It is consolidation time in India Inc. Mergers and acquisitions (M&A) are getting more frequent and bigger by the day. Driven by the desire for economical sizes and core competence, scores of companies are looking at M&A as one sure way to attain corporate nirvana. Says Amitava Guha-Roy, executive director of PricewaterhouseCoopers: "Companies are clamouring for slots among the top three in an industry. This is driving M&A today." The new-found focus on enhancing shareholder values too has been propelling M&A deals of late.

The trend is clear. Companies want to build up their market positions and capacities. They want to consolidate in vertical streams, down the supply chain. Says Sanjay Dhir, assistant director (investment banking) with Jardine Fleming India Securities: "Businessmen are realising today that they need to pool in their resources." Little surprising that they are gradually turning emotionally less attached to their assets. Their obsession with a 51 per cent control seems to be over. Indian businessmen are turning contented with just a foothold in emerging opportunities.

Strategic tool
What do all these trends imply? M&A is fast becoming a strategic tool. Today, M&A addresses issues such as what business to be in and why one might have sustainable comparative advantages in certain businesses. Says Rajeev Gupta, executive vice president of DSP Merrill Lynch and head of its M&A division: "M&A addresses precisely those questions which are usually handled by management consultants such as McKinsey." True, companies are asking their investment bankers whether the proposed acquisition fits into their portfolio and what comparative advantage does that bring in.

The Indiaworld deal, the three-way deal involving AT&T, the Tatas and the Birlas, and Hindalco's acquisition of Indian Aluminium are some of the deals that reflect this growing trend. Says Munesh Khanna, country head (corporate finance) of Arthur Andersen India: "We are moving away from standard buyouts and getting into structured deals such as Tata Tea's acquisition of Tetley." This is one of the emerging trends in Indian M&A.

Dogs in the manger
Sure, the M&A road is getting longer with the number of deals rising. But, the ride is not smooth: the road is littered with obstacles. Financial institutions (FIs) are one big hurdle that is preventing Indian M&A from getting turbocharged. These FIs have a difficult-to-change mindset and are impediments to wealth creation. They are irrational and continue to hold stakes in companies which bring in no returns. Quite often, their decisions and actions have prevented industries from becoming competitive. For, their decision to sell corporate stakes are not driven by merits of the offers, but by what their political masters tell them to do. Says Gupta of DSP Merrill Lynch: "FIs are the real dogs in the manger."

No doubt that the FIs have not allowed a lot of deals to go through. The Essar Power-Marathon, the RIL-L&T and the DLF-Gujarat Ambuja deals are a few examples of how the Indian FIs act as spokes in the M&A wheel. In the DLF-Gujarat Ambuja deal, the FIs actually discouraged the French major Lafarge from buying into DLF. Says Sunil Gulati, managing director of Bank of America and head of its investment banking group: "Their rationale behind discouraging Lafarge was that the takeover would result in price-undercutting leading to conflict of interests." As owners and lenders, the FIs did not allow the proposed takeover.

That brings up another issue. Quite often, the FIs happen to be term-lenders and equity-holders in the same company. If the FIs are lenders and owners, not in one company, but across most companies in a sector, there is a real conflict of interest. A suggestion here: let the FIs not be on company boards.

What needs to be done now? In the case of all those companies where the FIs hold substantial stakes, they need to offload their stakes through open market deals or strategic sales. The FIs should begin using M&A as a vehicle for restructuring their portfolios. Says Rana Kapoor, managing director of Rabo India Finance: "FIs can act as sounding boards and do assessment on corporate report cards." Thus, the FIs can trigger off M&A deals. This should happen.

When would that happen is anybody's guess. Consider the FIs' ongoing dilemma over what they should do with their stakes in Modi Rubber. This clearly shows that FIs lack focus. It is high time they turned more proactive in managing their portfolios. Developmental investments acquired while financing corporate projects form a bulk of FIs' investments and they make up the FIs' investment portfolio. But, then they have market portfolios too. Says Kapoor of Rabo India Finance: "Once the developmental objectives are fulfiled, FIs need to merge their investment portfolio with their market portfolio." This calls for tremendous rationalisation in the attitude of the FIs.

Such a rationalisation should ensure that FIs do not hold their investment portfolio in perpetuity, regardless of returns. This is what being proactive is all about. Proactive investment and debt strategies should help the FIs create an active market for corporate control. Says Khanna of Arthur Andersen India: "FIs should be willing to write off loans, restructure them and convert them into equity." Such a change in FIs' mindset has the potential to accelerate the pace of Indian M&A.

