India economic update
Milind S. KothariManaging Partner
M & A tracker
Rajesh ThakkarPartner /Transaction Tax
Tax & Regulatory Services
Samir ShethPartner and Head/
Deal Advisory Services
Leader/ Private Equity
The interim budget in place of a full-fledged annual budget was announced on 01 February 2019. This budget was largely focused on reducing widespread stress in the agriculture sector and providing relief for small taxpayers. The full budget for the year would be announced by a new government that would be formed post central elections, due in the summer of 2019.
The economic agenda, that has taken a back-seat on account of the ensuing elections, would need an urgent redressal as soon as a new government assumes power. With the growing size of the economy and nearly a million new jobs needed every month, an 8% plus GDP growth is a must. Given the recent past, this has been a challenge despite the estimate that in 2019, India’s economy is set to grow its fastest in 3 years at 7.2%, up from 6.7% last year. Another compelling challenge would be growth in the manufacturing sector, that despite the present Government’s ‘Make in India’ program, has yet to reach its critical mass with its share in GDP @15% which is much smaller to share of manufacturing in China @29%. Also, the bottle-neck in infrastructure growth can seem to be revitalized only with a successful public private partnership (‘PPP’) model that would be a catalyst to attract the much needed private investment.
The economic data remained subdued; both wholesale and retail inflation eased to an 18-month low @2.19% on the back of cooling of food and fuel prices. On the other hand, factory output grew only by 0.47%, ostensibly on a high base, post festival dip in manufacturing and fewer working days. However, the fiscal deficit at 115% of the full year estimate at the end of November stoked concerns and it is feared that the gap between the target set for FY 2019 and the final tally could only widen as the fiscal year draws to a close on March 31, 2019.
One of the largest challenges during the term of this Government has been the level of non-performing assets (‘NPA’s) estimated to be in the range of US $130 bn. The introduction of the Insolvency & Bankruptcy Code has been one of the significant achievements but the resolutions that would bring money to the starved banking industry, currently reeling under spate of litigations by various stakeholders, are eagerly awaited.
The economy was disrupted by regulatory changes with activities like online shopping, logistics apps, online pharmacies, online groceries, fintech and start-up funding all coming under the regulatory gaze, impacting the business models of these new economy businesses. The total size of the e-commerce business is estimated in the range of US $60 bn with nearly US $20 bn plus, being invested by private capital in the last 3 years. The new data protection policy mandates global internet firms to start storing data locally, not just to safeguard critical citizen-data, but also to ensure that due taxes are paid by these digital firms for services including advertisements that are sold to local clients.
In a big jolt to Amazon and Flipkart, a company recently acquired by Walmart, the government announced changes to the Foreign Direct Investment policy for e-commerce sector that could shake up the way these companies conduct business in the country. This move was to mollify brick-and-mortar retailers who have had long standing grievance against e-commerce sites for offering discounts to win customers. The new rules announce that related entity can no longer sell on a platform; an e-commerce portal cannot discriminate amongst vendors and a single vendor can’t sell more that 25% to one portal. The new rules came into effect on February 1, 2019 with no reprieve of extension given by the government.
Drones were in the news, this time with the government announcing to allow drones beyond the line of sight under the second phase of the drone policy with draft guidelines to be placed soon. As part of the policy the government proposes to set up a dedicated drone corridor, create drone ports and allow 100% Foreign Direct Investment in manufacturing the remotely piloted aircraft in the country.
So much to reckon and reconcile as India marches on with political, regulatory and economic changes impacting its stride.
M&A in India
Between November 2018 to January 2019, around 98 M&A deals were announced/completed aggregating to approx. USD 10,667.13 mn; dominated by domestic deals (59) followed by cross border deals (39)
In terms of sectors, Consumer Staples sector (Food, Beverage & Tobacco) saw the maximum deal value with deals worth USD 4,542.39 mn followed by Financial Service sector (Banks) with deals worth USD 3,001 mn and Information Technology sector (Software & Services) USD 1,775 mn
(Deals mentioned in the M&A Tracker do not include those with undisclosed deal values as well as those which have been announced but not closed)
Target Company: Tangible Play Inc.
