Market turbulence has forced many Indian corporates to re-evaluate their domestic and international capital-raising strategies. But in spite of the difficulties, there is no shortage of investors willing to gamble on India, Chris Crowe reports from London

Amid the fluctuating fortunes of the world’s stock markets, Indian companies looking to raise capital for growth and expansion are experiencing a testing time. The sharp fall in Reliance Power’s share price after its prodigious US$2.9 billion Bombay Stock Exchange listing in January illustrates the unpredictable nature of the world’s stock markets.

Both the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE) have soared over the last few years, demonstrating strong growth compared to leading international exchanges. But the recent plummet in the Indian bourses has been more pronounced than at major exchanges elsewhere.

The downturn has claimed a number of casualties: Wockhardt Hospitals pulled its US$164 million IPO in February and Emaar-MGF Land’s proposed US$1.8 billion offering was also withdrawn. Many other companies are now grappling with difficult capital-raising decisions and it’s certainly the case that fund-raising options are not as clear-cut as they were a few months ago.

But has the allure of the domestic exchanges that was in existence throughout 2007 evaporated completely?

Optimism endures

Shobhan Thakore, a founding partner of Talwar Thakore & Associates, believes that the Indian exchanges remain attractive. “There’s a large body of target investors,” he says, pointing out that there is still no shortage of people willing to gamble on India.

Shobhan Thakore, Talwar Thakore & Associates

Leaving aside market volatility, domestic stock exchanges continue to represent a popular method of raising capital. Since the beginning of 2007, more than five domestic listings have raised over US$1 billion (see Top 10 equity capital markets deals on page 14). And while listings by Indian behemoths such as Reliance Power have grabbed the global headlines, a multitude of smaller entities have successfully raised significant, albeit more modest sums.

Top 10 equity capital markets deals list

Thakore, whose Mumbai-based law firm is known for its collaboration with Linklaters, says that domestic listings can still expose companies to a broad spectrum of investors: “In India, 50% of the offering is to institutional investors, 25% to retail investors and the balance to high net-worth individuals,” he says.

Vibhava Sawant of Khaitan & Co adds: “We would advise Indian companies to list on the domestic exchanges in view of the growing awareness amongst the investor class of the benefits of equity investments. The number of equity investors is steadily growing.”

Companies that list on the domestic markets can also raise additional funds through a US “Rule 144A offering”, which allows the issuer to reach global investors through an institutional placement to qualified institutional buyers.
Thakore suggests that domestic listings present issuers with greater flexibility over pricing compared to most overseas offerings, but he warns that issuers must pay close attention to their existing shareholders. “The regulations for listing both domestically and offshore … do not pose any problems for Indian corporates except for those that have private equity investors … because for a domestic listing, stock exchanges insist that all special rights granted to private equity investors must be withdrawn,” he says.

A surprise from SEBI

In 2005, the Securities and Exchange Board of India (SEBI) introduced new rules that effectively boosted the domestic capital markets. The regulator imposed restrictions on Indian companies issuing global depositary receipts (GDRs) and foreign currency convertible bonds if they hadn’t already completed a public offering in India.

Such foreign transactions were only allowed as follow-on offerings, forcing capital-hungry corporations to access the domestic capital markets first. In doing so, SEBI appeared to be seeking to protect the Indian markets from the unpredictable investment models of international institutional investors, and was clearly encouraging investors to speculate on domestic offerings.

The effect of these regulations was profound, culminating in a capital-raising frenzy on the Indian exchanges. Reliance Power’s IPO was the biggest domestic listing in India’s history and involved legal teams from Amarchand Mangaldas, J Sagar Associates and Cleary Gottlieb Steen & Hamilton. In another landmark deal, Tata Steel raised US$2.3 billion in a follow-on issue in November. Amarchand Mangaldas along with Cleary Gottlieb Steen & Hamilton, Herbert Smith, Milbank Tweed Hadley & McCloy and Thakore Jariwala & Associates guided the deal to fruition.

Even real estate companies, which have historically shied away from the domestic stock markets, joined in the fray: In June last year, property developer DLF raised almost US$2.3 billion on the Bombay Stock Exchange. Legal advice was provided by teams from Amarchand Mangaldas, AZB & Partners, White & Case, Linklaters and Luthra & Luthra.

