A STUDY ON LEVERAGED BUYOUT’S IN INDIA

Description

Evidence to date provides some answers about the LBO phenomenon and its effects. Stockholders of LBO targets are big winners, experiencing immediate gains averaging 30 to 50 percent from surrendering their shares. These gains cannot be attributed, in general, to bondholder losses. Although the value of some nonconvertible debt securities depreciates significantly after LBOs, the average effect on bond value is less clear. Furthermore, stockholder gains appear to be unrelated to bondholder wealth effects, rejecting the hypothesis that bondholder losses are the sole source of stockholder gains.

A STUDY ON LEVERAGED BUYOUT’S A STUDY ON LEVERAGED BUYOUT’S IN INDIA IN INDIA
Project submitted in partial fulfillment for the award of the
Degree of
MASTER OF BUSINESS ADMINISTRATION
DECLARATION
I hereby declare that this Project Report titled
“LEVERAGED BUYOUT” submitted by me to the Department
of XXXXXX is a bonafide work under taken by me and it is not
submitted to any other University or Institution for the award
of any degree diploma certificate or published any time
before!
1
Name and Address of the "tudent "ignature of the "tudent
Date#
ABSTRACT
$he project titled %leveraged buyout in India& gives us the brief
idea regarding leveraged buyout's (mergers ) ac*uisitions+
and its present scenario in Indian market! $he various things
that can be known through the study of this report are the
history of leveraged buyout, buyout effects, challenges
associated with it, governmental policies, and also brief history
about Indian banking sector ) private-e*uity firms!
$he project provides us basic knowledge regarding
.undamental by studying financial structure and characteristics
of companies! /verall, it provides a greater e0posure to
2
international finance by studying the financial aspects ) terms
associated with the study!
TABLE OF CONTENTS
CONTENTS PAGE NO.
List Of Tables i
List Of Fi!"es ii
C#APTER$%
%. INTRODUCTION %
&. OB'ECTIVE OF T#E STUDY (
(. SCOPE OF T#E STUDY )
). MET#ODOLOGY *
*. LIMITATIONS OF T#E STUDY +
C#APTER$&
+. LEVERAGED BUYOUTS ,$&-
C#APTER$(
3
-. INDIAN BAN.ING SYSTEM / PRIVATE E0UITY FIRMS &,$(,
C#APTER$)
,. CRITICISM /
C#ALLENGES IN EXECUTING LBOs IN INDIA (1$+*
C#APTER$*
1. FINDINGS OF T#E STUDY ++$-(
%2. SYNOPSIS -)$-+
%%. BIBLIOGRAP#Y --
LIST OF TABLES
TABLE PAGE NO
I. Ba34s 5a"ti6i5ati73 i3 8ebt fi3a36i3 ()
II. B!97!ts b9 I38ia3 67:5a3ies )&
III. B!97!ts 7f I38ia3 67:5a3ies )(
IV. Foreign direct investments limits 47
V. Res7!"6es "aise8 f"7: t;e 8ebt :a"4ets *2
4
LIST OF FIGURES

TABLE PAGE NO
T#E CORUS STEEL FACTORY IN I'MUIDEN 12
REVIE< OF STOC.S CORUS Vs TATA STEEL &)
STRUCTURE OF INDIAN BAN.ING INDUSTRY (%
FOREIGN #OLDING COMPANY STRUCTURE +%
5
LEVERAGED BUYOUT
IN$R/DU3$I/N
$he evolution of leveraged buyouts came into e0istence in
1456's! During the 1476's 89/'s became very common and
increased substantially in si:e, 89/'s normally occurred in
large companies with more than ;166 million in revenues! 9ut
many of these deals subse*uently failed due to the low *uality
of debt used, and thus the movement in the 1446's was
toward smaller deals (featuring small to medium si:ed
companies, with about ;<6 million in annual revenues+! $he
most common leveraged buyout arrangement among small
businesses is for management to buy up all the outstanding
6
shares of the company=s stock, using company assets as
collateral for a loan to fund the purchase! $he loan is later
repaid through the company=s future cash flow or the sale of
company assets!
A management-led 89/ is sometimes referred to as >going
private,> because in contrast to >going public>?or selling
shares of stock to the public?89/s involve gathering all the
outstanding shares into private hands! "ubse*uently, once the
debt is paid down, the organi:ers of the buyout may attempt
to take the firm public again! @any management-led, small
business 89/s also include employees of the company in the
purchase, which may help increase productivity and increase
employee commitment to the company=s goals!
7
OB'ECTIVE OF T#E STUDY
%! $o know standards re*uired for a company to go for
8everaged buyout deal
&! $o study post leveraged buyout deal in metal industry
(TATA-CORUS+
(! $o study banking ) private e*uity firms
8
SCOPE
$he study is limited only to few Indian firms
It covers only a brief snap shot about Indian banking industry
and private e*uity firms with respect to debt financing in
various buyouts
$he study is limited to the availability of information, and it
does not covers international accounting policies, procedures
or any legal aspects, only limited information which deals with
the project has been studied
9
MET#ODOLOGY
SECONDARY DATA
? Data collected from 9ooks, Newspaper ) @aga:ines!
? Data obtained from the Internet!
? Data obtained from company Aournals!
10
LIMITATIONS
? $he data collected is basically confined to secondary
sources, with very little amount of primary data
associated with the project!
? $here is a constraint with regard to time allocated for the
research study!
11
? $he availability of information in the form of annual
reports ) stock fluctuations of the companies is a big
constraint to the study!
LITERATURE REVIE<
12
LEVERAGED BUYOUT
MEANING
$he term leveraged buyout (89/+ describes an ac*uisition or
purchase of a business, typically a mature company, financed
through substantial use of borrowed funds or debt by a
financial investor whose objective is to e0it the investment
after B-2 years! In fact, in a typical 89/, up to 46 percent of
the purchase price may be funded with debt!
13
$he term Cle=e"ae8' signifies a significant use of debt for
financing the transaction! $he purpose of a 89/ is to allow an
ac*uirer to make large ac*uisitions with out having to commit
a significant amount of capital!
(A typically transaction involves the setup of an ac*uisition
vehicle that is jointly funded by a financial investor and the
management of the target company! /ften the assets of the
target 3ompany are used as collateral for the debt! $ypically,
the debt capital comprises of a combination of highly
structured debt instruments including pre-payable bank
facilities and or publicly or private placed bonds commonly
referred to as high-yield debt! $he new debt is not intended to
be permanent 89/ business plans call for generating e0tra
cash by selling assets, shaving costs and improving profit
margins! Dt e0tra cash is used to pay down the 89/ debt!
@anagers are given greater stake in the business via stock
options or direct ownership of shares+!
$he term Cb!97!t' suggests the gain of control of a majority of
the target company's e*uity! ($he target company goes private
after a 89/! It is owned by a partnership of private investors
14
who monitor performance and can set right away if something
goes awry! Again, the private ownership is not intended to be
permanent! $he most successful 89/s go public again as soon
as debt has been paid down sufficiently and improvements in
operating performance have been demonstrated by the target
company+!
A8=a3taes
A successful 89/ can provide a small business with a number
of advantages! .or one thing, it can increase management
commitment and effort because they have greater e*uity stake
in the company! In a publicly traded company, managers
typically own only a small percentage of the common shares,
and therefore can participate in only a small fraction of the
gains resulting from improved managerial performance! After
15
an 89/, however, e0ecutives can reali:e substantial financial
gains from enhanced performance!
$his improvement in financial incentives for the firm=s
managers should result in greater effort on the part of
management! "imilarly, when employees are involved in an
89/, their increased stake in the company=s success tends to
improve their productivity and loyalty! Another potential
advantage is that 89/s can often act to revitali:e a mature
company! In addition, by increasing the company=s
capitali:ation, an 89/ may enable it to improve its market
position!
"uccessful 89/s also tend to create value for a variety of
parties! .or e0ample, empirical studies indicate that the firms=
shareholders can earn large positive abnormal returns from
leveraged buyouts! "imilarly, the post-buyout investors in
these transactions often earn large e0cess returns over the
period from the buyout completion date to the date of an initial
public offering or resale! "ome of the potential sources of
value in leveraged buyout transactions include

16
1+ Eealth transfers from old public shareholders to the buyout
group
<+ Eealth transfers from public bondholders to the investor
group
B+ Eealth creation from improved incentives for managerial
decision making and
F+ Eealth transfers from the government via ta0 advantages!
$he increased levels of debt that the new company supports
after the 89/ decrease ta0able income, leading to lower ta0
payments! $herefore, the interest ta0 shield resulting from the
higher levels of debt should enhance the value of firm!
