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India's takeover restrictions under
scrutiny
By Jayanthi Iyengar
NEW DELHI - For the capital-deficient countries
of Asia, the biggest challenge of the current century
revolves around attracting foreign investment,
particularly foreign direct investment (FDI), with least
sacrifice. FDI is preferred over foreign portfolio
inflows as it is stable, long term and asset creating.
Portfolio, by definition, is short term, volatile, often
speculative, and capable of being pulled out at short
notice, thereby endangering the financial health of the
country where the investments have been made.
For emerging markets, the late 1990s threw up
potential for attracting FDI through M&A (mergers
and acquisition) activities. Globally, liberalization,
greater market access and privatization were some of the
leading causes leading to corporate consolidation. In
the case of Asia, the Southeast Asian meltdown in 1997
made cross-border consolidation possible for
transnational companies. The availability of undervalued
stock resulted in a change in the nature of FDI flows to
Asia in the late 1990s from investments in greenfield
projects (start-ups) to cross-border acquisitions.
M&A activity can be within the national
boundary between domestic companies, domestic and
foreign-owned companies incorporated within the
geographical boundaries of a country, as well as by
foreign companies that do not have a presence in a
country. Besides, M&A activity can be friendly or
hostile, though as a norm, the larger the cross-border
acquisition, the greater are the chances of it being
hostile. Trends during the past five years show that
acquisitions have grown larger and larger and they have
also become more hostile.
Thus, the biggest
acquisition announcement of 1998 - Exxon's purchase of
Mobil - was valued at US$86 billion. It gave way to the
telephone giant MCI Worldcom's proposed buyout of its
rival Sprint at $129 billion in 1999. Early 2000 saw two
of the largest combinations ever, between America Online
and Time Warner for $166 billion, and between Britain's
Vodafone Airtouch and Germany's Mannesmann for $198.9
billion. Of these, Worldcom and Vodafone's acquisition
announcements were hostile.
Thomson Financial
Securities Data show that 14 percent of the mergers in
1999, worth $487 billion, involved hostile takeovers.
Since these figures are four times their last peak in
1988, they reflect another record for 1999.
A
hostile takeover can be defined as one that is opposed
when it is made. There isn't much of a dispute on the
non-desirability of hostile takeovers, going by the
intense reaction they generate, but are M&As always
desirable? This question is answered succinctly by
Michael Renner, senior researcher at the Worldwatch
Institute.
In the Worldwatch Institute's vital
signs 2000, he notes, "Mergers are held to increase
shareholder value and boost corporate efficiency. But
evidence suggests that these expectations are not always
fulfilled. From a broader vantage point, there is
concern that mergers and a proliferation of strategic
partnerships among corporations are leading to a greater
degree of market concentration in many industries,
giving a few producers an undue amount of influence on
the market. Market power often also translates into
political influence.
"Large corporations have
enormous influence on how billions of people work and
live. In recent years, for instance, concern has risen
about the push by biotech firms to manipulate the
genetic makeup of food and plants, about media giants'
control over the way we learn about global events, about
highly mobile companies weakening labor's bargaining
position, about civic culture coming under the sway of
corporate advertisements and sponsorships, and about
industry lobbyists influencing the outcome of elections
and legislation. Ultimately, consolidation trends may
threaten democratic norms, labor standards, human
rights, and environmental quality." Understandably, not
all countries, thus, are open to the idea of
cross-border consolidation. On paper, India's takeover
code applies to all companies, Indian and foreign, and
mounting a hostile takeover under its provisions is
technically possible for all companies. Yet the ground
reality is that foreign companies can embark on the
following activities - take over Indian companies,
enhance their stake in existing joint ventures, and set
up new operations in competing areas after exiting joint
ventures - but only after obtaining the permission of
the Indian partner. This curb on the growth of foreign
companies is imposed not through the takeover code, but
through an executive directive under FDI norms, called
Press Note 18.
