Outbound acquisition by Indian firms: Case of acquisition of Peguform Group by Samvardhana Motherson Group

Indian corporates are on buying spree-more specifically outbound acquisitions.  Recently, on 13 July, 2011 board of directors of Motherson Sumi Systems Limited (MSSL) approved the acquisition of 80% shareholding in Pegasus group, Germany (Pegasus) from Cross Industries AG, Austria (Cross Industries). 

MSSL is a JV between Samvardhana Motherson Group (SMG) and Sumitomo Wiring Systems, Japan and is listed on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).  MSSL specializes as manufacturer of automotive rearview mirrors, automotive wiring harness, plastic components and modules to the automotive sector, HVAC systems, automotive and industrial applications and other diverse support systems related to automotive accessories sector,

Pegasus Group, is owned by Cross Industries and specializes in manufacture, supply and distribution of high quality interior and exterior products for the automotive and related industries.

Transaction Structure

The outbound transaction (as proposed) was outlined in the press report submitted with the Bombay Stock Exchange.  The proposed transaction structure is as follows:

Under the present structure, MSSL, through a special purpose vehicle (SPV) along with Samvardhana Motherson Finance Limited (SMFL) would acquire 80% shareholding/ stake in Peguform Group, Germany from Cross Industries.  Cross Industries would continue to hold 20% in Peguform Group.  This would also include acquisition of 50% shareholding of Wethje Carbon Composite (Wethje) which is a part of Cross Industries.

SPV would be structured in a form of 51:49 JV between MSSL and SMFL.

Legal provisions concerning outbound acquisition in India

The relevant Indian law provisions pertaining to outbound acquisitions are:

• Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (notification no. FEMA 120/RB-2004 dated July 7, 2004) (FEMA 120) seeks to regulate acquisition and transfer of a foreign security by a person resident in India i.e. investment by Indian entities in overseas joint ventures (OJV) and wholly owned subsidiaries (WOS) as also investment by a person resident in India in shares and securities issued outside India.  Overseas investments can be made under two routes (i) automatic route and (ii) approval route.
• The criteria for investment under automatic route are as under:
• The Indian Party can invest up to 400 per vent of its net worth (as per the last audited Balance Sheet) (50 % of net worth in case of listed Indian companies) in JV / WOS for any lawful activity permitted by the host country. The ceiling of 400% of net worth will not be applicable where the investment is made out of balances held in the EEFC account of the Indian party or out of funds raised through ADRs/GDRs.
• The Indian Party is not on the Reserve Bank of India’s (RBI) exporters' caution list / list of defaulters to the banking system published/ circulated by the Credit Information Bureau of India Ltd. (CIBIL)/RBI or  any other credit information company as approved by RBI or under investigation by the Directorate of Enforcement or any investigative agency or regulatory authority.
• The Indian Party routes all the transactions relating to the investment in a JV/WOS through only one branch of an authorised dealer to be designated by the Indian Party
• Investment in an overseas OJV / WOS may be funded out of one or more of the following sources:
• drawal of foreign exchange from an AD bank in India
• capitalisation of exports
• swap of shares
• proceeds of External Commercial Borrowings (ECBs) / Foreign Currency  Convertible Bonds (FCCBs)
• in exchange of ADRs/GDRs issued in accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993, and the guidelines issued thereunder from time to time by the Government of India
• balances held in EEFC account of the Indian party
• proceeds of foreign currency funds raised through ADR / GDR issues.
• In case of partial / full acquisition of an existing foreign company, where the investment is more than USD 5 million, valuation of the shares of the company shall be made by a Category I Merchant Banker registered with SEBI/ other foreign regulatory authority.
• In case of acquisition by way of share swap-prior approval from Foreign Investment Promotion Board is required.
• Prescribed form under FEMA 120 should be filed with the Reserve Bank of India within prescribed time (30 days from date of transaction, presently) for the purpose of reporting and legal compliance.
• More information on direct foreign investments by Indian firms is available at http://rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=2126.
• In addition to above under section 6 of the Competition Act, 2002 (Competition Act), (if requirements under section 5 of the Competition Act are met) no person or enterprise shall enter into a combination which causes or is likely to cause an appreciable adverse effect on competition within the relevant market in India and such a combination shall be void.  Further, the parties to the combination would have to approach the Competition Commission of India (the Commission or the CCI) under section 6(2) of the Competition Act and take prior approval from the Commission before executing the transaction. If the approval is not given, the parties to the combination shall not enter the transaction or work upon it.
• For investing in target company, in excess of 60% of the net worth of the company or 100% of its free reserves, the company under the Companies Act, 1956 would require approval from the shareholders of the company.

Outbound acquisition in practice

• In practice the vast majority of the transactions have been structured as friendly, plain vanilla, all-cash acquisitions of the target company, with few using company shares as consideration.
• Indian firms have been able to use ADRs and GDRs to ease access to foreign capital markets and to facilitate M&A activities in foreign markets.
• Indian firms have been able to raise acquisition financing abroad, they have faced difficultly in raising acquisition financing in India as Indian regulations restrict the ability of Indian banks to provide acquisition financing.
• The typical structure for the Indian acquirer to set up an SPV by providing some equity financing, and then to raise large amounts in the SPV through senior debt and mezzanine financing for which the target company‘s assets will be provided as security.
• RBI approval for financing of outbound investment by way of pledging of shares is rarely given in practice.
• Combination provisions under Competition Act has just started operation (from 1 June, 2011), so it would be pretty early to comment on CCIs practice, but as per the Competition Act and Combination Regulations, it appears that CCI would not take more than 30 days (210 days in case a show cause communication is issued) to clear a transaction which have no appreciable adverse effect on the competition in India.

Present deal- acquisition of Peguform Group by SMG

• The present deal (Peguform Acquisition Deal) appears to be a plain deal where the outbound investment would be following a plain vanilla through Mauritius route under automatic route. 
• With debt to equity ration of 0.8 of MSSL, the promoters of SPV (MSSL and MSFL) would face less-problem in raising finances for the acquisition.
• If the thresholds are met under section 5 of the Competition Act, Peguform Acquisition Deal would require prior approval from the CCI and a notification under section 6 of the Competition Act and Combination Regulations is required in this deal.
• If the Peguform Acquisition Deal happens to be a ‘no-all cash’ deal, then perhaps, in all likelihood, MSSL and MSFL would enter into a receivable agreement/ guarantee/ financing  agreement with a lender-preferably an Indian bank having branches outside India or having some association with foreign bank- which would in turn provide loan to Mauritius/ Cyprus/ BVI based SPV.
• MSSL and MSFL (through SPV) may enter into share-pledge agreement (not involving any Indian asset), put-option agreement with Financial Institution/ Bank in order to get financing.