@oreover, these motivations for leveraged buyout transactions
are not mutually e0clusiveG it is possible that a combination of
these may occur in a given 89/!
Not all 89/s are successful, however, so there are also some
potential disadvantages to consider! If the company=s cash flow
and the sale of assets are insufficient to meet the interest
payments arising from its high levels of debt, the 89/ is likely
to fail and the company may go bankrupt! Attempting an 89/
17
can be particularly dangerous for companies that are
vulnerable to industry competition or volatility in the overall
economy! If the company does fail following an 89/, this can
cause significant problems for employees and suppliers, as
lenders are usually in a better position to collect their money!
Another disadvantage is that paying high interest rates on 89/
debt can damage a company=s credit rating! .inally, it is
possible that management may propose an 89/ only for short-
term personal profit!
STANDARDS RE0UIRED FOR TARGET / AC0UIRER COMPANY
$he standards are characteri:ed into operating characteristics
and financial characteristics, therefore these characteristics are
considered as ideal leveraged buyout target (89/ target+!
T95i6al 75e"ati3 a38 fi3a36ial 6;a"a6te"isti6s 7f
att"a6ti=e LBO ta"ets
OPERATIONAL C#ARACTERISTICS FINANCIAL C#ARACTERISTICS
18
Lea8i3 :a"4et 57siti73 > 5"7=e3
8e:a38 f7" 5"78!6t
Si3ifi6a3t 8ebt 6a5a6it9
St"73 :a3ae:e3t tea: Stea89 6as; fl7?
P7"tf7li7 7f st"73 b"a38 3a:es
@if a55li6ableA
A=ailabilit9 7f att"a6ti=e 5"i6es
St"73 "elati73s;i5 ?it; 4e9
6!st7:e"s a38 s!55lie"s
L7? 6a5ital i3te3sit9
Fa=7"able i38!st"9 6;a"a6te"isti6s P7te3tial 75e"ati3 i:5"7=e:e3t
F"a:e3te8 i38!st"9 I8eall9 l7? 75e"ati3 le=e"aes
Stea89 "7?t; Ma3ae:e3t’ s!66ess i3 i:5le:e3ti3
s!bsta3tial 67st "e8!6ti73 5"7"a:s
POST$BUYOUT EFFECTS OF TATA$CORUS
S#ORT$TERM IMPLICATIONS
T;e st764;7l8e"s
$he stockholders of firms that complete an 89/ typically
receive cash for their shares representing a substantial
premium above the market price of stock prior to the 89/
announcement! $he average 89/ stockholder premia per year
ranged from B1 percent to F4 percent comparable to the
premia paid in mergers and ac*uisitions in general!
19
$he large premia paid to the target firm stockholders represent
prima facie evidence of immediate stockholder gains
associated with leveraged buyouts! $he *uestion remains,
however, whether e*ual or even larger gains would have been
earned in the future anyway because the buyout is motivated
by the private investor group=s favorable inside information
about the firm=s future prospects!
$wo empirical regularities contradict this notion! .irst, no
support has been found for the hypothesis that management
understates reported earnings or earnings forecasts before the
buyout is completed in order to depress the price of stock!
"econd, the stock price increase upon unsuccessful 89/
proposals is not permanent,> as would be e0pected if the offer
merely reflects advance knowledge of a rise in future cash
flows! Nevertheless, the possibility that the purchase price for
the stock represents a discount to the >true value> of the stock
cannot be ruled out entirely!
"etting aside momentarily the e0ploitation of market under-
valuation as a primary source of the stockholder gains, the
implications of the stockholder premia regarding the
20
productivity gains and social benefits of 89/s are still far from
clear! /ne e0planation for the increase in e*uity value is an
increase in management efficiency associated with the new
ownership structure! An alternative view is that the
stockholder gains represent the e0propriation of wealth from
other corporate stakeholders, e!g!, bondholders, employees,
and suppliers, as well as a reduction in ta0es! Although this
alternative view does not preclude productivity gains, it does
identify potential problems with inferring their magnitude from
the stockholder premia alone!
FROM TATA’S POINT OF VIE<
Investors with a one-to-two year perspective may find the $ata
"teel stock unattractive at current price levels! Ehile the
potential downside to the stock may be limited, it may
consolidate in a narrow range, as there appears to be no short-
term triggers to drive up the stock! $he formalities for
completing the ac*uisition may take three to four months,
before the integration committees get down to work on the
deal! In our view, three elements are stacked against this deal
in the short run!
21
EB!it9 8il!ti73
$he financing of the ac*uisition is unlikely to pose a challenge
for the $ata group, but the financial risks associated with high-
cost debt may be *uite high! $hough the financing pattern is
yet to be spelt out fully, initial indications are that the ;F!1
billion of the total consideration will flow from $ata "teel$ata
"ons by way of debt and e*uity contribution by these two and
the balance ;7 billion, will be raised by a special investment
vehicle created in the UH for this purpose! Preliminary
indications from the senior management of $ata "teel suggest
that the debt-e*uity ratio will be maintained in the same
proportion of 27#<<, in which the first offer was made last
/ctober!
22
T#E CORUS STEEL FACTORY IN I'MUIDENC T#E NET#ERLANDS
9ased on this, a <6-<I per cent e*uity dilution may be on the
cards for $ata "teel! $he e*uity component could be raised in
the form of preferential offer by $ata "teel to $ata "ons, or
through JDRs (global depository receipts+ in the overseas
market or a rights offer to shareholders!
$his dilution is likely to contribute to lower per share earnings,
whose impact will be spread over the ne0t year or so! As $ata
"teel also remains committed to its si0-million-tonne
Jreenfield ventures in /rissa, its debt levels may rise sharply
in the medium term!
Ma"i3 5i6t!"e
"hort-term triggers that may help improve the operating profit
margin of the combined entity seem to be missing! In the third
*uarter ended "eptember <665, 3orus had clocked an
operating margin of 4!< per cent compared with B< per cent by
$ata "teel for the third *uarter ended December <665! In
23
effect, $ata "teel is buying an operation with substantially
lower margins!
$his is in sharp contrast to @ittal=s ac*uisition of Arcelor, where
the latter=s operating margins were higher than the former=s
and the combined entity was set to enjoy a better margin!
Despite that, on the basis of conventional metrics such as
KLK9I$DA and KLtonne, Arcelor @ittal=s valuation has turned
to be lower than $ata 3orus! /n top of that, $ata is making an
all-cash offer for 3orus vis-à-vis the cash-cum-stock swap
offer made by @ittal for Arcelor!
3orus has been working on the >Restoring "uccess> program
aimed at closing the competitive gap that e0isted between
3orus and the Kuropean steel peers!
$he gap in <66B was about 5 per cent in the operating profit
level when measured against the average of Kuropean
competitors! And this program is e0pected to deliver the full
benefits of 576 million pounds in line with plan! Eith this
program running out in <665 and being replaced by M$he
3orus Eay=, the scope for $ata "teel to bring about short-term
improvements in margins may be limited!
24
Kven the potential synergies of the ;B66-BI6 million a year
e0pected to accrue to the bottom line of the combined entity
from the third year onwards, may be at lower levels in the first
two years! As outlined by @r! 9!@uthuraman, @anaging
Director of $ata "teel, synergies are e0pected in the
procurement of material, in the marketplace, in shared
services and better operations in India by adopting 3orus=s
best practices in some areas!
T;e steel 696le
Ehile the industry e0pects steel prices to remain firm in the
ne0t two-three years, the impact of 3hinese e0ports has not
been factored into prices and the steel cycle! $here are clear
indications that steel imports into the KU and the U" have
been rising significantly! At 16-1< million tonnes in the third
*uarter of <665, they are twice the level in the same period
last year and 3hina has been a key contributor!
$his has led to considerable uncertainty on the pricing front!
$hough regaining pricing power is one of the objectives of the
25
$ata-3orus deal, prices may not necessarily remain stable in
this fragmented industry! $he top five players, even after this
round of consolidation, will control only about <I per cent of
global capacities! Dence, the steel cycle may stabilise only if
the latest deal triggers a further round of consolidation among
the top ten producers!
LONG$RUN PICTURE
Ehenever a strategic move of this scale is made (where a
company takes over a global major with nearly four times its
capacity and revenues+, it is clearly a long-term call on the
structural dynamics of the sector! And investors will have to
weigh their investment options only over the long run!
