India economic update
Milind S. KothariManaging Partner
M & A tracker
Rajesh ThakkarPartner and Leader/
M&A Tax and Regulatory
Deal Advisory Services
Lata MorePartner and Leader/ Valuations
The months of April and May 2021 sent shockwaves across the world as India continued to report a vertical rise in infections and the number of deaths that consistently crossed global peaks. The second wave of the pandemic overwhelmed a large nation with a population of nearly 1.38bn people. Just two months ago, no one could have imagined this fate when the leaders had self-declared a victory against the virus, and the economy seemed to be on a roll. At present, it is heartening to know that the numbers and situation both seem to be improving and will hopefully continue to be better. The current lockdown-like restrictions in some of the Indian states are likely to be lifted by June-July, allowing for economic normalisation by August and September of this year.
With the Government left grappling with the virus for the past few months; the agenda of reforms, keeping the economy back on track and other economic issues came to a standstill - with nearly no significant policy announcements being made. The economic activity itself was on a low ebb, with many key industries such as automobile and manufacturing grinding to a halt. One prime indicator - the generation of e-way bills that records the inter-and intra-state movement of goods plummeted to the lowest in a year, as restrictions to control the second wave of COVID-19 infections reduced mobility.
Expectedly, the price for the disruption of economic activity is being paid by small manufacturers; with the payment cycle being deeply affected once again, jettisoning their chances of survival from a ‘barely-there recovery’ from the first wave. Last year, a good monsoon that propelled rural demand saved the day for India. This time, it is feared that if the rural economy is impacted due to the agricultural output failing, it would be a significant downside risk for the overall economy.
The credit agencies are re-evaluating the impact on the GDP because of the critical challenges posed by a persistent slowdown in growth, weak government finances, and financial sector risks. At the beginning of this fiscal year (April 2021-March 2022), the growth forecast pegged at above 12% was revised to less than 10%. Most believe that this year, the GDP growth will remain a moving target, to be watched each month with ‘uncertainty’ occupying centre-stage.
In a recently released report by the Reserve Bank of India, India’s central bank took the view that India’s economy is at a cusp. A virtuous combination of public and private investment can ignite a shift towards investment and a trajectory of sustained growth. For records, the central bank has been developing policy measures to revive the economy since March 2020, when the Government locked down the nation to prevent COVID-19 infections. Since then, it has cut rates, raised liquidity, and launched special pandemic-relief initiatives.
Despite the health adversities compounded by the curbs on activities across the country, it is hoped that India will still achieve its export target of USD 400bn, this fiscal year, as the recovery in the country’s exports is expected to be broad-based and substantial. The promising factor is that, in April, all the 30 major export sectors grew to almost twice the size of the preceding year. Alongside, the imports too grew by more than 67% over the last year.
The Foreign Direct Investment(FDI) figures show an encouraging sign, with inflows growing by 19% year-on-year in the financial year 2020-21 to a record USD 59.64bn. Despite the disruption caused by the pandemic, India attracted the highest ever total FDI inflow. Credit is due to the measures taken by the Government, especially in the domains of FDI policy reforms, investment facilitation, and ease of doing business, which have facilitated increased inflows. The trends are an endorsement of India’s status as a preferred investment destination with global investors. Amongst the Indian states, Gujarat was the top recipient with a 37% share of the total FDI equity inflows, followed by Maharashtra and Karnataka with 27% and 13%, respectively. Computer Software and Hardware emerged as the top sectors with around 44% of the total FDI equity inflow, followed by Construction and Infrastructure-related activities.
With a rapid and steady drop in infections and deaths; it is hoped that India will emerge battered but stronger from the second wave. On the flip side, there is a dire possibility of a third wave. Hopefully, the lessons learned from the second wave will hold good and timely measures will be put into place to mitigate the consequences to the extent possible.
M&A in India
Between March 30 2021 to May 28 2021, around 92 M&A deals were announced of which 51 M&A deals were completed. The aggregate value of deals announced is USD 8749.05mn; dominated by 60 domestic deals (USD 3649.47mn) followed by 32 cross border deals (USD 5099.58mn)
In terms of sectors (considering only closed deals), the Consumer Discretionary sector saw the maximum deal value, with deals worth USD 1279mn followed by the Information Technology sector with deals worth USD 233.28mn and the Energy sector with deals worth USD 63.97mn
Significant Deals completed between March 30 2021 to May 28 2021
Target Company: Aakash Educational Services Limited
Acquiring Company: Think and Learn Private Limited
Deal Value (in Mn USD): 1000
Sector: Consumer Discretionary
- Think and Learn Private Limited (Byju’s) acquired Aakash Educational Services Limited for a total consideration of USD 1bn (INR 73.26bn)
- The transaction was a mix of cash and stock
- The acquisition would enhance Think and Learn Private Limited's presence in the test preparation segment in the country
- As part of the transaction, the Founders of Aakash and Blackstone will become shareholders in Think and Learn Private Limited
- Byju’s and Aakash Educational Services Limited would work towards building an omnichannel learning offering that would accelerate the test-prep experience to the next level
- Aakash Educational Services Limited would continue to operate as a separate entity and further expand its presence in the country
Target Company: InternalDrive Inc.