Steep stamp duties
Stamp duties too pose a serious problem for Indian M&A. Stamp duty is a state subject and thus varies from state to state. By any standard, stamp duties are high in India: for instance, they are at a high of 21 per cent in Bihar. The proposed merger involving Tata Power, Andhra Valley Power and Tata Hydro could not go through only because of a huge stamp duty demand. In mergers, where huge real estate is involved, stamp duty payable tends to be quite exorbitant. Certainly the state governments can follow the example of Singapore which has abolished the four per cent stamp duty payable on mergers.

One solution to the stamp duty issue is to put in place an uniform stamp duty structure. Or, stamp duties need to be rationalised and brought down to realistic levels by the state governments. Better still, make stamp duty a central subject. Disagrees Kapoor of Rabo India Finance: "It is difficult to have an uniform stamp duty across states."

One solution is to fix an one-time tax-deductible fee to be paid by the merged entity. Says Dara Kalyaniwala, vice president (merchant banking) of LKP Shares and Securities: "Such a fee should be based on slabs of assets or sales." This could help making stamp duty uniform across the states.

There is another issue about stamp duty. There is no clarity whatsoever on how stamp duty should be levied in demergers. Whether stamp duty here should be levied on value of shares or on value of assets remains ambiguous. Consider a hypothetical demerger in a diversified company: the company wants to demerge one of its divisions and wants to induct a joint venture partner as a prelude to an M&A deal. No one is sure here about what would be the cost of such a transaction.

If the demerged business is pushed to a subsidiary, high court process is not needed. If the business is sliced off into a separate company, shareholders need to get shares in both companies. How do you compute the stamp duty payable in such cases? Says T V Raghunath, vice president of Kotak Mahindra Capital Company: "In most demergers, one does not know the transaction cost for the purposes of computing stamp duty." The only way out is to make assumptions and go ahead. There are no precedents, whatsoever.

Consider this example. Great Eastern Shipping demerged its property division and formed a separate company styled Gesco Corporation. Since the demerged entity was a property company, computation of stamp duty did not pose a problem. For, whether the stamp duty was computed on assets or transaction value, it would not have made much difference. But, if there is a demerger in a software company, what should be the valuation for stamp duty? This is a ticklish issue since a software company has a huge market valuation but little tangible assets.

Tortuous merger process
Court process needed to put through mergers is another spoilsport in the Indian M&A scene. The merger process is tortuously slow. And if the companies involved in a merger fall in two different legal jurisdictions it takes much longer time. What needs to be done? Rationalise the merger process and achieve a better co-ordination with the Registrar of Companies. There is a huge pre-merger checklist which needs to be trimmed. Says Gulati of Bank of America: "Mergers should not need a court process, particularly if they are straight mergers involving share swaps." Anyway, court processes do not add much value to mergers either.

One can argue that court process is needed to protect the interests of creditors in mergers. In that case, one can always have a special meeting of creditors and thrash the matters out. Suggests Khanna of Arthur Andersen: "If approved by creditors and 75 per cent of the shareholders, a merger should be allowed to go through. We can do away with the court process." This suggestion makes great sense: go to the courts only if there are problems, only in an exceptional situation. That calls for amending sections 391 to 394 of the Indian Companies Act.

Here is a suggestion from Kapoor of Rabo India Finance: "The Securities Exchange Board of India, Sebi, should have an extension or a special department within the existing legal framework to approve mergers." This should shorten the time taken to turn mergers around. Suggests Ashok Wadhwa, managing director of the Mumbai-based Ambit Corporate Finance: "Why go to the courts? If two listed companies are merging, inform the stock exchanges concerned and go to Sebi." The thrust of all these suggestions is on entrusting mergers to one authority and doing away with the court process.

Holes in Takeover Code
Court process apart, Sebi's Takeover Code too is posing serious problems for Indian M&A. For instance, the Code permits an acquirer to make a minimum offer instead of making an offer to all shareholders. If an acquirer crosses the 15 per cent threshold, he has to make a minimum offer to 20 per cent of the shareholders. That means by just acquiring a 35 per cent stake, anyone can take the whole company over. Says Dhir of Jardine Fleming India Securities: "After acquiring a 15 per cent stake, an acquirer is needed to make an offer only to a little more than one out of four shareholders, 20 per cent from the balance 85 per cent, to take the whole company over." This certainly is an anomaly.

Another grey area is that the Takeover Code is not clear about what constitutes management control and what is a change in management control. This confusion was evident in the Gujarat Ambuja's acquisition of a 7.2 per cent stake in ACC sometime during December 1999. However, on 21 April this year, Sebi ruled that the acquisition is not a takeover and will not require a public offer to ACC's shareholders. Sebi's rationale: the acquisition does not meet the two basic conditions of the Takeover Code. These conditions: minimum acquisition should be 15 per cent and the deal should amount to taking control of a company by being in a position to appoint a majority of directors. Meanwhile, the Tatas have sold another four per cent in ACC to Gujarat Ambuja on 9 May.