/ver a long time frame, the management of the combined
entity has far greater room to manoeuvre, and on several
fronts! If you are a long-term investor in $ata "teel, the key
developments that bear a close watch are
P"7"ess 73 l7?$67st slabs
26
Research shows that steel-makers in India and 8atin America,
endowed with rich iron ore resources, enjoy a <6 per cent cost
advantage in slab production over their Kuropean peers!
Dence, any meaningful gains from this deal will emerge only
by <664-16, when $ata "teel can start e0porting low-cost slabs
to 3orus!
$his is unlikely to be a short-term outcome as neither $ata
"teel=s si0-million-tonne greenfield plant in /rissa nor the
e0pansion in Aamshedpur is likely to create the kind of capacity
that can lead to surplus slab-makingsemi-finished steel
capacity on a standalone basis!
"econd, there may be further constraints to e0ports, as $ata
"teel will also be servicing the re*uirements of Nat"teel,
"ingapore, and @illennium "teel, $hailand, its two recent
ac*uisitions in Asia!
Dowever, this dynamic may change if the $atas can make some
ac*uisitions in low-cost regions such as 8atin America, opening
up a secure source of slab-making that can be e0ported to
3orus=s plants in the UH! /r if the iron ore policy in India
27
undergoes a change over the ne0t couple of years, $ata "teel
may be able to e0plore alternatives in the coming years!
Rest"!6t!"i3 at C7"!s# $he raison d'etre for this deal for
$ata "teel is access to the Kuropean market and significantly
higher value-added presence! In the long run, there is
considerable scope to restructure 3orus= high-cost plants at
Port $albot, "cunthorpe and the slab-making unit at $eesside!
$he job cuts that $ata "teel is ruling out at present may
become inevitable in the long run! $hough it may be
premature at this stage, over time, $ata "teel may consider
the possibility of divesting or spinning off the engineering
steels division at Rotherham with a production capacity of 1
million tonnes! $he ability of the $atas to improve the
combined operating profit margins to <I per cent (from around
1F per cent in <66I+ over the ne0t four to five years will hinge
on these two aspects!
In our view, two factors may soften the risks of dramatic
restructuring at the high-cost plants in UH! If global
consolidation gathers momentum with, say, the merger of
28
$hyssenkrupp with Nucor, or "everstal with Jerdau or any of
the top five players, the likelihood of pricing stability may ease
the performance pressures on $ata-3orus!
$wo, if the $atas contemplate global listing (say, in 8ondon+ on
the lines of Ledanta Resources (the holding company of
"terlite Industries+, it may help the group command a much
higher price-earnings multiple and give it greater fle0ibility in
managing its finances!
LONG$TERM OUTLOO. POSITIVE FOR TATA STEEL
29
$he famous stock market saying, price discounts all, is truly
reflected in the movement of the $ata "teel stock prices over
the last si0 months! In the si0 months from the beginning of
Auly <665 to the end of Aanuary <662, $he stock lost 1B per
cent! $his is a steep underperformance when viewed in relation
to the B< per cent rise in the "ense0 in the same period! Its
peer, "teel Authority of India managed a B< per cent gain in
this period!
$he response of the stock markets to the $ata "teel=s takeover
of 3orus has been unenthusiastic from the outset! $he nascent
recovery that began in the stock price from Aune lows was
brought to an abrupt end in /ctober at the price of Rs IF2,
when $ata "teel e0pressed its interest in 3orus! $he stock
price has not crossed this level since then!
$he volumes on the $ata "teel stock too reflect the poor light
in which the stock markets viewed this entire process! $he
flurry of activity that is associated with the stock has been
missing over the last three months! $he daily traded volume
30
has been below 16 lakh shares between Aanuary 1 and Aanuary
<<, <662, in the run-up to the auction!
TEC#NICAL VIE<
$he technical chart of $ata "teel has been under pressure since
/ctober <665! 9ut the long-term outlook for this stock is
positive! long-term outlook will be altered only if the stock
price falls below Rs B66! $he chart has completed a I-wave
impulse formation from the low Rs 72 made in @ay <66B to
the peak formed in Aune <665! $he movement since Aune <665
has been a correction of this long-term up-move! $he
correction halted at Rs B25 in Aune <665, which is a I6 percent
retraction of the previous up-move!
$he stock price movement post-Aune <665 seems like a
consolidation at lower levels before the resumption of the long
term up-trend that can take the stock to a new high! 9ut the
sideways move between Rs F66 and Rs II6 can e0tend for a
few more months!
8ong-term investors can look out for buying opportunity every
time the stock price nears the lower boundary!
31
TaDes
3onsiderable corporate ta0 savings are associated with some
89/s! $hese ta0 savings primarily result from the incremental
interest deductions associated with the buyout financing, and
to a lesser e0tent from the step-up in ta0 basis of purchased
assets and the subse*uent application of more accelerated
depreciation procedures!
Although the incremental interest and depreciation deductions
associated with some 89/s are relatively easy to *uantify,
estimation of the net effect of 89/s on changing ta0 revenues
is more complicated! Increases in ta0able operating income
may result from improvements in management efficiency!
3apital gains ta0able at the corporate level may result from
divestitures undertaken to help finance the buyout! .inally,
capital gains of bought-out stockholders and interest revenues
earned by 89/ debt-holders may be subjected to ta0!
32
T#E INDIAN BAN.ING SYSTEM
$he Indian banking system is the most dominant segment of
the financial sector, accounting for over 76N of the funds
flowing through the financial sector! A key feature of India's
33
banking system is that overall, 2BN of the total financial
system assets are state owned institutions!
EVOLUTION OF T#E BAN.ING SYSTEM
In the first half of the 14
th
century, the east India company
established three banksG the bank of 9engal! In 1467, the
bank of 9ombay in 17F6 and the bank of madras in 17FB!
$hese three banks, known as presidency banks, were self-
governing units and functioned well! A new bank, the imperial
bank of India, was established with the amalgamation of these
three banks in 14<6! Eith the passing of the state bank of
India was taken by the newly constituted state bank of India!
$oday, it is far the largest bank of India!
.oreign banks like D"93 and 3redit 8yonnais started their
3alcutta operations in the 17I6s! $he first fully Indian owned
bank was the Allahabad bank set up in 175I! 9y the 1466s the
market e0panded with the establishment of banks such as
Punjab national bank (174I+ in 8ahore, bank of India (1465+,
34
in @umbai O both of which were founded under private
ownership!
Indian banking sector was formally regulated by reserve bank
of India from 14BI with the passing of reserve bank of India
14BF! After India's independence in 14F2, the reserve bank of
India, the central bank, was nationali:ed and given broader
powers!
.ormerly, all the banks in India were private banks! /n Auly
14,1454, 1F major banks of the country were nationali:ed and
on 1I
th
April 1476 si0 more commercial private sector banks
were taken over by the government after this, until the 1446s,
the nationali:ed banks grew at a moderate pace of around FN
p!a!, closer to the average growth rate if the Indian economy!
In the early 1446s the government embarked on a policy of
liberali:ation and gave licenses to a small number of private
banks, which came to know as new generation tech-savvy
banks, including banks such as I3I3I bank and DD.3 bank
with the rapid growth in the economy of India, the banking
35
sector in India, displayed rapid growth with strong contribution
from all the three sectors of banks, namely, government
banks, private banks and foreign banks!
$he ne0t phase for the Indian banking began with the
proposed rela0ation in the norms for foreign direct
investments, where all foreign investors in banks were allowed
voting rights, which could e0ceed the present cap of 16N!
C!""e3tl9C I38ia ;as
77 scheduled commercial banks ("39's+
<7 public sector banks (that is with the government of India
holding a stake+,
<4 private banks (these do not have government stakeG they
may be publicly listed and traded on stock e0changes+ and
B1 foreign banks
$hey have a combined network of over 52,666 branches and
12,666 A$@'s! According to a report by I3RA limited, a rating
agency, the public sector banks hold over 2I N of total assets
of the banking industry, with the private and foreign banks
holding 17!<N and 5!IN respectively!
36
STRUCTURE OF INDIAN BAN.ING INDUSTRY
PRIVATE > E0UITY FIRMS
The Advent Of Global Private Equity Players In India
India has witnessed a significant inflow of foreign capital
including that from global private e*uity players that are
37
setting up shop in India! $his trend is e0pected to continue and
fuel the growth of buyout and leveraged buyout activity in
India!
Kuropean buyouts veteran Denderson Private 3apital, which
manages funds of ;1!I billion, is investing in India out of its
;<16 million Denderson Asia Pacific K*uity Partners I .und! It
was set to create a ;B66-million fund for Asia, of which F6N
will be invested in India!
