Deals in Distress
A few months ago, no one thought remote-controlled drones, used in military warfare, logistics and search and rescue operations, will be used in M&As. But travel restrictions are making investment bankers use drone footage of factories to give prospective buyers a 360-degree view from inside and outside.
"The buyer can visit the plant when the deal reaches the final stages," says an investment banker involved in one such deal. Negotiations are taking place over Zoom or Skype. This is probably one reason why deal street is buzzing despite lockdown since end-March. The investment banking community has found many ways to complete a transaction, including structuring the deal in a way that it is linked to future deliverables. So far, the M&A deals in 2020 have crossed $32 billion.
A big backlog of pre-Covid deals had smooth sailing in Q1 of FY2021. Jio Platforms, the subsidiary of Reliance Industries, raised over $20 billion from a dozen marquee investors such as Facebook, Google, KKR, General Atlantic, TPG, Silver Lake and Intel, among others. Jio Platforms alone pushed private equity (PE) and venture capital investments in May 2020 to $5.4 billion, compared to $2.8 billion a year ago. GMR Infrastructure, which operates Delhi and Hyderabad airports, sealed a deal to sell 49 per cent in its airport business to France-based ADP. In July this year, Carlyle signed a deal to acquire a 25 per cent stake in Bharti Airtel's data centre business.
"Among the deals under way, a few are in pharma, tech and digital services. Buyers see these as fundamentally good assets, neutral-to-positive in terms of Covid impact, with a favourable market trajectory," says Amitabh Malhotra, Head, Investment Banking, HSBC India.
Similarly, low market valuations in some commodity businesses are providing promoters a once-in-a-lifetime opportunity to buy back shares. Anil Agarwal of Vedanta and Gautam Adani of Adani Power have decided to delist their companies. Promoters are also raising confidence capital for M&A opportunities in an economy which is likely to head into a recession. Uday Kotak of Kotak Mahindra Bank has said that they are open to inorganic opportunities in financial services. V. Ramakrishnan, Chief Financial Officer of IT giant TCS, recently said economic downturns are the best time to strike deals. TCS had struck one after the 2008 financial crisis when it had acquired the Citigroup Global Service business for $505 million. So, how will deal street pan out in the post-Covid world?
Puneet Renjhen, Executive Director, Investment Banking, Avendus Capital, shares his past experience of such events. "M&A and fund raising generally get heightened after a year or so. Hence, the M&A outlook looks very robust in the next 12 to 36 months, especially in sectors hit by Covid," says Renjhen.
Clearly, opportunities are opening up for promoters with a war chest, financial investors and PE players.
Domestic Consolidation
Investment bankers say domestic consolidation will be the theme. "Domestic consolidation will have three broad elements; large corporate and private equity deals, PE-to-PE transactions and management buyouts by PE," says Gopal Agrawal, Co-Head, Investment banking, Edelweiss Financial Services. At present, large/strong corporates are focusing on managing their ownership, as they need capital to survive in the post-lockdown world.
Many corporates will require rescue capital or funding support to survive in the challenging operating environment. Consumer discretionary companies (malls, multiplexes, travel, fashion), micro-finance institutions, apart from affordable housing, hospitality, tourism and auto component players, will face liquidity issues. These companies are restructuring to cut costs. Airport, hospitality, tourism, NBFC and micro-finance players are also severely hit. A big transaction of a sovereign fund acquiring a stake in a micro-finance company got stuck because of business disruption and uncertainty in the micro-finance industry. "It is not a question of revised business plan but what is the business plan and how you can draw conviction," says an investment player.
Given the risk aversion among banks, many companies will look to sell non-core assets or raise money by parting with equity. "Companies would try to improve their liquidity position, reduce leverage and strengthen balance sheets," says Ajay Arora, Partner, and M&A head, EY India. An EY India 2020 survey says the current economic situation will require companies to raise capital through disinvestments. "Sixty-seven per cent of companies surveyed said they will look to reduce debt through divestments," according to the survey. It says divestments will also be aimed at raising funds for a technologically enabled future.
