M&A: New Norms in a New World

CFOs are uniquely positioned to add huge value during an M&A transaction. Everything from target identification to due diligence and post-close execution requires Finance’s well-rounded capabilities. Changing regulations in the M&A landscape also cast a high degree of responsibility on the CFO. Schneider Electric’s proposed acquisition of L&T’s automation and electric business for USD 2.1 billion – the biggest deal in India this year – and similar ones in the past, hold valuable lessons. from the pressure to achieve the expected synergies to the complexities of integrating systems, processes, people, brands and corporate cultures.

The Indian Deal Market: H1 2018

H1 2018 recorded the highest ever half-yearly deal value of USD 75 billion

The deal environment will remain challenging in H2 due to political uncertainties and capital-market volatility

  • 2018 has been a breakthrough year for M&A activities. The first half of the year saw over 600 deals worth a total of USD 75 billion – the highest-ever recorded half-yearly value.
  • The top 10 deals accounted for 84% of the total M&A deal value in H1, and the top 10 PE deals accounted for 41% of the total PE deal value. Telecom and e-Commerce saw big ticket deals, while real estate and the start-up space attracted the greatest volume.
  • Regulatory interventions, such as the Insolvency and Bankruptcy Code (IBC), which is designed to resolve large NPAs, have been instrumental in driving merger deals in 2018. The key themes driving the deals are consolidation and market entry.
  • The main challenges to the deal market include: uncertainty surrounding the 2019 elections, and domestic capital market turbulence. Accordingly, PE and venture capital funds are expected to remain circumspect.
  • However, heightened activity by US companies, who are flush with money owing to Donald Trump’s tax policies, may offset the challenges in the Indian deal market. Further, more and more global brands are looking to enter India, pushing up deal activity moving forward.

A Paradigm Shift in the CFO Framework

The changing M&A deal environment casts a high degree of personal responsibility on CFOs

Tightening regulations and the activist nature of the judiciary have complicated the deal environment

Businesses face valuation-based tests under the new company and tax laws

  • Over the last 5-7 years, there has been a paradigm shift in how the CFO and M&A interact. New regulations have made CFOs personally liable.
  • There is also a huge movement towards substance over form. More and more firms require tax accounting on account of heightened scrutiny and new reporting standards. For instance, the largest insurance deal in the country collapsed because it failed the IRDA test on substance.
  • Regulators are becoming increasingly belligerent. Courts are upholding the true essence of a transaction, enabling regulators to ask in-depth questions and even to reject transactions that would have previously gone through.
  • GAAR, the re-negotiation of tax treaties, and changes in tax residency conditions through the Place of Effective Management (PoEM) provisions, have complicated the deal environment.
  • The authorities are working in close coordination, and becoming more aggressive in terms of scrutiny and the imposition of fines. Therefore, in an environment of perfect information, the onus is on the CFO to ensure that the deal gets through in law and in substance.
  • More and more companies face valuation-based tests under the new tax and company laws. Today, for instance, any gain made on a ‘bargain purchase’ (i.e., the amount by which the fair value of the acquired assets exceeds the purchase price) is subject to tax.
  • Increasing activism by proxy advisors and shareholders poses challenges to deal making. In many recent cases, shareholders restricted the movement of funds across the Indian entities, citing conflicts of interest. Further, the likely inheritance tax in the medium term on Indian promoter-led structures also has a bearing on deals.
  • Complicating matters are Indian laws that inhibit local borrowing to finance share acquisitions. Further, handling a global acquisition involves withholding obligations and value attribution to India. For instance, the sale of Flipkart Singapore attracted tax in India.

Schneider Electric’s M&A Framework

Successful M&A requires a clear assessment of the benefits from a deal

Key risks and safeguards should also be evaluated beforehand to prevent value erosion post acquisition

Pre-close planning and preparation

  • The success or failure of an M&A deal lies in the ability to clearly define the likely benefits in terms of gain in market share, the resultant synergy between business models, the investment value of the core business, and the monetisation of non-core business.
  • A clear business plan is key to arrive at a realistic target enterprise value after factoring in the discounted cash flows (DCF) of the target and acquirer, and the potential synergies. The ultimate goal is to ensure that the combined DCF is greater than the sum of the parts. The upfront communication of the DCF numbers to shareholders seems to have a positive impact on total shareholders returns.
  • A critical first task is to preserve the value of the combined entity. The next big task is to identify opportunities, and the effort required to ‘create value’.
  • Once the deal team has identified specific market opportunities, it is vital to define a unified go-to-market strategy to achieve the growth objectives, maintain business continuity, and leverage the firms’ combined talent and resources. Ahead of the Schneider-L&T deal, the factors that were considered included complementary cross-sales channels, training and communication with regard to the sales force, new performance measurement matrices, and possible volume reductions and price risks.
  • The combined entity’s product portfolio should also be assessed well in advance. Steps should be taken to identify product improvements, and crucially, the products that are to be eliminated.
  • Potential synergies can come out of manufacturing assets, headcount, and procurement. These can be assessed using industry benchmarks.
  • Finally, key risks must be assessed and other safeguards put in place to prevent value erosion. Normalised profits/cash flow should be arrived at after provisioning for doubtful debts, inter-group transactions, inventory valuation, liquidated damages, employee benefit provisions, stretched creditors, deferred capex, contingent liabilities and bills discounted.

Post-close: key focus areas

Managing talent post-merger is crucial to ensure the best people are retained

  • Nailing down synergies after a merger requires a disciplined approach to identification and validation, and creating a detailed plan.
  • It is also vital to monitor synergies in the post-merger due diligence phase to adjust and improve them on an ongoing basis.
  • When a company announces M&A, it has a bearing on the talent pool – people get either rattled or euphoric. Therefore, identifying the key talent in advance, and managing these individuals after the merger is crucial to ensuring that they stay on. Many large acquirers have an inclusive talent management approach, with management incentives plans to ensure that key staff remain in the game.

This article is based on discussions with:

Sugata Sircar Sugata Sircar, CFO and Country Finance Partner, Schneider Electric India

Vivek Gupta Vivek Gupta, Partner and National Head, M&A/PE Tax at KPMG



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