$he "ingapore government, the second largest foreign private
e*uity investor in India has shifted focus from early-stage
investments to growth and buyout capital! Its direct
investments company $emasek Doldings has teamed up with
"tandard 3hartered Private K*uity to set up the ;166 million
@erlion India .und!
Jlobal private e*uity firm $he 3arlyle Jroup announced in
mid-<66I that it had established a buyout team in India based
out of @umbai! $he 3arlyle India buyout team is part of
3arlyle's Asia buyout group, which manages a ;2I6 million
Asia buyout fund! 3arlyle also has two dedicated Asia growth
capital funds totaling ;B<B million!
38
$he 9lackstone Jroup recently elevated India to one of its key
strategic hubs in Asia! 9lackstone hired several consulting
firms, including @cHinsey ) 3o!, and looked at investing in
various emerging markets! It chose India as the place to set
up its ne0t in-country office and intends to invest ;1 billion in
local companies!
8ondon-based Actis is among the most e0perienced investors
in India! Actis' .und II is a ;1!5 billion fund of which ;B<I
million has been earmarked for investments in India! Actis has
been active in India since 1447 in private e*uity and since
1445 as a venture capital investor! Another e0perience global
player, Earburg Pincus has been is active in India since 144I
and has made several successful private e*uity investments
and profitable e0its in India such as the sale of a 14N stake in
9harti $ele-Lentures for ;1!5 billion (cost ;<4< million+!
Jeneral Atlantic Partners has an office in India since <661 and
has e0ecuted several successful private e*uity transactions
including the sale of Daksh e-"ervices and the initial public
offering of Patni 3omputers!
39
Eith the presence of most major bo lbo shops in india, a
greater number of buyouts leveraged buyouts are e0pected
going forward!
DEBT RAISED IN INDIA
Indian banks participate in providing working capital loans to
companies that are buyout targets! .urther, Indian banks also
tend to participate in the syndicate for bank debt of 89/s!
etails of Parti!i"ation
Company Debt Details of Participation
GE Capital International ervices !215
million
ICICI "an# $as one o% 6 lead arrangers
o% t&e loan'
ICICI "an# participated in t&e
s(ndicate )( &olding 8'6* o% t&e loan'
GE Capital International ervices !250
million
ICICI "an# $as one o% 6 co+arrangers
o% t&e loan'
ICICI "an# participated in t&e
s(ndicate )( &olding 7'4* o% t&e loan'
,E -otor .olding "/
0s1)sidiar( o% 12lon Energ(3
4450
million
1
ICICI "an# and tate "an# o% India
$ere among t&e lenders &olding
33'33* and 25* o% t&e de)t
respectivel('
5" Gro1p I6-
13'1
)illion
ICICI "an# 7 8andated arranger
Annual venture capital investment in India skyrocketed 155
per cent in <662, according to Dow Aones Lenture"ource!
3onsumerbusiness services and web-related companies
accounted for more than half of all deals!
40
9angalore, @umbai and New Delhi (<1 .ebruary <667+?
Lenture capitalists invested some ;4<7 million in 76 deals for
entrepreneurial companies in India during <662, according to
the Puarterly India Lenture 3apital Report published Dow
Aones Lenture"ource! $his was a whopping 155N increase
over the ;BF4 million invested in B5 deals in <665 and easily
the highest total on record for the region!
$he report found nearly F7N of all venture financing deals in
India were for Information $echnology (I$+ companies, as B7
rounds were completed, accounting for ;B7F million, more
than India's entire <665 venture investment total! $he most
popular recipients of venture capital in the I$ industry were
companies in the Eeb-heavy %information services& sector,
which accounted for << deals and nearly ;1F1 million in
investment! Among the deals in this area was the ;16 million
second round for 9angalore-based .our Interactive, an online
provider of local information on food, events, lifestyle,
shopping and more!
"ervice-oriented companies in India?both in the technology
fields and the non-technology areas of hotels, ta0is and similar
41
services?continue to attract investment and this is likely due
to their low capital re*uirements as well as to the rapidly
emerging nature of the broader Indian economy,& said Aessica
3anning, Director of Jlobal Research for Dow Aones
Lenture"ource, %It takes relatively little money and little time
for these kinds of companies to begin generating revenues
and, because of this, Eeb-related and consumer and business
services companies accounted for more than half of all the
venture capital deals done in India in <662!&
According to the data, the overall businessconsumerretail
industry saw B6 deals completed in <662 and more than ;BF5
million invested, a 4<N jump over the ;176 million invested in
15 deals in the industry in <665! As said, the
businessconsumer service area accounted for the bulk of the
interest in this industry, with << deals and ;<IF million
invested!
India=s health care industry, while still in its infancy, also saw
increased investor interest in <662 with seven completed deals
and nearly ;166 million invested, more than double the ;F1
million invested in the prior year!
42
%$his is only the beginning for the venture capital market in
India,& said @s! 3anning! %In <662, 24N of all deals in India
were for seed and first rounds and a lot of these companies
will continue raising venture capital as they progress toward
profitability and li*uidity! And because the majority of
investment is going to early-stage companies, we aren=t seeing
ballooning deal si:es like those in the U!" and Kurope where
investors are focused more on later-stage companies!&
In fact, the median si:e of a venture capital round for
companies India was ;4 million in <662, up slightly from ;7!2
million in <665 but well below the ;17!7 million median seen in
<66I! /f all the companies in India that received venture
funding in <662, nearly 2BN were already generating revenues
or profitability!
$he Puarterly India Lenture 3apital Report covers venture
capital investment specifically, which Dow Aones Lenture"ource
defines as growth capital made available to entrepreneurial
companies in e0change for ownership in the form of private
securities! $hese investments are often seen as shorter-term
and do not include private e*uity investments such as
43
leveraged buyouts or me::anine and debt financing!
$he investment figures included in this release are based on
aggregate findings of Lenture"ource's proprietary Indian
research! $his data was collected by surveying professional
venture capital firms, through in-depth interviews with
company 3K/s and 3./s, and from secondary sources! $hese
venture capital statistics are for e*uity investments into early-
stage, innovative companies and do not include companies
receiving funding solely from corporate, individual, andor
government investors! No statement herein is to be construed
as a recommendation to buy or sell securities or to provide
investment advice!
Criticism o% 9":s
Kver since the 89/ cra:e of the 1476s?led by high-profile
corporate raiders who financed takeovers with low-*uality debt
and then sold off pieces of the ac*uired companies for their
44
own profit?89/s have garnered negative publicity! 3ritics of
leveraged buyouts argue that these transactions harm the
long-term competitiveness of firms involved! .irst, these firms
are unlikely to have replaced operating assets since their cash
flow must be devoted to servicing the 89/-related debt! $hus,
the property, plant, and e*uipment of 89/ firms are likely to
have aged considerably during the time when the firm is
privately held! In addition, e0penditures for repair and
maintenance may have been curtailed as well! .inally, it is
possible that research and development e0penditures have
also been controlled! As a result, the future growth prospects
of these firms may be significantly reduced!
/thers argue that 89/ transactions have a negative impact on
the stakeholders of the firm! In many cases, 89/s lead to
downsi:ing of operations, and employees may lose their jobs!
In addition, some of the transactions have negative effects on
the communities in which the firms are located!
@uch of the controversy regarding 89/s has resulted from the
concern that senior e0ecutives negotiating the sale of the
company to themselves are engaged in self-dealing! /n one
45
hand, the managers have a fiduciary duty to their shareholders
to sell the company at the highest possible price! /n the other
hand, they have an incentive to minimi:e what they pay for
the shares! Accordingly, it has been suggested that
management takes advantage of superior information about a
firm=s intrinsic! $he evidence, however, indicates that the
premiums paid in leveraged buyouts compare favorably with
those in inter-firm mergers that are characteri:ed by arm=s-
length negotiations between the buyer and seller!
C#ALLENGES IN EXECUTING LEVERAGED
BUYOUTS IN INDIA
Ma6"7 Fa6t7"s Ma4i3 Le=e"ae8 B!97!ts Diffi6!lt I3 I38ia
46
$his paper distinguishes between buyouts of Indian companies
from those buyouts where an Indian company does a 89/ of a
foreign target company, with the intention of analy:ing the
former! $he reason for making this distinction and restricting
the scope of this paper to buyouts of Indian companies is, in
the case of 89/s where the target company is located in
countries such as the United Hingdom or the United "tates, the
ac*uiring Indian companies financial investors are able to
obtain financing for the leveraged buyouts from foreign banks
and the buyout is governed largely by the laws and regulations
of the target company's country!