Control premium
Control premium is something that is not addressed by the Takeover Code. In a takeover, all shareholders are treated equally. That is the underlying principle in any acquisition. However, a controlling stake has a premium to it and it is unfair to treat a shareholder with a 20 per cent stake at par with another one having just one per cent stake. But, offering a control premium for a large stake brings up an issue: should an acquirer pay the same premium to all shareholders? "This is not a comfortable idea," says Jinesh Panchali, associate professor with the UTI Institute of Capital Markets. After all, in every market there is a wholesale price and a retail price.

Amidst this welter of arguments and counter-arguments, the Takeover Code continues to be silent about the whole issue of control premium. Anyway, the ground reality is that minority shareholders will not be able to sell their holdings off at the acquisition price because of the scaling-down.

Then there are these privatisation deals where the government passes on strategic control to strategic partners. But, if there are two strategic partners, one holding a 25 per cent stake and another holding a 26 per cent stake, should this trigger the Takeover Code provisions? There are no answers.

Cash or shares
Yet another question here. Should it continue to be mandatory for shareholders of the target company to accept what the acquirer doles out? Giving cash or shares for acquisition is left to the bidder. Once the bidder decides, the shareholders have to accept the bidder's mode of payment. Investors have no choice today. This area needs reforms.

There could be instances when a shareholder does not want to accept the shares. Shareholders do not know the value of shares at some future point in time, when the shares are actually received. Market price might have been higher at the time of accepting the offer. But, when the shares are actually received, the market price might have dipped down. What could be done about this? Suggests Panchali of the UTI Institute of Capital Markets: "Leave the decision to the investor, offer him both options of cash and shares."

Legal hurdles
Consolidation of accounts is another issue that is dampening Indian M&A fervour. Even if the acquired company becomes a 100 per cent subsidiary of the acquiring company, there is no provision allowing consolidation of holding company and subsidiary company accounts. That is why, say, Tata Tea will not be able to consolidate the accounts of Tetley with its own accounts. Says Khanna of Arthur Andersen: "This inability to consolidate accounts has a serious implication for the acquirer. He cannot have a bigger balance sheet despite an acquisition." Such a situation prevents the acquirer from getting a better rating.

Meanwhile, the Foreign Investment Promotion Board (FIPB) is doing its bit to discourage M&A deals. One FIPB rule says that no foreigner can acquire a stake in an Indian company without the approval of the Indian company's board. That means no takeover is possible without the wishes of the target company in India. This is a hurdle for M&A.

But for this FIPB ruling, many Indian companies could have been acquired by foreign companies. Says Gupta of DSP Merrill Lynch: "Had British Steel acquired Essar Steel, the latter's FRN imbroglio would have been long sorted out." And, Essar Steel's capital utilisation would have improved too.

M&A activity in India could be accelerated by amending the definitions of mergers and demergers in the Indian Income Tax Act. Conditions stipulated in the Act are too onerous. If 90 per cent of shareholders of the merging company do not become shareholders of the merged entity and 75 per cent of the assets and liabilities are not transferred to the new entity, the deal cannot be called a merger.

That means the deal is not tax-exempt and the merged entity has to pay capital gains tax at a hefty 22 per cent. Certainly, such taxation provisions push up the cost of a deal.

Financing M&A
Then there is this issue of financing which is hindering the pace of Indian M&A. Indian banks cannot lend against shares, takeover funding is inadequate, asset cover continues to be the focus in bank lending and there is no market for mezzanine debt. This calls for changes in mindset of all the parties concerned (See story on Pg 7).

Attitudinal changes
Accelerating the pace of Indian M&A also calls for drastic attitudinal changes among Indian business families, M&A intermediaries and corporate managers. Indian business families hardly know anything about share valuation. Concepts such as discounted cash flows and shareholder values are alien to them. Says Kai Taraporevala of India Advisory Partners: "Most M&A intermediaries offer their clients mistaken ideas of how much a company is worth." This is the biggest hurdle in closing M&A deals in India.

One noteworthy thing here is that most M&A deals involve large companies. There are many mid-cap companies which are in trouble today and are not saleable. This restricts the number of M&A deals. Such companies should go in for M&A with a little help from the FIs.

The government too needs to change its mindset. A huge part of Indian enterprise still belongs to the government. So, the government should consider strategic sale of its controlling stakes than just listing five or ten per cent of PSUs. Says Kapoor of Rabo India Finance: "The government should divest lock, stock and barrel." Until all these happen, the true potential of Indian M&A is bound to remain untapped.