foreign jurisdictions such as the US, Germany and other European countries cannot be directly enforced in India. Instead, in such cases, parties will have to initiate separate enforcement proceedings before an Indian court, which can be time-consuming and cumbersome. In case the investor prefers a foreign jurisdiction, arbitration should be chosen as the mode for dispute resolution, as arbitral awards from most jurisdictions can be enforced under the New York Convention in India.
2021 saw a frenzy in the M&A market as acquirers raced to exploit their cash reserves and low interest rates to leverage key growth opportunities across sectors. While not as buoyant, the outlook for 2022 remains optimistic. Popular sectors such as IT, pharmaceuticals, e-commerce, edtech and fintech are continuing to attract investments. Moreover, clarity on India’s restrictions on investments from border sharing countries may finally be forthcoming after a delay of almost two years, which is likely to lead to more investment from China, Hong Kong and other neighbouring jurisdictions.
Lastly, while inflation and regulatory scrutiny are on the rise, India’s fiscal policy remains benign and supportive as India has so far refrained from increasing taxes or interest rates. A combination of these factors paints an encouraging picture for M&A activity in 2022.
Akil Hirani is the Head of the Transactions Practice & Managing Partner, and Rukshad Davar is the Head of the M&A Practice at the firm.