/n the other hand, a leveraged buyout of an Indian company
by either an Indian or a foreign ac*uirer needs to comply with
the legal framework in India and the scope of e0ecution
permissible in India! $his section of the paper e0amines the
legal and regulatory hurdles to a successful 89/ of an Indian
company!
India has e0perienced a number of buyouts and leveraged
buyouts since $ata $ea's 89/ of UH heavyweight brand $etley
for Q<21 million in <666, the first of its kind in India!
47
List 7f b!97!ts b9 I38ia3 67:5a3ies

List 7f b!97!ts 7f I38ia3 67:5a3ies
Target
Company
Country Indian
Acquirer
Value Typ
e
2$etley United
Hingdom
$ata $ea Q<21
million
89/
Ehyte )
@ackay
United
Hingdom
U9 Jroup QII6
million
89/
3orus United
Hingdom
$ata "teel ;11!B
billion
89/
Dansen
$ransmissions
Netherlands "u:lon Knergy RF5I
million
89/
American A0le
1
United "tates $ata @otors ;< billion 89/
8ombardini
<
Italy Soom Auto
Ancillaries
;<<I
million
89/
Company Financial investor Value Typ
e
.le0tronics "oftware
"ystems
1
Hohlberg Hravis
Roberts ) 3o! (CHHR'+
;466
million
89/
JK 3apital International
"ervices (CJK3I"'+
Jeneral Atlantic
Partners, /ak Dill
;566
million
89/
Nitre0 3hemicals Actis 3apital ;1B!7
million
@9/
<
Phoeni0 8amps Actis 3apital ;<7!4
million
B
@9/
Punjab $ractors
F
Actis 3apital ;56
million
I
@9/
48
1! Renamed Aricent! Referred to as .le0tronics "oftware
"ystems throughout this paper!

<! @anagement 9uyout (C@9/'+
B! Paid for B5!2N promoter stake! Post the open offer, Actis'
"take will increase from FIN to 5IN!
F! Jovernment privati:ation!
I! $otal controlling interest of <7!FN! Punjab $ractors
continues operating as a publicly listed company!
5! Paid for 5IN controlling stake! 9alance held by the
promoter family!

7' Purchase of an 7IN stake from 9ritish Airways!
RESTRICTIONS ON FOREIGN INVESTMENTS IN INDIA
Nilgiris Dairy .arm Actis 3apital ;5I million
5
@9/
EN" Jlobal "ervices Earburg Pincus ;F6 million
2
9/
R.38
(businesses of
Ranba0y+
I3I3I Lenture ;<I million 89/
Infomedia India I3I3I Lenture ;<I million 89/
LA $ech EA9AJ India I3I3I Lenture ;<I million @9/
A3K Refractories
(refractories business
of A33+
I3I3I Lenture ;56 million 89/
Nirula's Navis 3apital Partners ;<6 million @9/
49
$here are < routes through which foreign investments may be
directed into India O the .oreign Institutional Investor (%.II&+
route and the .oreign Direct Investment (%.DI&+ route!
$he .II route is generally used by foreign pension funds,
mutual funds, investment trusts, endowment funds and the
like to invest their proprietary funds or on behalf of other funds
in e*uities or debt in India! Private e*uity firms are known to
use to .II route to make minority investments in Indian
companies! $he .DI route is generally used by foreign
companies for setting up operations in India or for making
investments in publicly listed and unlisted companies in India
where the investment horin is longer than that of an .II
and or the intent is to e0ercise control!
Li:its 73 FII I3=est:e3t
$he Jovernment of India has laid down investment limits for
.IIs of 16N based on certain re*uirements and the ma0imum
.II investment in each publicly listed company, which may at
times be lower than the sectoral cap for foreign investment in
50
that company. .or e0ample, the sectoral cap on foreign
investment in the telecom sector is 166N! Dowever,
cumulative .II investment in an Indian telecom company
would be subject to a ceiling of <FN or F4N, as the case may
be, of the issued share capital of the said telecom company!
RESTRICTIONS AND CAPS AND FOREIGN INVESTMENT
PROMOTION BOARD @EFIPB’A APPROVAL
"ectors where .DI is not permitted are Railways, Atomic
Knergy and Atomic @inerals, Postal "ervice, Jambling and
9etting, 8ottery and basic Agriculture or plantations with
specified e0ceptions! .urther, the Jovernment has placed
sector caps on ownership by foreign corporate bodies and
individuals in Indian companies and 166N foreign ownership is
not allowed in a number of industry sub-sectors under the
current .DI regime!
.urther, under the .DI route, .IP9 approval is re*uired for
foreign investments where the proposed shareholding is above
the prescribed sector cap or for investment in sectors where
.DI is not permitted or where it is mandatory that proposals
be routed through the .IP9
51
REGULATORY DEVELOPMENTS IN FDI
Despite the detailed guidelines for foreign investment in India,
regulations relating to foreign investment continue to get
formulated as the country gradually opens its doors to global
investors! $he evolving regulatory environment coupled with
the lack of clarity about future regulatory developments create
significant challenges for foreign investors!
.or e0ample, the Indian government lifted a ban on foreign
ownership of Indian stock e0changes just three weeks before
the NT"K Jroup, Joldman "achs and other investors bought a
<6N stake in the National "tock K0change of India! At the time
of lifting the ban, the Indian Jovernment allowed international
investors to buy as much as a combined F4N (.DI up to <5N
and .II investment of up to <BN+ in any of the << Indian stock
e0changes! $he "ecurities and K0change 9oard of India set the
limit for a single investor at IN!
52
LIST OF SE#TORS $%ERE FI LI&IT IS LESS T%A' ())*
$he following table summari:es the list of sectors where the .DI
limit is less than 166N! (as of .ebruary <5, <665+
Source: Investment Commission of India
"ector
/wnership
8imit
Kntry
Route
Domestic Airlines F4N Automatic
Petroleum refining-P"Us <5N .IP9
P"U 9anks <6N
Insurance <5N Automatic
Retail $rade I1N .IP9
$rading (K0port Douse, "uper $rading Douse, "tar $rading Douse+ I1N Automatic
$rading (K0port, 3ash and 3arry Eholesale+ 166N .IP9
Dardware facilities - (Uplinking, DU9, etc!+ F4N
3able network F4N
Direct $o Dome <6N
$errestrial 9roadcast .@ <6N
$errestrial $L 9roadcast Not Permitted
Print @edia - /ther non-newsnon-current affairsspecialty
publications
2FN
Newspapers, Periodicals dealing with news and current affairs <5N
8ottery, 9etting and Jambling Not Permitted
Defense and "trategic Industries <5N .IP9
Agriculture (including contract farming+ Not permitted
Plantations (e0cept $ea+ Not permitted
/ther @anufacturing - Items reserved for "mall "cale <FN Automatic
Atomic @inerals 2FN .IP9
53
LIMITED AVAILABILITY OF CONTROL TRANSACTIONS
AND PROFESSIONAL MANAGEMENT
Private e*uity firms face limited availability of control
transactions in India! $he reason for this is the relative small
pool of professional management in corporate India! In a large
number of Indian companies, the owners and managers are
the same! @anagement control of such target companies
wrests with promoters promoter families who may not want
to divest their controlling stake for additional capital! As a
result, a large number of private e*uity transactions in India
are minority transactions!
In management buyouts, the Indian model is different from
that in the Eest! @ost of the @9/s in India are not of the
classic variety wherein the company's managements create the
deal and then involve financial investors to fund the change of
control! In the Indian version, promoters have spun off or
divested and private e*uity players have bought the
businesses and then partnered with the e0isting management!
$he managements themselves don't have the resources to
engineer such a buyout!
54
In the absence of control, it may be difficult to finance a
minority investment using leverage given the lack of control
over the cash flows of the target company to service the debt!
.urther, a minority private e*uity investor will be unable to sell
it's holding to a strategic buyer, thereby limiting the e0it
options available for the investment!
UNDERDEVELOPED CORPORATE DEBT MAR.ET
India is a developing country where the dependence on bank
loans is substantial! $he country has a bank-dominated
financial system! $he dominance of the banking system can be
gauged from the fact that the proportion of bank loans to JDP
is appro0imately B5N, while that of corporate debt to JDP is
only FN! As a result, the corporate bond market is small and
marginal in comparison with corporate bond markets in
developed countries!
$he corporate debt market in India has been in e0istence since
Independence! Public limited companies have been raising
capital by issuing debt securities in small amounts! "tate-
owned public sector undertakings (CP"U'+ that started issuing
55
bonds in financial year 147I-75 account for nearly 76N of the
primary market! Ehen compared with the government
securities market, the growth of the corporate debt market has
been less satisfactory! In fact, it has lost share in relative
terms!