In the past, Press Note 18 has
drawn flak from commentators and foreigners alike. In
1998 and 1999, when M&A activity peaked,
commentators badgered the Indian government to remove
the restrictive directive. Citing figures for global
cross-border M&As, which peaked at $3.8 trillion in
1999 (breaking its own record at $2.8 trillion in the
previous year) as proof of opportunities lost, these
experts have argued that India should not be so wary of
M&A activity since foreign investments through the
M&A route and FDI are essentially the same. They
pointed out that M&A and FDI merely represent
different modes of entry of foreign investments into a
country.
The Indian government was, however,
adamant, since the measures taken by it were more
political than economic, but global developments in the
late 1990s seem to have vindicated the Indian
government's position, even if by default.
Global developments which turned public opinion
against M&As include the UK-based Vodafone
AirTouch's all-share bid of Germany's Mannesmann and the
telephone giant MCI Worldcom's proposal to buy out of
its arch rival, Sprint. Both bids were announced in
1999, the former for $183 billion, the later for $129
billion. Both evoked strong reactions. Immediately after
Vodafone announced its hostile takeover bid on November
13, 1999, the Mannesmann executive board rejected it,
calling it an "inferior offer" which is "extremely
unattractive for Mannesmann shareholders".
Simultaneously, the hostile takeover bid kicked
off an intense debate on the future of the German model
of capitalism. German trade unions and the Mannesmann
works councils strongly rejected Vodafone's bid in order
to defend the German culture of corporate governance,
which is based on strong employee involvement and
co-determination. With the employees' viewpoint
supported by most political parties in Germany, Vodafone
reacted by saying that it would fully accept the German
system of industrial relations and corporate governance.
On February 4, 2000, four months after the
initial takeover announcement, Mannesmann accepted
Vodafone AirTouch's "sweetened" bid of 58.96 shares of
Vodafone stock for each share of Mannesmann AG. The deal
was finally clinched at $198.9 billion, about 8.6
percent higher than Vodafone's earlier offer at $183
billion. It gave Mannesmann shareholders ownership of
49.5 percent of the combined group. The deal valued the
German company at $365 a share.
Four months down
the line, there was another development. On June 27,
2000, the US Department of Justice said that it was
suing to block MCI Worldcom's hostile acquisition bid
for Sprint, arguing that a marriage of the second and
third-largest US long-distance phone companies would
harm competition and lead to higher prices for consumers
and businesses.
A day later, the European
Commission decided to prohibit the merger on the grounds
that it would give the combined company a dominant
position in the market for global Internet backbone
services.
Soon after the ruling, Jeff Kagan, an
independent analyst in Atlanta, told James Niccolai and
Elizabeth de Bony of the IDG News Service, "It sounds
like WorldCom is picking up their bat and ball and going
home." Kagan and other analysts said that the chances of
reaching an agreement that would satisfy the Department
of Justice and the European Commission - not to mention
the shareholders of WorldCom and Sprint - were slim.
"The government wants Sprint and WorldCom to be
competitive, and it isn't interested in carving up
Sprint because that would weaken it as a competitor,"
said Scott Cleland, an analyst at The Precursor Group, a
research company in Washington.
Today, the deal
is "effectively dead", as summarized by Cleland, but had
it gone through, it would have seen the culmination of
18 successive mergers over the past two decades, 11 of
which were multibillion-dollar combinations.
Interestingly, the Mannesmann takeover saga did
not end there. The EU parliament stepped in on December
14, 2000, to change laws to protect target companies in
the EU. This led to a strong protest from the UK, which
is outside the EU. The UK's takeover panel and the
Association of British Insurers, who had lobbied hard to
get members of parliament to rethink, decried the
development. As one analyst commented, "This would
significantly reduce investor protection and goes very
much against the principle of the single market, as
defensive action permitted by member states would
inevitably differ."
India apart, similar
reactions are beginning to be seen in other parts of
Asia. There are recent reports (October 2002) that the
National Union of Bank Employees (NUBE) Philippines, is
preparing to present before delegates of the
International Labor Organization a paper detailing the
growing anxiety of workers on M&As in the banking
industry. NUBE - a group of 16 bank unions - recently
drafted a unified stand on the issue of bank M&As,
stressing that "no [such] mergers or consolidations
should take place without consultation with the bank
employees and unions".
