By Samir Sheth and Priya Rohira
With gradual unlocking of the India economy, some economic indicators started improving-improvement in GST collections, reducing unemployment and sustained momentum in digital transactions. However, many other indicators (petrol consumption, mobility index etc) remain below pre-COVID levels. Importantly, in the core financial services sector, there is continued uncertainty around the extent of restructuring, slippages in the medium term and expected provisions for bad loans, which will always be a deterrent to growth and lending. The loan repayment moratorium has temporarily masked the actual damage that restrictions can cause to the economy.
While it has been two months since the RBI issued the onetime debt recast guidelines based on KV Kamath Committee recommendations, the response has been muted. Whether it is the lack of clear awareness among the bankers and borrower community, or the 10% provisioning requirement or the stringent condition of the debt recast being available only to standard assets at the commencement of lock-down; but clearly, the response seems nowhere close to expectations. There is a possibility of banks and NBFCs viewing additional funding where possible in conjunction with the Emergency Credit Line Guarantee Scheme (ECLGS) disbursements as a better mode than using the debt recast option. However, for cases where this is not possible and debt recast is also not an option, the end of the moratorium period would mean that borrowers will have to resort to M&A as an option. This could be in various forms including hiving off non-core business, JVs/ partnership for core businesses, distress sale of entire business, etc.
We should also note that for businesses which have suffered because of COVID, the Insolvency & Bankruptcy Code (IBC) is under suspension till December with provision to extend the suspension by another quarter. However, once the IBC is back, there is a fear that promoters would lose control of their businesses if they continue not to service their debt. Additionally, it should be noted that neither the debt recast package nor IBC suspension applies to businesses which were already stressed at the beginning of the lockdown and would have suffered further during the lockdown.
We believe that all the above factors will lead to businesses being available at attractive valuations, resulting in a significant increase in M&A in the next few quarters. We expect to see a large-scale consolidation in the Indian markets. Cash-rich strategic players or players with the ability to raise debt and PE buyers will scout for any such opportunities to increase their market share, build supply chain economies and consolidate their pole positions. We are witnessing M&A momentum in sectors of telecom, consumer staples, healthcare and financials; the second half of this financial year may also see good momentum led by the stressed situation, higher interest in MSMEs, manufacturing supply chain capabilities (especially inbound) etc.
We also expect supply chain relocations to play a significant contribution in M&As and overall FDI into the country. There will be growing interest from not only larger global corporations, but even mid-market companies in overseas geographies to enter India due to the negative image the pandemic has created of China; this could lead to an increase in inbound M&A. MNCs are already redefining their supply chain strategies and re-looking at China vs. India. Also, the production linked incentive scheme has seen strong traction – major iPhone assemblers for Apple Inc. were among the 16 companies that won approval to manufacture products in India under a plan aimed at attracting investment of over Rs 10.5 trillion ($ 143 billion) over the next five years for smartphone production. Global players would also look at acquiring Indian corporates / SMEs to beef up their initial presence and operations.
Recapitalisation of banks/ NBFCs will also be another factor contributing to deal charts in the form of fundraise or M&A. India has already been dealing with massive bank/ NBFC problems regarding bad loans. With the possibility of a significant percentage of loans under moratorium getting into default zone, there would be a need to recapitalise banks and NBFCS. Hence, some big private banks are already in fundraise mode.
Digital India attractiveness will continue to be another leg of value maximisation. India’s multi-pronged investment metrics–huge millennial population, one of the largest digital economies, huge consumer base, third-largest start-up economy, rising affluence, etc. remain long-term attractive factors and will drive huge FDIs/ FIIs into India. In H1CY20, Jio Platforms reported closure of 8 PE deals aggregating to a deal value of about $ 9.6 billion. The Facebook investment worth $ 5.7 billion is classified as M&A and is over and above the about $ 9.6 billion deals. Further, the last quarter has shown increased activity in VC/PE deals. A lot of this money is being invested in digital/ technology led businesses.
Also, financial investors will accelerate their portfolio reassessment, and this could result in more deal opportunities. Unpredictability of demand, moratorium on loans, new valuation approach, emerging financing mechanisms, and risk balancing between the buyers & sellers’ market call for a new paradigm in the deals/ M&A segment. The ensuing quarters will be interesting for M&A markets to look forward to.
( Samir Sheth, Partner and Head – Deal Advisory Services and Priya Rohira, Director – Due Diligence, BDO India)