Resour!es raised fro+ the debt +ar,ets INR billion
Finan!ial
year
-))).)( -))(.)- -))-.)/ -))/.)0 -))0.)1
Total debt
raised
(231)415 -2)0)456 -2/1)465 -21)64)6 -2)1)43(
Of 7hi!h8
#or"orate
15149/ 1(145( 1/(4(9 1-941- 160496
/(* -1* -/* -(* -6*
Of 7hi!h8
Govern+ent
(-3043/ (21-14)3 (23(6496 (263(419 (20154)-
56* 91* 99* 96* 9(*
Sour!es8 RBI2 'SE2 And Pri+e atabase
Another noteworthy trend in the corporate debt market is that
a bulk of the bulk of debt raised has been through private
placements! During the five years <666-61 to <66F-6I, private
placements, on average, have accounted for nearly 4<N of the
total corporate debt raised annually! $he dominance of private
placements has been attributed to several factors, including
ease of issuance, cost efficiency and primarily institutional
demand! P"Us account for the bulk of private placements! $he
56
corporate sector has accounted for less than <6N of total
private placements in recent years, and of that total, issuance
by private sector manufacturingservices companies has
constituted only a very small part! 8arge private placements
limit transparency in the primary market!
Another interesting feature of the Indian corporate debt
market is the preference for rated paper! Ratings issued by the
major rating agencies have proved to be a reliable source of
information! $he data on ratings suggest that lower-*uality
credits have difficulty issuing bonds! $he concentration of
turnover in the secondary market also suggests that investors'
appetite is mainly for highly rated instruments, with nearly
7FN of secondary market turnover in AAA-rated securities! In
addition, the pattern of debt mutual fund holdings on B6 Aune
<66F showed that nearly IB!BN of non-government security
investments were held in AAA-rated securities, 1F!2N in AA-
rated securities and 16!7N in P1U rated securities!
$his is in sharp contrast to the use of high-yield bonds (also
known as junk bonds+ which became ubi*uitous in the 1476s
through the efforts of investment bankers like @ichael @ilken,
57
as a financing mechanism in mergers and ac*uisitions! Digh-
yield bonds are non-investment grade bonds and have a higher
risk of defaulting, but typically pay high yields in order to make
them attractive to investors! Unlike most bank debt or
investment grade bonds, high-yield bonds lack Cmaintenance'
covenants whereby default occurs if financial health of the
borrower deteriorates beyond a set point! Instead, they
feature Cincurrence' covenants whereby default only occurs if
the borrower undertakes a prohibited transaction, like
borrowing more money when it lacks sufficient cash flow
coverage to pay the interest!
$he use of credit derivatives allows lenders to transfer an
asset's risk and returns from one counter party to another
without transferring the ownership! $he credit derivatives
market is virtually non-e0istent in India due to the absence of
participants on the sell-side for credit protection and the lack
of li*uidity in the bond market!
Indian enterprises now have the ability to raise funds in foreign
capital markets! Indeed, an underdeveloped domestic market
pushes the better-*uality issuers abroad, thereby accentuating
58
the problems of developing the corporate debt market in India!
All these drawbacks of the Indian corporate debt market make
the use of the domestic debt market for financing leveraged
buyouts in India virtually impossible.
RESERVE BAN. OF INDIA @ERBI’A RESTRICTIONS ON LENDING
Domestic banks are prohibited by the R9I from providing loans
for the purchase of shares in any company! $he underlying
reason for the prohibition is to ensure the safety of domestic
banks! $he R9I has issued a number of directives to domestic
banks in regard to making advances against shares! $hese
guidelines have been compiled in the @aster 3ircular
Dir!93!461B!62!6I47 dated August <7, 1447! As per these
guidelines, domestic banks are not allowed to finance the
promoters' contribution towards e*uity capital of a company,
the rationale being that such contributions should come from
the promoters' resources!
$he R9I @aster 3ircular states that the *uestion of granting
advances against primary security of shares and debentures
including promoters' shares to industrial, corporate or other
59
borrowers should not normally arise! $he R9I only allows
accepting such securities as collateral for secured loans
granted as working capital or for other Cproductive purposes'
from borrowers!
$he R9I has made an e0ception to this restriction! Eith the
view to increasing the international presence of Indian
companies, with effect from Aune 2, <66I, the R9I has allowed
domestic banks to lend to Indian companies for purchasing
e*uity in foreign joint ventures, wholly owned subsidiaries and
other companies as strategic investments! 9esides framing
guidelines and safeguards for such lending, domestic banks
are re*uired to ensure that such ac*uisitions are beneficial to
the borrowing company and the country!
9esides rising financing from Indian banks, companies have
the option of funding overseas ac*uisitions through K0ternal
3ommercial 9orrowings (CK39s'+! $he Indian policy on K39s
allow for overseas ac*uisitions within the overall limit of
U";I66 million per year under the automatic route with the
conditions that the overall remittances from India and non-
60
funded e0posures should not e0ceed <66N of the net worth of
the company!
$he Reserve 9ank of India has prescribed that a bank's total
e0posure, including both fund based and non-fund based, to
the capital market in all forms covering
(a+ Direct investment in e*uity shares,
(b+ 3onvertible bonds and debentures and units of e*uity
oriented mutual fundsG
(c+ Advances against shared to individuals for investment in
e*uity shares (including IP/s+, bonds and debentures, units of
e*uity-oriented mutual fundsG and
(d+ "ecured and unsecured advances to stockbrokers and
guarantees issued on behalf of stockbrokers and market
makers should not e0ceed IN of its total outstanding
advances as on @arch B1 of the previous year (including
3ommercial Paper+! Eithin the above ceiling, bank's direct
investment should not e0ceed <6N of its net worth!
All these restrictions make it virtually impossible for a financial
investor to finance a 89/ of an Indian company using bank
debt raised in India!
61
RESTRICTIONS ON PUBLIC COMPANIES FROM
PROVIDING ASSISTANCE TO POTENTIAL AC0UIRERS

3ompanies Act, 14I5, "ection 22(<+ states that a public
company (or a private company which is a subsidiary of a
public company+ may not provide either directly or indirectly
through a loan, guarantee or provision of security or
otherwise, any financial assistance for the purpose of or in
connection with a purchase or subscription made or to be
made by any person of or for any shares in the company or in
its holding company!
Under the 3ompanies Act, 14I5, a public company is different
from a publicly listed company! $he restrictions placed by this
section on public companies implies that prior to being
ac*uired in a 89/, a public company, if it is listed, must delist
and convert itself to a private company! Delisting re*uires the
3ompany to follow the "ecurities and K0change 9oard of India
(Delisting of "ecurities+ Juidelines O <66B! $his section makes
it impossible to obtain security of assets firm financing
arrangements for a publicly listed company until it delists itself
and converts itself into a private company!
62
RESTRICTIONS RELATING TO EXIT T#ROUG# PUBLIC
LISTING
$he most successful 89/s go public as soon as debt has been
paid down sufficiently and improvements in operating
performance have been demonstrated by the 89/ target!
"K9I guidelines re*uire mandatory listing of Indian companies
on domestic e0change prior to a foreign listing! Indian
companies may list their securities in foreign markets through
the Issue /f .oreign 3urrency 3onvertible 9onds And /rdinary
"hares ($hrough Depositary Receipt @echanism+ "cheme,
144B! Prior to the introduction of this scheme, Indian
companies were not permitted to list on foreign bourses!
In order to bring these guidelines in alignment with the "K9I's
guidelines on domestic capital issues, the Jovernment
incorporated changes to this scheme by re*uiring that an
Indian company, which is not eligible to raise funds from the
Indian capital markets including a company which has been
restrained from accessing the securities market by the "K9I
will not be eligible to issue ordinary shares through Jlobal
Depository Receipts (CJDR'+! Unlisted companies, which have
63
not yet accessed the JDR route for raising capital in the
international market would re*uire prior or simultaneous listing
in the domestic market, while seeking to issue ordinary shares
under the scheme! Unlisted companies, which have already
issued JDRs in the international market, would now re*uire to
list in the domestic market on making profit beginning financial
year <66I-65 or within three years of such issue of JDRs,
whichever is earlier!
$hus, private e*uity players that e0ecute a 89/ of an Indian
company and are looking at e0iting their investment will
re*uire dual listing of the company O on a domestic stock
e0change as well as a foreign stock e0change O if they intend
to e0it the investment through a foreign listing!
