India's M&A market: 2017 promises to be a big year of activity

"After a relatively dull 2016, India’s mergers and acquisitions (M&A) market is headed for some action this year. Last year had a slow start, but October witnessed big-ticket deals with total transactions worth $4.5 billion, taking the January-October deal tally to $32.55 billion. The momentum achieved in October still continues, giving us confidence to forecast an action-packed year ahead."
Pankaj Dave, Senior Partner, B.M. Chatrath & Co

Challenges persist, but reasons to be positive

The number of deals in 2016 reflects a spike in private equity backed M&A deals. But, a lack of clarity on tax reforms and foreign direct investment (FDI) norms continues to challenge deal activity - large companies are playing the wait-and-watch game and are treading carefully. Budget reforms including the goods and services tax, foreign direct investment and sops for digital transactions are likely to push M&A activity further and we expect the deal numbers to be much higher than last year.

India dominates the Asia Pacific M&A market

According to a merger market M&A trend report, India is becoming an increasingly influential M&A market with M&A activity reaching $64.5 billion in 2016, comprising 8.8% of the overall Asia Pacific deals market, the highest figure since 2007. M&A deals involving Indian companies increased to 82% cent in the first half of 2016 with online businesses leading this trend.

Furthermore, the sudden announcement on demonetisation in November had a knee-jerk effect on deal activity. While economic activity slowed due to anticipated reforms failing to materialise, the announcement forced companies to realign their business strategy further fuelling deal activity.

Big ticket deals in the energy, mining and utilities sectors

Energy, mining and utilities replaced financial services as the most active M&A sector in 2016 with deals totaling $17.1 billion - this is almost three times that of the year before. This was fueled largely by Essar Group selling a combined 98% stake in Essar Oil to Rosneft and Trafigura for a combined $12.7 billion. Another big-ticket deal in October was the merger of Makemytrip and Ibibo, estimated at $1.8 billion.

Tech deals are down as investors await more realistic valuations

Acquisition of technology assets is a strategic move in M&A as it can prove to be more effective than outsourcing when a company plans to make technology a critical part of its business model. Technology accounted for only 56 deals last year, down from 89 in 2015. This was the largest decline in deal count across all sectors.

However, despite the dip in activity in the technology sector last year, 2017 should be better. Experts say however that the year is unlikely to reach the heights of 2015 as investors wait for further movement towards more realistic multiples and valuations.

Foreign investment focused on M&A

M&A deals are likely to be the favoured route for foreign direct investment flows into India in 2017 as market consolidation is expected in sectors facing a cash crunch such as ecommerce and telecommunications.

Tax related incentives in the Union Budget will certainly boost the confidence of foreign investors as they make a call on investment in the country or whether to forge new ventures.

The Financial Times’ FDI Report 2016 noted that the biggest change in Greenfield FDI (for starting new ventures) in 2015 globally was the near tripling of Greenfield FDI into India, with an estimated $63 billion pouring in.
According to the report, India was the global leader for FDI in 2015 for the first time, overtaking the U.S. ($59.6 billion of Greenfield FDI) and China ($56.6 billion).

However, the UNCTAD-World Investment Report 2016 ‘FDI overview’ showed that (inbound FDI) cross border M&A — in terms of ‘sales (net)’ —fell in India to $1.4 billion in 2015 from $7.54 billion in 2014. However, cross border M&A activity is set to rise in 2017.

An increase in FDI inflows through M&A transactions looks likely in stressed sectors such as e-commerce and telecoms. The renewable energy sector is likely to see M&A deals, but it could also attract Greenfield investments. The new insolvency and bankruptcy regime will also facilitate the sale of distressed assets, and thereby a hike in M&A activity.

Related article

• 2016 Alliott Group Global M&A Round Table

Concerns over tax

Among the concerns over tax is a recent clarification by the Central Board of Direct Taxes (CBDT) on indirect transfer provisions under the Income Tax Act. The indirect share transfer norms were brought in following transactions where control over Indian assets and businesses was transferred indirectly through offshore transfers. In 2015, the Government had provided a safe harbour for small investors who held less than 5% and who do not exert any management control.

India's rating by international agencies (in November 2016) are set out below: 

Growth rates (in %) in the last 5 years and projected growth for the next 5 years 3 are explained below:

With an average projected growth rate of 5.7%, India is projected to be the fastest growing economy for the 2016-2020, with China's growth rate pegged at 4.8%. Current trends support this projected growth rate.

Increasing FDI inflows in 2016 validated India as the leading investment destination:

GDP in the quarter ended September 30 2016 expanded by an annual 7.3%, which was an improvement from the previous quarter's increase of 7.1%.

Demonetization dampens India's growth prospects

This, however, may be the last 7%+ growth reading for some time to come. The improved growth is no cause for cheer going forward, since consumption - the main growth driver of the economy - will likely be the biggest casualty in the months ahead as demonetization takes its toll on overall consumption, especially in rural areas.

A controversial plan to swap all 500 and 1,000 rupee notes - a combined 86% of all currency in circulation - with new notes has created a nationwide cash crunch amid a limited stock of script.

Consumers are holding off from spending as cash is removed from the system, with a daily limit on the number of old notes that can be exchanged. Private consumption accounts for a whopping 60% of GDP, so the frugal mood could have weighty economic consequences. The sectors most impacted are those with high reliance on cash transactions, which can range from daily foodstuff to big-ticket items such as jewellery and real estate. These sectors are likely to feel the slump in demand in the near term.

"Traditionally, Indian investors have focused on developed markets and will continue their strategy of pursuing cross border deals to acquire new technologies and establish a strong business reputation. Indian investors are now actively exploring emerging markets such as South America, African countries and the Middle East for strategic reasons, to showcase their global reach and attract a higher echelon of international client."

India's key drivers

• Companies seeking growth by entering foreign markets
• Companies seeking lower labour costs
• Companies seeking proximity to suppliers and materials
• Companies seeking lower taxes and/or corporate inversions
• Companies seeking new intellectual property
• Companies seeking access to raw materials or natural resources.

India's main obstacles

• Inadequate experience in managing international operations
• Inability to access affordable local currency financing
• Foreign political instability
• Currency fluctuations
• Local compliance-related risks.

For information or advice on M&A transactions in India

Contact Pankaj Dave at B.M. Chatrath, a leading accounting firm with offices across India.