Last month, billionaire Ajay Piramal, Chairman, Piramal Enterprises, agreed to sell a 20 per cent stake in the pharmaceutical business for $490 million. "This fund infusion will strengthen our balance sheet and provide us a war chest for the next phase," said Piramal. Investment bankers say many corporates are raising confidence capital to face any worst-case scenario in the near future and buy stressed assets. Reliance Industries recently completed a successful Rs 53,124-crore rights issue. Many other rights issues are in the pipeline. ICICI Bank, HDFC Bank and Axis Bank have lined up capital-raising plans of over Rs 1 lakh crore this year.
"We have too many players in every sector because of the large market. But in the post-Covid world, smaller players may find the going difficult. We may see consolidation in the near future," says Suraj Malik, Partner, M&A and Transaction Tax, at BDO India. There are other non-business issues which will accentuate in a slowing economy. "Smaller enterprises where next generation is not interested will also explore M&A opportunities because of changing business dynamics such as digital acceleration or higher technology adoption, supply chain issues with China and slowing economic growth," says Rajesh Narain Gupta, Managing Partner at SNG & Partners, a full service Law firm. India Ratings and Research has predicted additional stressed loans of Rs 1.67 lakh crore, which is over and above the Rs 2.54 lakh crore anticipated during the post-Covid period. High promoter pledge is another factor that will encourage M&As. Dish TV and Kishore Biyanis Future Lifestyle Fashion come in this category. There are already murmurs of a deal between Reliance Industries and Future Group.
Low market valuations in some sectors have thrown open new opportunities such as promoter buyback and delisting for those with access to funds. Global markets are flush with funds at near zero interest rates, while Indian banks too are willing to lend to well-established promoters. Vedanta, whose parent Vedanta Resources plans to buy the remaining 49 per cent stake in it, has a market cap of Rs 41,000 crore with a low price to book of 0.59 times. Adani Power, whose board has approved the delisting, has a market cap of Rs 13,788 crore with price to book of 0.87 times.
But this will happen in rare cases. "Delisting will happen in select cases as it entails giving money to minority shareholders," says Salil Pitale, Joint MD at Axis Capital Ltd. In the pre-Covid world, the focus was on companies buying back shares, while post-Covid, the focus has shifted to promoter buybacks. "Promoters are risk takers. There is nothing wrong if they want to buy back shares and increase their holding or even delist," says Mahesh Singhi, Founder and MD, Singhi Advisors, which calls itself a global investment banking firm.
Outbound, Inbound & Private Equity
Outbound M&A never recovered post the 2008 global financial crisis. Over-leveraging and costly overseas acquisitions by large Indian corporate houses around the 2008 period kept them away. In the post-Covid world, outbound M&A will be strategic, say investment bankers. There are firms looking to buy new technology to bridge product gaps, R&D facilities and molecules for agri-chemicals. Some are trying to get into newer technologies in packaging due to stringent environment norms. "We would probably see select outbound activity in sectors like technology and life sciences, driven by the need to acquire new technologies and products," says EY's Arora.
Supply chain disruptions in global markets, especially China, will encourage M&As for securing raw materials. "We don't see much action in the short term, but there will surely be a move to own supply chain assets in the future," says a banker. There are several opportunities in European markets where many mid-sized companies are experiencing succession issues. Wealthy clients are also enquiring about buying property in popular tourism destinations such as Spain and France. "There are aspiration-driven buyout possibilities. Some excellent properties are available at a dirt-cheap prices," says an investment banker.
Rupee depreciation has partly reduced outbound deal activity. While low global interest rates are a positive, these rates are not available to every company looking for acquisition abroad.
The inbound M&A space is changing. Many European and US companies are starting to see opportunities in their own countries because of US-China trade tensions.
The third big driver of M&A is PE deals. Many PEs are stuck because of market uncertainty. Everstone Capital in Burger King, CX Partners in Barbeque Nation Hospitality and TPG Capital in Shriram Properties were ready to exit but Covid disrupted their plans. At present, PEs are busy managing their portfolio companies. But the PE industry is flush with funds. The figure quoted for committed capital for India from limited partners such as endowment funds, family offices, pension funds, is to the tune of $80 billion. "It is going to be a buyer's market. You can pick and choose, decide where you want to play and at what valuation," says Malhotra of HSBC India.