"K9I listing regulations re*uire domestic companies to identify
the promoters of the listing company for minimum contribution
and promoter lock-in purposes! In case of an IP/, the
promoters have to necessarily offer at least <6N of the post-
issue capital! In case of public issues by listed companies, the
promoters shall participate either to the e0tent of <6N of the
64
proposed issue or ensure post-issue share holding to the
e0tent of <6N of the post-issue capital!
.urther, "K9I guidelines have stipulated lock-in (free:e on the
shares+ re*uirements on shares of promoters primarily to
ensure that the promoters, who are controlling the company,
shall continue to hold some minimum percentage in the
company after the public issue! In case of any issue of capital
to the public the minimum contribution of promoters shall be
locked in for a period of three years, both for an IP/ and
public issue by listed companies! In case of an IP/, if the
promoters= contribution in the proposed issue e0ceeds the
re*uired minimum contribution, such e0cess contribution shall
also be locked in for a period of one year! In addition, the
entire pre-issue share capital, or paid up share capital prior to
IP/, and shares issued on a firm allotment basis along with
issue shall be locked-in for a period of one year from the date
of allotment in public issue!
.or a private e*uity investor in a 89/ of an Indian company,
the IP/ route does not allow the investor a clean e0it from its
65
investment due to the minimum promoter contribution and
lock-in re*uirements!
9esides these drawbacks, there are other factors that play an
important role in e0iting a 89/ in India! K0it through the public
markets depends upon the target company's operations! If the
operations are located solely in India, sale in the domestic
public markets is most lucrative! If the portfolio company has
operations or an e0port presence in foreign markets, it may be
more beneficial to list the company in foreign capital markets!
STRUCTURING CONSIDERATIONS FOR LEVERAGED BUYOUTS IN INDIA
$he hurdles to e0ecuting a 89/ in India, as discussed in the
previous section, has given rise to two buyout structures,
referred to in this paper as the .oreign Dolding 3ompany
"tructure and the Asset 9uyout "tructure, that may be used
for effecting a 89/ of an Indian company! Dowever, both these
structures are rife with their own set of challenges that are
uni*ue to the Indian environment! $he Dolding 3ompany
structure along with key considerations drawbacks are
discussed as follows!
66
FOREIGN #OLDING COMPANY STRUCTURE
$he financial investor incorporates and finances (using debt
and e*uity+ a .oreign Dolding 3ompany! Debt to finance the
ac*uisition is raised entirely from foreign banks! $he proceeds
of the e*uity and debt issue is used by the .oreign Dolding
3ompany to purchase e*uity in the Indian /perating 3ompany
in line with .IP9 Press Note 4! $he amount being invested to
purchase a stake in the India /perating 3ompany is channeled
into India as .DI! $he seller of the Indian /perating 3ompany
may participate in the 89/ and receive securities in the
.oreign Dolding 3ompany as part of the payment, such as
rollover e*uity and seller notes!

67
$he operating assets of the purchased business are within the
corporate entity of the Indian /perating 3ompany! As a result,
cash flows are generated by the Indian /perating 3ompany
while principal and interest payment obligations reside in the
.oreign Dolding 3ompany! $he Indian /perating 3ompany
makes dividend or share buyback payments to the .oreign
Dolding 3ompany, which is used by the latter for servicing the
debt! Under the current .DI regime foreign investments,
including dividends declared on foreign investments, are freely
repatriable through an Authori:ed Dealer!
LIEN ON ASSETS
9ased on the 89/ structure above, the debt and the operating
assets lie in two separate legal entities! $he Indian /perating
3ompany is unable to provide collateral of its assets for
securing the debt, which resides in the .oreign Dolding
3ompany! Ehile this feature of the .oreign Dolding 3ompany
"tructure may be anathema for lenders looking at providing
secured debt for the 89/, it may be of less significance when
the 89/ target is an asset-light business such as a business
68
process outsourcing or a information technology services
company! Investing in a services company may be a rational
strategy of using this 89/ structure!
.inancial investors may consider legally placing certain assets
of the business in the .oreign Dolding 3ompany, such as
customer contracts of a business process outsourcing or
information technology services company! $hese assets may
be used as collateral and generate operating income for the
.oreign Dolding 3ompany! 3ontracts between the .oreign
Dolding 3ompany and the Indian /perating 3ompany will have
to satisfy India's transfer pricing regulations!
FOREIGN CURRENCY RIS.

$he .oreign Dolding 3ompany structure entails an e0posure to
foreign currency risk since revenues of the Indian /perating
company are denominated in Indian Rupees and the debt in
the .oreign Dolding 3ompany is denominated in foreign
currency! $he foreign currency risk may be hedged in the
financial markets at a cost, which increases the overall cost of
the 89/! Alternatively, if the Indian /perating 3ompany's
69
revenues are denominated primarily in foreign currency due to
an e0port-focus, this risk is mitigated due to the natural hedge
provided by foreign currency denominated revenues!
TAX LEA.AGE T#ROUG# DIVIDEND TAX
$here is ta0 leakage under the .oreign Dolding 3ompany
structure through mandatory dividend ta0 payments on
dividends paid by the Indian /perating 3ompany to service the
debt of the .oreign Dolding 3ompany! As per 9udget <662
introduced for the financial year <662-<667, Dividend
Distribution $a0 rate has increased from 1<!IN to 1IN!
FACILITATION OF EXIT T#ROUG# FOREIGN LISTING
$he .oreign Dolding 3ompany structure allows the financial
investor to list the holding company domiciled in a foreign
jurisdiction on a U" Kuropean stock e0change without listing
the Indian /perating 3ompany on the Indian stock e0change!
$his provides the financial investor a clean e0it from the
investment
70
STAMP DUTY LIABILITY AND EXECUTION RIS.
In an Asset 9uyout structure, the Domestic Dolding 3ompany
which is buying the operating assets is liable to pay stamp
duty on the assets purchased! "tamp duty adds an additional
I-16N to the total transaction cost depending upon the assets
purchased and Indian state in which stamp duty is assessed,
since different states have different rates of stamp duty!
.urther, the purchase of assets re*uires the purchaser to
identify and value each of the assets purchased separately for
the purpose of assessment by the relevant authorities e!g!
land, building, machinery etc as each such asset has a
separate rate of stamp duty! A 89/ of an asset-intensive
company may make the transaction unfeasible!
$he identification and valuation of individual assets purchased
along with assessment of the stamp duty by the relevant
authorities involves comple0 structuring of the transaction
making the e0ecution of this structure comple0 and risky
71
FINDINGS OF LEVERAGED BUYOUTS IN INDIA
Industries of Fo!us
$wo of the largest 89/s in India were those of business
process outsourcing companies O .le0tronics "oftware "ystems
(renamed Aricent after the 89/+ and JK3I" (renamed
Jenpact+! Attractive industry sectors for 89/s in India would
be outsourcing companies, service companies and high
technology companies! 3ompanies in these industry sectors
are labor intensive and their costs are globally competitive due
to a low-cost, highly educated Knglish speaking workforce in
India! $he labor intensity of these businesses makes the target
company scalable for achieving the high growth re*uired to
make the 89/ successful! .urther these companies typically
earn their revenues from e0ports denominated in foreign
currency, which mitigates foreign currency risk when the 89/
is financed using foreign currency denominated debt raised
from foreign banks! $hese companies also have low ta0 rates
due to the ta0 incentives of operating from "pecial Kconomic
Sones and "oftware $echnology Parks!
72
/utsourcing, service and technology companies form an
important part of India's e0ports, boast of a global customer
base and have established a global reputation for service,
*uality and delivery!
GRO<T# CRITICAL TO T#E SUCCESS OF T#E LBO
"tandard ) Poors e0pect the Indian economy to grow at a rate
of 2!4 O 7!FN for the year <662-<667! /ne of the key drivers
of return in a 89/ in India is growth! India is in a growth stage
and the markets are relatively young compared to those in
developed countries! Indian companies face large capital
re*uirements and despite the ample availability of capital in
the international markets and in India for portfolio
investments, there is a shortage of capital for funding
operations and growth!
Indian companies that are targets of buyouts are e0periencing
significant year-on-year growth, generally 1I-<6N every year
and sometimes as high as F6-56N! A joint report published by
NA""3/@ and @cHinsey in December <66I projected a F<!1N
73
compound annual growth rate of the overall Indian offshore
business process outsourcing industry for the period <66B-
<665! $he NA""3/@-@cHinsey report estimates that the
offshore business process outsourcing industry will grow at a
B2!6N compound annual growth rate, from ;11!F billion in
fiscal <66I to ;II!6 billion in fiscal <616! $he NA""3/@-
@cHinsey report estimates that India-based players accounted
for F5N of offshore business process outsourcing revenue in
fiscal <66I and India will retain its dominant position as the
most favored offshore business process outsourcing
destination for the foreseeable future! It forecasts that the
Indian offshore business process outsourcing market will grow
from ;I!< billion in revenue in fiscal <66I to ;<I!6 billion in
fiscal <616, representing a compound annual growth rate of
B5!4N! Additionally, it identifies retail banking, insurance,
travel and hospitality and automobile manufacturing as the
industries with the greatest potential for offshore outsourcing!