Acquiring Company: Eruditus Learning Solutions Pte. Ltd
Deal Value (in Mn USD): 200
Sector: Consumer Discretionary
- Eruditus Learning Solutions Pte. Ltd. acquired InternalDrive Inc. (iD Tech) for a total consideration of USD 200mn (INR 14.62bn)
- As part of the transaction iD Tech will work autonomously, keeping up its group of teachers and representatives while expanding footprint and leveraging Eruditus brand accessibility to iDTech and K-12 segment
- The acquisition will mark the Mumbai-based entity’s expansion beyond higher education into the K-12 STEM space or school education in the science and mathematics stream
- Eruditus wants to make iD Tech’s courses accessible to consumers across Southeast Asia, Latin America, and China
Target Company: SLK Global Solutions Private Limited
Acquiring Company: Coforge Limited
Deal Value (in Mn USD): 122.72
Sector: Information Technology
- Coforge Limited acquired a 60% stake in SLK Global Solutions Private Limited for USD 122.72mn (INR 9.18 bn)
- As per the agreement, Coforge is under the obligation to purchase a further 20% stake after 2 years
- As a part of the transaction, Fifth Third Bank would partially exit the company. In the first phase of the transaction, Fifth Third Bank’s stake would drop to 40%, which would be further reduced to 20% after the completion of 2 years. The acquisition would further strengthen Coforge’s financial services business, scale BPM operations and expand its US footprint
- Coforge’s technology and digital capabilities would be highly relevant to SLK Global’s customer base that includes several marquee names in the BFS and Insurance industries, while the latter’s capabilities would enable Coforge to compete more effectively for deals that have a major BPM/BPO operations component. SLK Global also provides Coforge with an attractive Tier-3 India city delivery location
- The transaction is being funded by Coforge with a combination of internal accruals and external borrowings.
Significant deals announced between March 30 2021 to May 28 2021 but not completed
Target Company: SB Energy Holdings Limited
Acquiring Company: Adani Green Energy Limited
Deal Value (in Mn USD): 3500
- Adani Green Energy Limited entered into an agreement to acquire SB Energy Holdings Limited from SoftBank Group Corp. and Bharti Airtel Limited for USD 3.5bn (INR 256.43bn)
- With this acquisition, Adani Green Energy will achieve a total renewable capacity of 24.3 GW and an operating renewable capacity of 4.9 GW
- This acquisition demonstrates Adani Green Energy’s intent to be a leader in sustainable energy transition globally, and makes it one of the largest renewable energy platforms in the world
- The portfolio comprises very high quality, large scale utility renewable assets, which are expected to be value accretive to the shareholders
- The closing of the transaction is subject to customary approvals and conditions
- The transaction is expected to be completed by August 2021
Target Company: Network Access Associates Limited
Acquiring Company: Eutelsat Communications S.A.
Deal Value (in Mn USD): 550
Sector: Telecommunication services
- Eutelsat Communications S.A. is acquiring a 24% stake in Network Access Associates Limited for USD 550mn (INR 41.13bn)
- As a part of the transaction, Eutelsat will receive governance rights similar to the UK government and Bharti Global, including board representation
- This investment will bring the company's total funding to USD 1.9bn (~ INR 142.08bn) in fresh equity
- It will enhance the commercial potential of both the companies, enabling Network Access Associates to leverage the latter's existing government and enterprise customer base
- The transaction is expected to be completed in the second half of 2021, subject to regulatory approvals
- Post transaction, Eutelsat, Bharti Global and the UK government will each hold a 24% stake while SoftBank, Hughes Network Systems and other minority investors will collectively hold a 28% stake in the company
Understanding business valuations in a post-pandemic world
The onslaught of the global pandemic impacted lives and livelihoods world over, bringing normal life as we knew it, to a complete halt. The COVID-19 pandemic is well into its second year, and countries around the world have taken their own approaches in managing the impact of the pandemic from both a health and economic perspective. India is in the middle of the second wave of Covid infections and there is a lot of uncertainty once again. The stock markets have recovered – effectively, reaching within 10% of the highs of pre-pandemic levels, but there still persists extreme volatility in the markets.
The pandemic and the related uncertainty in the market has resulted in market multiples that are extremely volatile. Lower market capitalisation results in lower multiples based on historical financial metrics. At the same time, using pre-pandemic financial metrics to calculate fair value may not represent reasonable outcomes.
The impact on business could be temporary, long-lasting, or permanent. As uncertainty continues around a companies’ future earnings growth, cash flows, and even ultimate survival, it could create valuation challenges for funds to market portfolio companies, companies for impairment testing of investments, transaction/deal valuation, etc.
‘Fair Value’ is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is important to understand that fair value is based on an orderly transaction and not on a distressed or fire-sale scenario.