It is pertinent to look
at the "poison pill" defense permitted by the EU. Such a
gambit, also known as a "shareholders rights plan", is
designed to make a takeover attempt so expensive that it
makes the attempt a "poison pill" to swallow. Under it,
a hostile bid automatically triggers a rights offering.
This would allow all shareholders, except the raider, to
buy new shares at half the market price. Further,
triggers can also be fixed. The rights offer is
triggered when any investor acquires 10 percent or more
of the company's shares or makes an offer to acquire 10
percent, or when an existing shareholder raises his
stake by 5 percent. This would made it exorbitantly
expensive for a prospective raider to acquire management
control.
India's takeover code does not permit a
"poison pill" defense, but it empowers Indian companies
to block hostile takeovers by foreign companies through
Press Note 18. The 18th in a series of press releases
issued by the Indian ministry of industry in 1998, it
reads as follows:
The automatic route for FDI and/or technology
collaboration would not be available to those who have
or had any previous joint venture or technology
transfer/trademark agreement in the same or allied field
in India. The Reserve Bank of India, therefore, has to
stipulate a necessary declaration before applications
for the automatic route are taken on record.
Investors of technology to the suppliers of the
above category, therefore, will have to necessarily seek
the FIPB/PAB (Foreign Investment Promotion Board/Project
Approval Board) route for joint ventures or technology
transfer agreements (including trademarks) giving
detailed circumstances in which they find it necessary
to set up a new joint venture/enter into new technology
transfer (including trademark).
The onus is clearly on such investors/technology
suppliers to provide the requisite justification and
also proof to the satisfaction of the FIPB/PAB that the
new proposal would not in any way jeopardize the
interests of the existing joint venture or
technology/trademark partner or other stakeholders. It
will be at the sole discretion of the FIPB/PAB to either
approve the application with or without conditions or to
reject it in toto, duly recording the reasons for
doing so.
Shorn of jargon, it means that foreign
companies wanting to set up new operations in India must
furnish a no objection certificate from Indian joint
venture partners, past or present. This certificate has
to be submitted to the FIPB, the Indian foreign
investment clearing authority under the Ministry of
Industry. The board would use its discretionary powers
to clear the new joint venture or permit the enhancement
of foreign equity in an existing joint venture.
Now if you think that this should not be much of
an issue, as India's FIPB more or less clears most
investment proposals submitted to it, then think again.
It's the provisions of this notorious note that played
the villain of the peace in stalling British American
Tobacco Plc's (BAT) attempt to acquire a controlling
stake in the professionally-managed India Tobacco
Company (ITC). BAT holds 31.7 percent in ITC and has
mounted several rounds of hostile takeover bids to take
management control of the company. BAT's efforts at
consolidation have been stalled by the professional
managers, backed by the financial institutions (FIs).
The FIs hold a 36.6 percent stake in ITC. The takeover
bid has been repeatedly stalled by citing Press Note 18,
apart from another stumbling block - a ban on capacity
and equity expansion in the tobacco sector.
Another standing example is TVS-Suzuki, a joint
venture company between a South India-based reputed
business house and Suzuki Motor Company (SMC) of Japan.
This joint venture will undoubtedly go down in Indian
FDI history as the rare company whose Indian promoters
managed to edge out the foreign partner, despite its
comparatively deeper pockets. It will also be a shining
example of how a new venture cannot be started by a
foreign company in the same sector, even after exiting
from an Indian joint venture.
After nearly two
years of incessant differences, SMC sold its 26 percent
stake in TVS-Suzuki to TVS in September 2001. After its
exit, SMC moved several applications to the FIPB seeking
permission to start a wholly-owned subsidiary, investing
$10 million over three years to manufacture and market
two- and three-wheelers, including scooters, motorcycles
and mopeds.