Earburg Pincus purchased 7IN of EN" Jlobal "ervices, a
business process outsourcing company, from 9ritish Airways
for ;F6 million in <66<! EN" Jlobal "ervices offers a wide
74
range of offshore support services to its global customers,
particularly within the travel, insurance, financial, enterprise
and knowledge industries! EN" Jlobal "ervices completed its
initial public offering on the NT"K in Auly <665! EN" Jlobal
"ervices has a market capitali:ation (as of @arch <662+ of
;1!14 billion! EN" Jlobal "ervices was a young and growing
company (instead of a mature company with steady cash flows
as re*uired for a typical 89/+ when it was ac*uired by Earburg
Pincus! Jiven the si:e of the transaction, it was all e*uity
financed as it may not have been possible to obtain debt for a
transaction of that si:e!
$he following table elaborates on the growth history, prospects
of some of the companies that are buyouts leveraged
buyouts in India!
75
GRO<T# #ISTORY F PROSPECTS OF TARGET COMPANIES
Company Growth History / Prospects
$A$A-3/RU"
3onsolidated net turnover of ;2!27 billion (Rs!B1,1II crore+
for the *uarter ended Aune B6, a O whopping increase of
FF< percent over the same period last year! Its net profit
rose to ;1!5 billion (Rs! 5,B77crore+ for April-Aune of <662-
<667, from ;<IB!I million (Rs!1,61Fcrore+ in the
comparable *uarter of previous fiscal <665-<662
JK-3apital
International
"ervices
Annual revenues of ;F6F million and ;F4B million in <66F
and <66I respectively! $he 3ompany has set a stiff target of
achieving annual revenue of ;1 billion by December <667!
/f this, the additional revenue growth of ;I66 million
includes ;BI6 million through organic growth and ;1I6
million through ac*uisitions!
.le0tronics
"oftware
"ystems
Revenues for the year ended @arch B1, <66I amounted to
;112!I million as per reported U" JAAP financial
statements! 9ased on an /ctober <665 interview, the
company disclosed annual revenues to be Ca bit more than
;B66 million'! $he company is targeting to achieve revenues
of ;1 billion by <611-1<!
EN"-Jlobal
"ervices
Reported revenues of ;16F million, ;15< million and ;<6B
million for <66F, <66I and <665 respectively! 9etween fiscal
<66B and fiscal <665, revenue grew at a compound annual
growth rate of IF!4N!
Infomedia
India
K0pected to show a very significant increase in revenue and
profits in financial year <662, and is e0pected to double its
profits in that year from that in the previous year'
LA-$ech
EA9AJ India
Revenues at LA $ech EA9AJ are e0pected to grow at a rate
of B6N over financial year <66I-65!
A3K
Refractories
(refractories
business of
A33+
Ace Refractories is e0pecting to grow revenues by more
than <6N, with e0ports growing by about F6N!
76
$he high growth characteristic of the target company entails
greater e0ecution risk for the management of the target
company and the financial investor! @ost of the e*uity returns
are generated from growth by scaling and ramping up the
operations of the portfolio company through hiring and training
employees, e0panding capacity and adding additional customer
contracts! $his sort of rapid scaling up of operations re*uires
high *uality management talent, robust internal processes and
a large pool of skilled human resources! K0ecuting the growth
business plan and delivering the growth is key to return on the
investment!
GRO<T# PUTS STRUCTURAL LIMITATIONS ON
LEVERAGE
$he internal operating cash flows generated by a target
company, which is growing in e0cess of 1I-<6N every year,
would be re*uired to finance the growth through investment in
capital e0penditure and working capital! As a result, a financial
investor may not be able to gear a capital-intensive target
company to the same level as that in international markets!
77
INDIAN LBOS FAVOR T#E USE OF PAY$IN$.IND
SECURITIES <IT# BULLET REPAYMENT
"ince the debt servicing for a typical Indian 89/ is through
dividend payments proceeds of share buyback and the
.oreign Dolding 3ompany receives lump sum sale proceeds on
divestiture of the portfolio company, the debt that most is
most friendly to the 89/ is a non-amorti:ing loan with Pay-In-
Hind (%PIH&+ interest payments and a I-7 year bullet
repayment at maturity! $he debt is not re*uired to be serviced
through cash payments during the investment period, thus
saving dividend ta0 and the re*uirement to remit proceeds
through share buybacks! .urther, the payment on divestiture
of the operating company may be used to make the bullet
repayment of the loan! $his is very similar to the "eller Note
used as financing in the 89/ of .le0tronics "oftware "ystems
by HHR! Dowever, providing collateral to the lenders remains
an issue that may be addressed through the pricing of such a
security!
78
IDEAL LBO TARGETS IN INDIA
Diversified conglomerates operate in number of non-core
business areas in India that they are constantly looking to
divest! $hese businesses make ideal 89/ targets in India since
they have established operations, business processes and
professional management in place! $here is a large interest
among private e*uity players to buy non-core businesses from
conglomerates!
79
SYNOPSIS
Kvidence to date provides some answers about the 89/
phenomenon and its effects! "tockholders of 89/ targets are
big winners, e0periencing immediate gains averaging B6 to I6
percent from surrendering their shares! $hese gains cannot be
attributed, in general, to bondholder losses! Although the value
of some nonconvertible debt securities depreciates significantly
after 89/s, the average effect on bond value is less clear!
.urthermore, stockholder gains appear to be unrelated to
bondholder wealth effects, rejecting the hypothesis that
bondholder losses are the sole source of stockholder gains!
3onsiderable corporate ta0 deductions result from some 89/s,
primarily arising from the incremental interest charges on the
89/ debt! In some cases, the ta0 savings implied by the
incremental deductions can more than account for the total
stockholder premium paid in the buyout!
Additional financing in the form of the sale of assets with a
higher value elsewhere may lead to capital gains ta0es at the
80
corporate level! .inally, the increase in management efficiency
resulting from the new corporate ownership structure may lead
to higher ta0able corporate revenues!
$he change in ownership structure, in fact, is associated with a
significant increase in the average operating returns after 89/s
e0amined to date! $his increase in operating returns, another
potential source of stockholder gains, most likely reflects the
increase in operating efficiency associated with an
improvement in management incentives!
$he ability to sustain the high operating returns documented in
the short post buyout periods e0amined is not assured,
however! Although allegations of massive reductions in
>investments in the future such as e0penditures for
maintenance and repairs, advertising, and R)D, are not
supported by the evidence, the e0propriation of employee
rents and the associated effects on employee morale are still
an open issue! .urthermore, the postbuyout periods e0amined
to date are concentrated in a period of economic strength, i!e!,
mid-1476s! Although the sales of firms that have gone private
tend to be more recession-resistant before the buyout than the
81
sales of the typical public firm, the change upon 89/s in the
sensitivity of sales and profits to macroeconomic factors has
not been e0amined directly!
Perhaps the biggest gap in our knowledge of the 89/
phenomenon is an e0planation for the e0plosion of 89/ activity
during the past decade!
T;e t;i"st f7" LBOs ;as le8 I38ia3 67:5a3ies t7 ta4e
l7a3s t7tali3 Rs +2C222 6"7"e.
Cas;$"i6; ?este"3 ba34e"s ;a=e bee3 ;a559 t7 :a4e
t;e l7a3s. B!t "e5a9i3 t;e: ?ill be t7!;.
Ma39 LBOs i3=7l=e 67::78it9 5la9e"s. D7?3t!"3s i3
67::78it9 5"i6es 67!l8 si34 t;ese 67:5a3ies.
BIBLIOGRAP#Y
82
TEXT BOO.S
FINANCIAL MANAGEMENT - B9 PRASANNA C#ANDRA
FINANCIAL SYSTEM INDIA - 9y 8!@!9D/8K
FINANCIAL MAR.ETS AND SERVICES - B9 GORDON / NATARA'AN
<EBSITES
www!answers!com
www!economicstimes!com
www!google!com
www!yahoofinance!com
Investment 3ommission of India
Reserve 9ank of India %foreign investments in India&
83

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