"The next two to three quarters will be the right time to buy due to gap between intrinsic value and potential value. All investors need to do is figure out right businesses, intrinsic value and the right time to buy," says Renjhen of Avendus Capital. Big PE players are scouting for control transactions. "Global PE funds would be keen to do control transactions in businesses which are likely to be carved out of large corporate and businesses houses," says Arora of EY India. US-based KKR is acquiring a majority 54 per cent stake in drug maker JB Chemicals for Rs 3,100 crore. The deal was sealed during the lockdown. Another PE player Carlyle Group acquired 74 per cent in an animal healthcare product company SeQuent Scientific in May.
PE players are focusing on pharma, technology, telecom, energy and real estate sectors. "They have a clear 6-7 years to restructure and make money in an acquisition," says Singhi of Singhi Advisors.
A CRISIL study has given a different take suggesting that PEs and VCs will focus on managing existing portfolios and will be less aggressive about new investments over the next one year. It is possible that many PEs will focus on saving the better lot in their portfolio of companies. "They will be a little reluctant to go out versus working around existing deals to sustain and grow the business," says Malik of BDO, adding, "Once they stabilise operations of existing companies, they will look outside for new acquisitions. The worst hit would be early stage companies without any funding tie-ups."
"Many early stage companies will close down," says a player. With the Chinese door almost shut, there will be implications for Chinese origin PE/ VCs as they will also look at monetising or getting out of some investments.
The Sector Cut
The pharma sector is buzzing with two big deals, Piramal and JB Chemicals. If market sources are to be believed, at least a dozen deals ranging from $200 million to $1 billion are under negotiations. "There is a lot of inbound interest in pharma," says Agrawal. Renewables is another sector with a lot of investor interest. "The yields in renewable operating assets are in the range of 12-13 per cent which works out to 6-7 per cent in dollar terms. There is a lot of interest in low-risk completed assets," says Renjhen. Agrawal of Edelweiss says, "Some of the latest bids in solar assets saw entry of new players. The interest is from strategic players and sovereign funds."
The financial sector is also ripe for consolidation with opportunities in NBFCs, fintechs, MFIs and affordable housing. Fintech solution provider Infibeam Avenues recently acquired Bangalore-based Cardpay Technologies, which has a spend management platform for corporate India. Many are expecting deals in the fintech space as founders are short of capital and VC players are not willing to commit more at this stage.
"Consumer tech, edtech and health tech will see heightened deal activity both on account of fund-raising as well as consolidation," says Arora of EY India. Last but not the least is real estate. "There is going to be unabated interest in yields. We can see this in multiple asset heavy sector transactions that we are working on," says Renjhen, hinting at sectors like real estate. Similarly, there is lot of interest in data centres and cloud space.
The Big Valuation Challenge
Drones can help in deals but the critical factor is valuation. How do you value a business based on pre-Covid numbers, especially the 2019/20 EBITDA?
Businesses have been disrupted from Q1 FY2021. EBITDA, which shows operating profitability of a business, will not be the right benchmark for 2020/21. "Investment bankers are creating ' valuation bridges' by using innovative deal structures. The alternative structures in the form of earn-outs , stock deals would be an important lever to help bridge valuation gaps,' says EY's Arora. The GMR deal for selling 49 per cent stake to Groupe ADP for Rs 10,780 crore is the perfect example of deal structuring during Covid uncertainty. GMR received the first tranche of Rs 5,248 crore, while the balance Rs 4,475 crore is linked to milestones over the next five years. "There will be a lot more structured instruments, which will protect investors from downside. These can be optionality or deferred conversion type of instruments or both," says Malhotra of HSBC India.
Many deals that were announced in Q1 FY2021 were already in advanced stages before Covid. The stage is now set for post-Covid deals. "The time period to complete a deal and filters have increased tremendously. The risks are also much higher," says Singhi.
Ultimately, everybody wants a value deal.
@anandadhikari