Acquiring Company: Think and Learn Private Limited
Deal Value (in mn USD): 120
- In January 2019, Think and Learn Private Limited acquired Tangible Play Inc. for a total consideration of USD 120 mn (INR 8.47 bn) in an all-stock deal
- Tangible Play Inc. owns and operates a digital education platform under the name of Osmo. It uses augmented reality and artificial intelligence to bring physical toys into the digital world and offer games. However, post-acquisition Tangible Play Inc. team would continue to operate independently
- With this acquisition, Think and Learn Private Limited expands into a new age demographic and enters the world of younger kids (age group 3-8). The said deal would help kids to acquire the love for learning at an early age by introducing play-based learning
- Post-transaction, Tangible Play Inc. operates as a subsidiary of Think and Learn Private Limited
Target Company: Alpha Design Technologies Private Limited
Acquiring Company: Adani Defence Systems and Technologies Limited
Deal Value (in mn USD): 55.38
- In December 2018, Adani Defence Systems and Technologies Limited (‘Adani Defence’) acquired Alpha Design Technologies Private Limited (‘Alpha Design Technologies’) for a total consideration of USD 55.38 mn (INR 4 bn)
- Alpha Design Technologies is engaged in providing defense and technology integration products. Its products include night vision devices, electronic warfare system, military communication products, simulators, aerospace assembly, satellite manufacturing, etc.
- Alpha Design Technologies provides Adani Defence with a strong Tier- I capability for building a base for graduating to platform capabilities
- Adani Defence acquired 13,316,909 Equity Shares of Alpha Design Technologies at a price of INR 300.37 each.
Target Company: GMR Bajoli Holi Hydropower Private Limited
Acquiring Company: Tenaga Nasional Berhad Topaz Energy
Deal Value (in mn USD): 31.59
- In December 2018, Tenaga Nasional Berhad (‘TNB’), through its arm TNB Topaz Energy, invested USD 31.59 mn (INR 2.26 bn) in GMR Bajoli Holi Hydropower Private Limited (‘GMR Bajoli Holi’)
- GMR Bajoli Holi is engaged in providing electricity generation services. It owns a 180 Megawatt (‘MW’) hydropower plant
- TNB Topaz Energy invested in GMR Bajoli Holi by way of subscription to Compulsorily Convertible Debentures, the proceeds of which would be used for the construction of the 180 MW run of the river Bajoli Holi Project
- The transaction is in line with TNB’s strategy of expanding its renewable Energy Assets under the Reimagining Tenaga strategy to position TNB as one of the top global utility players by 2025
Target Company: Threadsol Software Private Limited
Acquiring Company: Coats Group Plc
Deal Value (in mn USD): 12
- Coats Group Plc acquired Threadsol Software Private Limited (‘Threadsol Software’) for a total consideration of USD 12 mn (INR 846.94 mn)
- Threadsol Software is engaged in the development of application software. It offers solution like Intellcut for execution control, Intellobuy for automate fabric buying, etc.
- The acquisition supports a key aspect of growth strategy i.e. to build an innovative software solution business for the apparel and footwear industries
- Post-transaction, Threadsol Software operates as a subsidiary of Coats Group Plc
THE NEXT WAVE: Unicorns of today, Giants of tomorrow
The Indian startup landscape has changed over the last five years. As India witnesses, a dramatic rise in the emergence of dynamic businesses, the country has become a significant contributor to the Unicorn club. The increase in the number of thriving startups and stellar emergence of Unicorns, prompted us to study factors that help build and power these businesses, making them future leaders. We launched a survey to understand the growth of Unicorns in India and identify factors fueling the growth of these enterprises. The survey was divided into five distinct dimensions, covering Growth/ Market share/ Diversification, Digital & Disruption, Opex & Capex Efficiency, Management & Board Room Composition and Valuations/ Fairness/Exits. The survey received 70+ responses from the PE/VC community, giving us robust insights into the operational, financial and sustainable frameworks of growing businesses.
Responses to the survey were launched in our report, ‘THE NEXT WAVE: Unicorns of today, Giants of tomorrow’. The report highlights characteristics/ moats that investors look at while identifying Unicorns, as well as to unearth interesting names from India which are on their way to becoming “Giants of Tomorrow”. As we see many exponential factors at play, these giants are well poised to leverage India’s growing economy.
India’s compelling growth story
India’s promising base of Unicorns/ Soonicorns will surprise the world in 2019. The last year has been eventful. Following US and China, India became the third largest country with respect to incremental additions to the Unicorn Club. This dominance will only accelerate as the (existing + new) emerging leaders of tomorrow leverage the structural changes in India.
Like China, India’s big advantage is a huge and vibrant domestic market. With a 1bn + population base, increasing number of aspirational & tech-embracing entrepreneurs, pervasive technological innovation, consumption story (a growing prosperous middle class), strong agricultural & industrial roots, high savings rate, exponentially growing digital infrastructure, favourable regulatory environment and declining cost of doing business only suggest India’s growth story can only surprise. Unlike traditional business houses, data & next-gen technologies are making Unicorns/ Soonicorns more competitive.
India is also witnessing many B2B firms becoming Unicorns/ Soonicorns in comparison to the past few years where B2C Unicorns were the talks of the town. The Unicorn Club is also diversifying in nature with participation from many more sectors.
