Mergers & Acquisitions

At first glance India seems irresistible to U.S. companies seeking global expansion. In particular India's English speaking work force and low labor costs entice foreign companies to invest in the country--largely in well-known service businesses but also in manufacturing, mining and heavy-industry sectors. But newcomers to India quickly discover conditions on the ground are more complicated than the macro picture might indicate.

"Setting up shop in India is quite a task," says Shardul Shroff, managing partner of the Amarchand Mangaldas law firm in New Delhi. "The cross-cultural challenges are unique, with many cultural differences between Indian and Western companies. And takeovers are regulated by complex rules, with detailed thresholds, requirements and restrictions.

Establishing a new company is even more tedious." Undaunted by such challenges, companies from the U.S. and other countries are scrambling to get into India. They're learning to navigate the country's complex M&A rules and establish a presence without getting bogged down in a regulatory quagmire. But as they address the country's many challenges, they're finding that India is not just a high-tech sweatshop. It's fertile ground for longterm business growth, in everything from beer to banking.

"Businesses are saying, 'I've got to have that market,' " says Scott Hobby, a partner in the outsourcing and systems integration group at Sutherland Asbill & Brennan in Atlanta. "The Indians are reaching out and saying, 'We have the money, but not the know-how. Let's partner and do this.' "

Under Construction
American companies considering doing business in India inevitably compare the country to China, its chief rival for foreign investment and development attention. These comparisons reveal more contrasts than similarities.

The contrasts are evident in India's culture and, by extension, its approach to regulating business and investment. Compared with China, with its collective mentality and central planning, India is diverse and fragmented. "India is more like the U.S.," says Richard G. Goetz, a partner with Dykema Gossett and formerly an associate general counsel for international business at Ford Motor Co. "Where China is fairly uniform, with one dominant ethnic group, India is a mixture.
And like the U.S., it's a valuable mixture--if you get everyone pulling in the same direction."

Achieving such collaboration poses difficult challenges for U.S. companies in India. For example Indians tend to treat contracts as a working framework rather than an inviolable commitment (see "Litigation & Arbitration," p. 52).

Rampant poaching forces employers to fight for skilled labor (see "Labor & Employment," p. 64). And unlike China, which has spent a trillion dollars modernizing its infrastructure, India's roads, seaports and power systems remain antiquated and overburdened. Freight moves across India at an average of 5 mph.

"India's potential is great, but you need to have patience," says Ajay Raju, partner and co-manager of Reed Smith's India practice group in Philadelphia.

"The infrastructure is still developing. A lot of it is stuck in bureaucratic debate." And India's bureaucracy, like its infrastructure, imposes limitations and challenges on companies seeking to build a business there. In recent years, the government has removed the most severe limits on foreign ownership in some industry sectors--most notably telecom, utilities and real estate--and such reforms continue. But restrictions persist in other areas, such as retail and banking. And where investment is allowed, a maze of regulation confronts companies seeking to establish a new business entity.

"You're talking about every single approval to do business in India," Shroff says. "There are title questions, operating registrations, permits, licenses, employment and labor registration ... the list is endless. It's possible to set up a new company, but not if you're in a hurry."

Combined with the challenge of developing the practical knowledge necessary to succeed in a diverse and complicated country, India's business regulations deter most foreign companies from building an Indian business from scratch. Instead, they are entering the market through joint ventures and acquisitions.

Red-Tape Labyrinth
Of the two common approaches for entering India's market, the joint venture is the easiest path. But generally joint ventures are short-term propositions, useful only until one or both partners decide to change strategic direction. "Most non-resident companies have used joint ventures for ascertaining the market and creating openings in India," Shroff says. "It's enough to help them understand the way the land lies, but once they do, they discover they want to own a piece of it."

Thus companies that start down the joint-venture road frequently wind up on the M&A path. Although Indian regulations allow foreign ownership of Indian companies, those laws dictate how acquisitions can be structured (see "Structuring M&As").

"Cash acquisitions usually are smooth and don't require special regulatory treatment," says S.R. Gopalan, CEO of financial advisory firm Dawn Consulting in Bangalore. "But if the acquisition involves cash plus stock, or if your transaction is structured as a merger in any form, you must plan on getting approval from a High Court and the Central Bank of India. Usually the requirements are easy to get, but you need to factor in three or four months of approval time."

In general, acquiring companies should plan on extra time for due diligence as they build a rapport with local executives and delve into the target company's work force, assets and market position. In addition, acquiring companies inherit the liabilities of an acquired company, which puts a premium on verifying the target has good compliance practices.

This process is complicated by India's large number of bureaucratic institutions. In each state the Registrar of Companies maintains records on corporate balance sheets, bank charges, mortgages and securities offerings.