In the current situation, it is important to not only consider the turbulence in public markets but also the impact of COVID-related developments on cash flows, growth rates, and margins. The valuation methodology remains unchanged; however, a re-look is required at the information that is flowing into the valuation and the adjustments to market inputs if the analysis indicates that there is an element of ‘noise’ or excessive volatility.
Given the challenges, the situation demands an unconventional approach for company valuations. Certain key aspects to be examined while analysing a business/company are:
- Future Projections: Assess if the business disruption is temporary or permanent. Incorporate company-specific as well as third-party, industry resources to develop both near-term and long-term projections.
- Working Capital: Expected changes in receivables and payables days affect the working capital cycle. Analyse the working capital thoroughly to understand the normalised level e.g.: negotiation for extended terms with suppliers, lease rental holidays, etc.
- Liquidity: Assess the cash and debt level and evaluate the liquidity needs for the short term and long term as well as the source of funding for meeting liquidity needs including working capital.
- Capital Expenditure: Assess the capital expenditure requirement in the business to achieve the projected inflows. The valuer may also assess the need to defer the capital expenditure and consider its impact on the projections as well.
- Valuing Private Loans: Incorporating market yields and benchmarking data for the valuation date based on judgement and support rather than just relying on pre-pandemic benchmarking.
- Cash Flow Projections: Evaluate different cash flow scenarios for understanding the range of potential outcomes for a business and its attached risks. For example, a business-as-usual scenario, a scenario with short/medium term disruption, a scenario with change in supplier’s cost or marketing cost, etc. The selection of scenario is based on the nature of a business and the assessment of the impact of COVID-19 on the business.
- The discount rate should be adjusted for idiosyncratic risk to be commensurate with a company’s expected ability to achieve the updated forecast. Check the credit rating assigned to a company and consider the impact of the same on the cost of debt of the company.
- Use multiple methodologies: Considering the market volatility and company-specific responses to the pandemic, the use of more than one valuation methodology is a better way to logically conclude either by the corroboration of estimates or relying on weighted conclusions.
Lastly, there is a distinction between price and value, and this distinction is more critical in the current market situation to ensure that it is possible to separate fundamental value changes from potential noise in the pricing of public securities. The valuer may ignore the pricing of increased volatility and consider the longer period to conclude on the multiples. In these times, it is imperative that a valuer possesses technical expertise and practical experience to provide sound, objective, and independent valuation advice.
COVID-19 a disruption or boon for Venture Capitalists (VC)?
When the pandemic hit India in March 2020, the overall venture activity was disrupted during the first two months of the health crisis, as most VCs understandably, were taking stock of their portfolios and were assessing the impact of COVID on the marketplace and their respective portfolios. While significant uncertainty prevailed during the first few months of the pandemic, we observed a whipsaw effect on the marketplace at large and to some extent on our portfolio.
Within the first few weeks, it was evident that businesses relying on brick & mortar stores, and manufacturing faced headwinds from the pandemic; SaaS companies and technology start-ups operating in the B2B domain, digital health companies, online education, strong e-commerce business models had tailwinds going for them. At Inflexor and Parampara, we largely invest in technology-driven start-ups with a B2B focus. While some of our portfolio companies faced a few initial issues/loss of customers, the majority of firms began to adjust to the new normal and business started picking up around June-July 2020.
Although we did not harbour any strong views on which way valuations would move in the ensuing months, we held a general view that there may be a minor correction in valuations. Post-June, the VC deal activity picked up pace, larger cheques of money began to flow into VC investments and contrary to what many in the industry suspected, start-up valuations moved upwards.
By this time, many PE/VC investors were flushed with dry gunpowder and many companies were amidst their fund-raising activity. Another trend that was gathering strength globally and particularly in the Indian context, was that non-traditional investors such as family offices, high net worth individuals began to embrace VC investments as a viable investment alternative. All this meant increased liquidity in the market for start-up investments and by corollary, also meant increased valuations for companies in many sectors.
Moreover, recent valuation increases for early-stage companies include some survivorship bias; investors are enthusiastically backing start-ups and technologies that will thrive in the new economy, and their potential impact post-COVID-19 may merit higher relative valuations, even during a downturn.
One year into the pandemic, our portfolio largely managed to deftly navigate the challenges thrown by the pandemic. While in few cases, the pandemic has opened new avenues for business, in certain cases managements went back to the drawing board to tweak business models to suit the changed market conditions. Some of our companies were also able to raise subsequent rounds of funding at larger valuations and some of them are embarking on their subsequent raises.
Overall, we now see that pre-money valuations have gone up to 2x to 3x of pre-pandemic levels in a few sectors and that companies are also raising larger rounds of money at each stage. Participation from capital-rich non-traditional investors has only gone up in the past few months and there are many more venture funds who have entered the fray. We are starting to see a thriving venture ecosystem in India; if you have an idea and are ready for the hustle, there is no better time to Start-up.