Emerging giants of tomorrow
Domestic startups are disrupting and influencing various industries, redefining business models, consumer experience and the investment world at large. They are thus becoming leaders in their respective industries and creating enormous wealth early in their development. In China, companies such as Tencent, Ant Financial, Baidu and JD.com emerged as giants in less than 25 years, in line, we may see some of India’s Giants become Decacorns and global giants much faster than expected.
We will see strategic partnerships and M&As by these Unicorns/ Soonicorns to strengthen their market share, deepen the understanding of their consumers, and increase the value of their own brand. Many Unicorns/ Soonicorns will embrace broadening of leadership and induction of independent directorship.
Not to forget the critical support of the capital markets, that will further fuel the growth of Unicorns/ Soonicorns. Investor Group is also diversifying and increasing their AUM base in India. Family owned offices and first generation entrepreneurs are relatively rich and potentially unexplored resources.
India is a unique place where demand dynamics in multiple sectors are seeing structural changes and approximately two-thirds of respondents feel that India’s Unicorn story will go the US way.
The tidal wave of unicorns in global business
About 5-years ago, Aileen Lee coined the word “Unicorn” to describe a new breed of startups – privately held companies that were valued at US$1 billion or more by investors. Aileen was using the term to describe these enterprises, choosing the mythical animal to represent the small number of such ventures. At that time, there were only 39 US-based companies that were valued at US$ 1 billion or more. They are not rare anymore.
According to CB Insights, as of January 2019, there were 308 Unicorns collectively valued at more than US$1 trillion. These companies have raised a combined total of US$257 billion in equity capital. US led, with more than 150 unicorns followed by China with 82. India had 18 unicorns and the list continues to grow. These companies operated in sectors ranging from auto technology to space to healthcare. While 2017 saw 57 startups becoming unicorns, 2018 saw 112 join the club.
More unicorns are consumer-oriented, though enterprise-oriented unicorns delivered higher returns on their investments. Software, e-commerce, fintech, healthcare, and on-demand are the major sectors in which unicorns operated. US investors lead the race in identifying and investing in unicorns. Sequoia Capital, Softbank, Andressen Horowitz, Tiger Global, Tencent, Alibaba were some of the top investors.
There are so many unicorns, that these enterprises are now distinguished by the pace at which they achieved unicorn status and a new term, “decacorns”; these are companies that are valued at more than US$10 billion.
What is fueling this growth? Everything from buyouts to rapid growth backed by technological innovation, rapid customer adoption and the availability of cheap capital. With low interest rates and yields, investors are betting on startups to provide higher returns. With the cost and challenges of going public, more companies are continuing to stay private and multi-billion-dollar buyouts are common. Consider Facebook’s US$19 billion acquisition of WhatsApp and Microsoft’s US$26 billion acquisition of LinkedIn. Even non-tech companies like Wal-Mart are buying startups, either to scale up someone else’s innovation or to shelve competition. Such liquidity events have a self-reinforcing effect; there is more capital available to VC & PE funds for future investments, unleashing a wave of wealth creation. In addition, private investments have provided better returns than public markets, and mega VC & PE funds have longer time horizons. With bigger war chests and the ubiquitous nature of innovation, unicorns are also expanding aggressively in international markets, which in turn fuels appetite for larger investments at higher valuations. Uber, WeWork are classic examples.
Investing in a soon-to-be-a-unicorn or a growth stage company is also less risky than early stage startups. By the time an enterprise reaches unicorn status, they are more established, have significant traction, product-market fit has been achieved and thus, less likely to fail.
With so many unicorns being created, there is an ongoing debate about valuations becoming frothy and unsustainable as well as the buildup of a “tech bubble”. The institutional nature of financial markets and market dynamics will play a role in the supply and demand of capital for new ventures and unicorns. But with low-interest rates predicted to continue for a while, the demand for riskier investments will remain high.
Technology & innovation will continue to impact macroeconomic factors like employment and wages. With automation replacing workers, the need for “nano” unicorns in emerging markets like India is becoming apparent. Nano unicorns are small businesses that attract small amounts of risk capital and generate jobs, especially in rural and semi-urban areas. These will play an important role in skill development, rural development and development of entrepreneurship beyond urban areas.
I believe that with Chinese markets cooling, predictions of a slowdown in the US and other markets including India, investors will be more cautious than in 2018 or 2017. Valuations will moderate and lesser unicorns will be created, but as long as capital is available, entrepreneurs will continue to dream and develop newer technologies and innovative products, thus continuing to create unicorns. The creation of unicorns is grounded in the hustle and the drive to dream big and create new things. As long as that drive exists, and investors are willing to back such entrepreneurs, unicorns will continue to be born and thrive.