Other compliance records will be found in a multitude of other public offices, such as state and federal environmental and labor regulatory agencies. Although these agencies are in the process of converting records to electronic form, most due-diligence work still calls for old-fashioned footwork. "This has to be done thoroughly," Shroff says. "If you don't, you could land yourself in a mess."

Vindaloo Hot
Despite the complexities of cross-border transactions, the M&A market in India is on fire. Transactions from January 2007 through September 2007 exceeded $50 billion in value--five times the value of transactions in all of 2006. About two-thirds of this total involves foreign acquirers (see "Outbound M&A").

"The GEs and Vodafones of the world can't resist the opportunity to do business in India," Raju says. "We're seeing tremendous demand for corporate finance and M&A services." In recent yea rs India's main attraction has been its cheap labor.

For example, last year EDS paid $380 million to acquire a majority stake in outsourcing vendor MphasiS. And Dallas-based Affiliated Computer Services announced plans to spend $2 billion on a series of Indian IT acquisitions--all aimed at business process outsourcing for global clients.

As India's economy matures, however, cross-border transactions reflect a longer-term strategy. "U.S. companies see a gigantic market in India," Hobby says. "In the short term, they are taking advantage of a low-cost, well trained work force. But they know the Indian middle class is going to explode, and they want to be ready to sell to that middle class."

Case in point: India's wireless phone market is expected to double in size by 2010, going from 250 million to 500 million users. A nd since the Ministry of Commerce & Industry increased the cap on foreign ownership in telecom and utilities from 49 percent to 74 percent in 2005, global telecom giants have come calling. England's Vodafone Group acquired wireless giant Hutchison Essar in May 2007 for $10.9 billion. And the Wall Street Journal in September reported AT&T plans to acquire a major presence in India, building upon the joint venture beachhead it established with manufacturing firm Mahindra.

The wireless market is just one example of India's historic potential. McKinsey & Co. expects India's consumer goods market will reach $400 billion annually by 2010, putting it in the world's top five. Accordingly, in the long term foreign companies will find their greatest growth opportunities in serving and selling to India's middle-class multitudes rather than just employing them.

Organic Growth
To expand its economic opportunities, Indian leaders understand they will need foreign investment as well as expertise and technology. India's leaders also know they're in a race with China, and India's institutional and practical hurdles might slow their progress in this race.

But India is not China.
Although the two countries face similar challenges, India's history, social structure and democratic institutions position the country for a different kind of growth--more organic and messier than China's top-down central plan. India's cultural and social diversity strengthens the foundation for its future potential. And in its colonial past, India learned the importance of caution in accepting foreign patronage.

"India is trying to protect and grow its economy," Hobby says. "It doesn't want to go back to its colonial past, either politically or economically." Barriers to entry likely will shrink over time, as regulatory reforms open doors to investment and developing infrastructure clears a path to India's burgeoning markets. India is fertile ground for growth but that doesn't mean growth will be easy for U.S. companies.

Structuring M&As
The following are some of the laws that regulate how foreign companies acquire Indian companies and assets:

The Companies Act forbids Indian banks to finance leveraged buyouts (LBOs). Acquirers must finance buyouts with equity or with debt capital raised in other countries.

No absorptions
Foreign companies can acquire a majority or 100 percent ownership in an Indian company (in most industries), but the Takeover Code forbids mergers resulting in the Indian company being dissolved.

No fire sales
The Takeover Code sets ownership percentage thresholds that trigger open listing and reverse book-building processes. These processes permit shareholders--rather than acquirers--to set the sale price in a takeover. Also, Indian tax code sets a minimum price for share buyouts, based on the target company's book value, to prevent tax-evasion schemes.

No layoffs
State and federal labor laws require maintaining head count, wages and benefits for employees being acquired. "The basic principle is no adverse change in labor or employment conditions," says Shardul Shroff, managing partner of Amarchand Mangaldas in New Delhi. "You can't downsize or cut wages as the result of a merger."

Outbound M&A
While foreign investors scramble to get into India's market, major companies in India are looking outward.
"Indian companies weren't acquiring foreign companies a few years ago," says Ajay Raju, partner with
Reed Smith in Philadelphia. "Now, there is so much demand for expertise and technology, Indian companies
are investing in American and European companies. It's a testament to India's growing economy."
Some noteworthy deals in 2007:

IT outsourcing company Wipro agreed to buy U.S.-based Info crossing for $600 million.

Tata Steel acquired Corus Group of the U.K. for about $8 billion.

Metals giant Hindalco paid $6 billion for U.S. aluminum company Novelis.

Wind-turbine manufacturer Suzlon spent $530 million to gain a controlling stake in Germany's REPower.


Michael T. Burr

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