TVS blocked these proposals by
refusing to give a no objection certificate on the
grounds that the agreement signed by the two partners at
the time of the breakup clearly stated that the
licensing agreement between them would be in force for a
period of 30 months, ie until March 31, 2004. SMC
represented to the FIPB through 2001 and early 2002 that
even if it were to be given permission to set up the
unit immediately, it would not be able to commence
production until 2004. The FIPB rejected all these
representations. SMC's application was finally cleared
in March 2002 only after TVS relented and furnished the
no objection certificate.
Another hostile
takeover attempt effectively stalled with the aid of
Press Note 18 relates to the UK's ICI Plc's takeover
attempt of Asian Paints. ICI purchased 3.66 million
Asian Paints shares, representing a 9.1 percent stake.
The stake was bought from Atul Choksey, one of the three
promoters of the company and its former managing
director. The other two promoters are the Dani and the
Vakil families. ICI's acquisition was at Rs 350 ($1 = Rs
48.50 at current rates of conversion) a share in August
1997.
But the Asian Paints board refused to
transfer the shares in ICI's name. It cited compromise
of shareholders' interests and breach of the provisions
of Press Note 18. The shares acquired by ICI thus
continued to be in the names of Atul Choksey and
associates in the books of the company. They were held
in the custody by investment bankers, Kotak Mahindra,
though already paid for by ICI.
The UK company
approached the FIPB for permission to transfer the
shares in its name, but it failed to get approval since
it couldn't get the no objection certificate from the
Asian Paints board, where the Danis and Vakils had a
presence. Finally, the custodian was forced to sell 1.88
million shares - or half of ICI's total acquisition - to
the Indian government-owned mutual fund, the Unit Trust
of India (UTI), at around Rs 281 per share. The sale was
entered into in May 1998. The rest of ICI's block of
holdings were finally sold back to the Danis and Vakils
in November 1999. ''We had taken a stand right in the
beginning that we were willing to buy the shares if they
were offered to us,'' Asian Paints vice chairman and
managing director Ashwin Dani told The Economic Times
soon after the hostile takeover bid was effectively
quashed.
Some may argue that the provisions of
Press Note 18 would apply to JVs and that wholly owned
subsidiaries would be outside its purview. This is only
partially the case. Today, India permits 100 percent FDI
in most sectors, with the exception of insurance,
telecom and the media. But to appreciate the importance
of Press Note 18, one needs to understand that India
opened up gradually, permitting FDI in various sectors
in stages. Thus, FDI caps were initially fixed at 26
percent or 49 percent, depending on the sector. These
caps were gradually raised to 100 percent after FDI
gained larger acceptance. Simultaneously, it is worth
noting that most of the Fortune 500 companies,
particularly manufacturing companies with larger
investments, set up shop in India in the first phase of
liberalization, between 1991-95. Since only JVs were
permitted then, most transnational entered India via the
JV route. The provisions of Press Note 18 apply to all
the JVs. Besides, they also apply to applications moved
by a company before the FIPB prior to the issue of Press
Note 18, but which were still under consideration when
the note was issued.
Interestingly, the past one
year has seen growing opinion within the bureaucracy
that the domestic industry's consolidation phase is over
and that it is ready to take on competition, including
from corporate raiders. This segment is mooting the idea
that the time has come for the withdrawal of Press Note
18 and that all hostile takeovers, irrespective of
whether they are of Indian or foreign origin, should be
regulated under India's takeover code. This code, like
any of its Western counterparts, regulates takeovers in
an orderly fashion through triggers, timely public
disclosures, regulation of the takeover price etc.
A first step was taken a year ago by the core
group of secretaries in the FIPB which argued strongly
in favor of doing away with the provisions of Press Note
18, at least with retrospect effect.
The Core
Group cited three cases - Nippon, Concast AG of
Switzerland and INA Bearings - which it was considering
at that point to make the case that the foreign firms
had set up a new subsidiary or the second joint venture
well before Press Note 18 was issued. Nippon, for
instance, had been given approval for its new joint
venture on June 17, 1998 - six months before Press Note
18 was issued.
Though the core group's proposal
didn't go through, other ministries, including India's
Ministry of Finance, have recently mooted the idea of
doing away with Press Note 18.
