Thursday, May 22, 2008

How to get LBOs in...?

Remember how we buy homes taking the mortgage route? We spot a good house, negotiate with the seller, lock the deal down by paying some token advance and finance the deal by mortgaging that property. Simple enough? But ever tried buying a company that way? No, you can't in India. After all, companies have a steady cashflow, substantial assets and if sellers are willing, why should regulators say No? Perplexed?

The regulations bar you from mortgaging the assets of the target company to buy it. Their interpretation - the company can’t raise debt pledging assets that it *wants to* buy. Ok, fair enough. It's like seeking to use your credit card to pay its past dues. What if a foreign company floats a specific SPV to do this acquisition? Can that SPV raise debt to buy the assets of this Indian company? The answer is NO again. Here the reason is foreign companies should bring in fresh capital from abroad to pay Indian sellers. I think this rules were drafted at a time when the country badly needed foreign exchange. Today, we are in a surplus situation. Should this law stand? Indian companies are permitted to borrow from domestic banks for purchasing equity in foreign JVs, wholly-owned subsidiaries and other companies as strategic investments. Indian companies also have the option of funding overseas acquisitions through ECBs. Recently they’ve been allowed to invest up to 4 times their networth abroad.

So what are the typical buyout structures that are allowed? Gaurav Taneja of E&Y says -

a) Foreign holding company – raises the debt overseas for acquiring the Indian company. The hurdle is the assets are in India and may not be allowed to be collateralized against the foreign debt. Another area is exchange rate. The loan is in foreign currency but the earnings are in Indian Rupees. Adverse movements in exchange rates can kill.

b) Asset buyout structure – Foreign buyer floats an Indian arm and injects equity and debt, sufficient enough to finance the asset by asset buyout of Indian companies. There could be issues of stamp duty and VAT but the major hurdle here is it works best only in a 100% buyout situation. Not in a partial acquisition of majority controlling stake.

But I suggest it is a far better alternative than using own equity by companies to buy other companies. At a time when costs of borrowing overseas are going up, we must put our vast forex resources to good use by allowing LBOs in India. Imagine some of the world’s best companies operating from Indian soil! I think that would be wonderful. Exxon, Shell, GM, Chysler, Harvard, Stanford – what if these companies/Institutions were subs of Indian companies/Institutions? In fact, their assets are a much more valuable than that of the borrower. A safe bet for the banks to lend.

So, SEBI – you’ve pretty little time left to get your act right. Play it wise. Anyway you are not extremely bothered about Food Stock or inflation. At lease work with the government and be a flexible, understanding and practical regulator.


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