Doing Business in emerging markets often requires as strong a stomach as eating at a roadside food stall, but investors last year were particularly wary of India, according to a report on inbound mergers and acquisitions by law firm Freshfields Bruckhaus Deringer LLP. The report shows that while China, Mexico, Russia and Brazil all experienced increased activity last year, India suffered a slump.
The value of foreign M&A investments targeting the top 24 growth markets grew 5% last year to $162.4 billion, rebounding from a 25% decline in 2011, even as global M&A value dropped almost 5%.
In India, however, which had a relatively strong 2011, deal value fell by 42% to $10.4 billion, said the report, which used Thomson Reuters data; although the number of transactions was almost unchanged (292 deals in 2012, versus 281 deals in 2011), the average size was far smaller.
Uncertainty over taxation (especially in the wake of the Indian government's decision -- since put on hold -- to impose a tax retrospectively on Vodafone Group plc's $11 billion acquisition of Hutchison Essar Telecom Ltd. in 2007) and the implementation of new antitrust rules contributed to the nervousness. Meanwhile, a depreciation of the Indian rupee, which undermines profitability for dollar-denominated funds, reflects a more general slowdown in Indian growth. Add that to concerns about large-scale corruption, exemplified last year by the furor over the allocation of second-generation mobile licenses and coal production licenses to allegedly favored companies, and investors have grounds for caution.
"I think there are a handful of factors you can look to, to explain a loss of confidence for people investing," said New York-based Freshfields partner Matthew Jacobson. "It's not necessarily in the underlying economics, but in the stability and predictability of what the rules will be."
PricewaterhouseCoopers International Ltd.'s Sanjeev Krishan, transaction services director at the firm's Indian affiliate, agreed. "For four or five months last year there was hardly any investment by private equity funds," he said. "There was so much regulatory uncertainty and it really spooked the investor community. Minds were not focused on making fresh investments, but on the tax implications if they did make them."
Krishan said not only inbound financial investment but also deals by strategic investors, with the possible exception of Japanese corporates, had dried up. While there were a number of very small deals, many of them venture investments worth less than $10 million, large transactions were elusive. With high prices and many previous infrastructure investments struggling with debt, and with the coal-sector scandal still reverberating, he added that people "did not want to touch infrastructure with a bargepole."
The statistics bear him out. According to IndusView Advisers Ltd. CEO Bundeep Singh Rangar, who advises multinational companies on opportunities in the Indian market, the number of deals in the Indian energy sector, for instance, has dropped dramatically. Deals in the sector fell from $837 million in the third quarter of 2011 to just $41 million a year later.
"The big-ticket deals will come from guys who want to buy a big mobile operator or a big energy company, which are expensive deals," Rangar explained. "But their boards are going to be cautious, and say we don't have clarity on the taxation and let's be sure we're buying into an economy that's continuing to grow."
He said financial investors were also worried about potential exits, because a depreciating currency could turn a rupees profit into a loss in dollars.
Yet valuations have not fallen in line with investors' expectations, Rangar said. "Indian entrepreneurs just need a bit of a reality check."
Transactions in some sectors have continued. In the IT sector, especially with the growth of broadband delivery, transaction values more than doubled from $503 million in the third quarter of 2011 to $1.3 billion a year later.
Waajid Siddiqui of Hogan Lovells LLP suggested that the proliferation of smaller deals might also be a natural development as the market matures, with both Indian and foreign investors shifting their focus from energy and real estate deals in favor of media and financial services, for example.
"These may not be the intuitive sectors for big transactions," he said.
A number of big private equity firms have been long-term investors in India, although none of those approached for this article -- 3i Group plc, Blackstone Group LP and Warburg Pincus LLC -- would comment. Last summer 3i CEO Simon Borrows said the firm was "cool on India" and likely to remain so "until there's greater certainty around the politics and the economy."
Warburg Pincus' website shows the firm made at least three investments in the country last year, two in retail and small business loans and one in classified advertising.
Taxation issues, and the long drawn-out battle to open the national market to large foreign retailers, have both been entangled in the country's perma-deadlocked coalition politics. However, Indian finance minister Palaniappan Chidambaram has indicated he will postpone the introduction of a wide range of general tax avoidance rules and may consider exempting some foreign investors entirely.
Chidambaram has also attempted to sort out the Vodafone mess, which has direct implications for billions of dollars worth of similar deals between two offshore shareholders, often structured through vehicles in Mauritius. Reports have made conflicting predictions, with some expecting him to propose exempting -- or "grandfathering" -- existing deals and to subject only future transactions to the new tax laws, but others suggest the government could reach a deal with Vodafone to waive the interest and late-payment penalties portion of its $2.6 billion tax bill and accept a reduced amount for the initial sum.
Meanwhile, antitrust legislation, which spooked investors because of the likely delays in completing deals, has turned out to be less of a worry than initially feared.
"It is not clear that the introduction of mandatory merger control with effect from June 2011 has affected the appetite to do deals or deals of a particular size," said King & Spalding International LLP lawyer Suzanne Rab, author of "Indian Competition Law: an International Perspective".
"Fears that the requirement to suspend implementation of transactions for up to 210 days until the regulator made a decision on a proposed deal do not seem to have been borne out. In practice, the Competition Commission of India has decided on a merger case well within that long stop time frame."
In fact, the government has also proposed shaving about a month off the merger process, by reducing the waiting period for deemed approval from 210 to 180 days, but Rab pointed out that the government may still spring surprises on mergers in certain sectors by changing the tests and thresholds for whether a deal should be subject to automatic antitrust scrutiny.
"Banking, pharma and regulated utilities have been mooted as particular sectors where modified thresholds might be adopted," Rab added.
As the government tries to remove at least some of the uncertainties, with what Freshfields' Jacobson calls "some of the right body language," optimism among dealmakers is beginning to return.
To spur growth, the Bank of India cut its key interest rate on Jan. 29 from 8% to 7.75% after adjusting its 2012-'13 financial year GDP growth forecast down slightly to 5.5% and predicting the next financial year will see growth of 6.5%; it has also emulated China by reducing the amount of cash Indian banks must set aside as reserves.
"India always likes to compare itself with China when it comes to economic growth," said IndusView's Rangar. "China's engine seems to be restarting a little bit, so India will be keen to follow."
Caution remains the watchword, however, not least because of India's perennial political uncertainty. Will the individual states implement the federal government's decision to open the market to foreign retail chains? Will the upper house of parliament agree to reforms pushed through the lower house? And will investors be able to rely on any decisions by the current government with elections due in a year's time?
PwC's Krishan warned: "It will take time before we recover. I'm not sure we've done enough to incite strategic investors to come back."
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