Interestingly,
India's move to relax checks on hostile takeovers by
foreign companies comes at a time when corporate
consolidation activity is down globally. A KPMG
Corporate Finance analysis, based on data supplied by
Dealogic, released on December 16, 2002, shows that the
total value of global M&A deals had fallen sharply
since its previous report in June, making it the fifth
successive half-yearly drop. The total value of global
deals by mid-December stood at $996 billion for 2002,
reflecting a 47 percent reduction from the $1.887
trillion of deals closed last year.
The survey
also reveals that worldwide deal numbers were down by 24
percent from 22,775 in 2001 to 17,414 till mid-December
2002. This is the most depressed set of statistics for
over seven years.
Remarks Gavin Geminder, head
of KPMG Corporate Finance for Hong Kong and China, "2002
has been the toughest year in our history and the worst
investment banks will have seen for over a decade. As
another year draws to a close we have yet to see any
tangible evidence of an arresting process, and we can
only hope that we will soon be bumping along the
bottom."
The survey says that Asia-Pacific took
the greatest hit with deal values falling 59 percent
compared to last year. However, deal flow in the region
proved robust, with total deal numbers matching the
number of closings for 2001. The US recorded a 53
percent decline in deal value (and 27 percent by
volume), while Europe saw the value of its activity fall
less markedly, dropping some 40 percent (and 29 percent
by volume) on last year's total.
"Deal numbers
held up in Asia-Pacific aided by an increase in inward
investment to China reflecting, we believe, positive
sentiment towards its entry into the World Trade
Organization. Meanwhile, US consumer confidence has
taken a battering. As a global force in buying patterns,
the impact of this, most keenly felt in North America,
has also contributed to the worldwide slowdown,"
Geminder states.
As for the prospects for 2003,
he states, "There is always the fear that we may see a
double dip within the next six months if there is a
further blow to consumer confidence. Over the next
twelve months, however, we do hope to see M&A reach
a nadir and by Q4 of 2003 we would want to be seeing
some signs of M&A activity starting on the road to
recovery."
M&A activity peaked in 1999 when
the value of worldwide mergers and acquisitions reached
a new record of $3.8 trillion, up from $2.8 trillion in
the previous year.
As far as India is concerned,
date complied by the Center for Monitoring the Indian
Economy, India's independent think tank, M&A
activity peaked during 1999-2000 in value terms at Rs
522 billion ($1 = Rs 48.50) and 1,495 deals in terms of
numbers. Of these, mergers and other acquisitions
accounted for 205 and 1,201 deals respectively.
Open offers were 89 in number. By 2001-02,
M&A activity had fallen in value terms to Rs 33
billion, the number of deals was down to 1,477. The main
change in patterns was that by 2000-02, government
disinvestment accounted for 10 percent of M&A
activity at Rs 38 billion, while the number of open
offers went up from 89 in 1999-00 to 98 in 2001-02.
Mergers were also up from 205 in 1999-00 to 294 in
2001-02, though other acquisitions were down from 1,201
deals in 1999-00 to 952 in 2001-02. The largest
contributor towards M&A activity in 2001-02 was
telecommunications, followed by chemicals and financial
services. Consolidation initiatives by telecom
companies, Bharti, BPL, Birla-Tata-AT&T accounted
for Rs 70 billion during the year.
Globally,
too, M&A activity has been predominant in three
sectors, namely, telecommunications, pharmaceuticals,
oil, automobiles and paper. In 1999, one third of the
worldwide merger value was concentrated in the
telecommunications industry, with $569 billion,
commercial banking ($377 billion) and radio and
television broadcasting ($246 billion). Among
cross-border deals, telecommunications was followed by
metals, oil and gas, and chemical industries.
Liberalization and privatization of
telecommunications assets in many countries has
triggered an endless series of takeovers. The media
industry is being thoroughly reshaped by the growing
integration of entertainment, news, publishing and
communications companies and by the rapid rise of the
Internet and digital communications. Just nine corporate
giants now dominate the world media market, notes
Michael Renner in the Worldwatch Institute's vitals
signs 2000.
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