White & Case partner Francis Fitzherbert-Brockholes, who was lead international counsel to DLF on the listing, says that domestic offerings have proven to be a triumphant success for Indian corporates: “That’s where your home market is and where the liquidity is.”

Domestic offerings have taken on extra vigour with the burgeoning interest amongst foreign institutional investors. Although this group must meet a high requirement threshold before they are permitted to buy participatory notes (or p-notes) of Indian traded stocks and futures, many have keenly sought registration. Foreign institutional investors are permitted to buy up to 24% of an Indian company’s paid up capital, but the Reserve Bank of India permits this ceiling to be raised in certain circumstances.

Vishal Gandhi, a partner at Mumbai-based law firm Gandhi & Associates, warns that companies looking to list must pay close attention to the prospectus and that any mistakes or inaccuracies could result in litigation. He also believes that listed companies may lay themselves open to aggressive buyers. “There’s no extraordinary risk, but one risk is that [the listed company] might become a target for a hostile takeover … however, the guidelines by SEBI are anti hostile takeovers.”

Indeed, in the year 2000, businessman Arun Bajoria acquired a significant stake in Bombay Dyeing & Manufacturing, leading to much conjecture about a possible hostile bid. The capital markets regulator suggested that Bajoria had not complied with disclosure requirements under SEBI takeover regulations after acquiring more than a 5% stake in the company. Expectations of a hostile takeover era came to nothing.

Debt plays second fiddle

In the debt markets, things have been a lot quieter (see Top 10 debt capital markets deals on page 16). A lack of enthusiasm for debt issuance and tight regulations relating to foreign debt have hindered activity.

Top 10 debt capital markets deals list

Aside from a respectable flow of convertible bond issuances, few headline transactions have gone through. The exception has been ICICI Bank, which since January 2007 has completed two debt issues of almost US$2 billion each. Davis Polk & Wardwell advised ICICI on both issues while Latham & Watkins represented the managers.

“The raising of … debt capital from the foreign market is subject to many end-use restrictions such as a cap on the total borrowing in a year, a minimum maturity period and a cap on the interest rates,” explains Jagvir Singh, a senior associate at FoxMandal Little.

Jagvir Singh, FoxMandal Little

Rabindra Jhunjhunwala of Khaitan & Co comments: “Convertible bonds have now virtually dried up because of the Reserve Bank of India’s restrictions on the use of proceeds, which are treated as external commercial borrowings.”

Furthermore, the liquidity situation at Indian banks means sophisticated debt financing for infrastructure and similar sectors is rarely used.

Seeking solace abroad

With debt not always a viable option and the domestic equity markets giving would-be issuers the jitters, an increasing number of Indian corporates may start looking overseas to meet their funding requirements.

New York, London, Singapore and others have attractive features, but companies wishing to raise capital abroad are faced with the Indian authorities’ preference for domestic listings over international ones.

In essence, Indian entities are not permitted to pursue overseas offerings until they have listed on the capital markets at home. This explains, to a large extent, the fervent charge among Indian institutions to float on the BSE, NSE or both.

“We see mostly domestic IPOs with additional institutional investor tranches, and that model has helped a lot of good companies raise money,” says Richard Baumann, a partner at Dorsey & Whitney in London, who along with fellow partner John Chrisman has completed a series of IPOs on behalf of Indian issuers.

Richard Baumann, Dorsey & Whitney

“They could come to Luxembourg or London and do a GDR, or go straight to the main London Stock Exchange or AIM (London’s Alternative Investment Market) – but if they want to list abroad, they have to list in India first,” he continues.

While this may be a limiting factor for now, there are grounds for optimism that the rules might eventually change.

It might even be the case that the current turbulence in the domestic markets turns out to be a catalyst for reform: “The regulators in India … may think that Indian companies need capital and respond by making it easier for them to access the international capital markets,” speculates Doug Peel, the Singapore-based head of White & Case’s India practice. “The regulation of international borrowing might become lighter.”

Aiming high

But even today, there are alternative models for tapping foreign funds without first listing in India. Following SEBI’s 2005 legislative surprise, several companies have accessed London’s AIM, and avoided the requirement for an initial domestic offering by creating an offshore holding company, typically in the Isle of Man.

Doug Peel, White & CaseThe offshore holding company floats on AIM – a sub-market of the London Stock Exchange – before pumping the proceeds back into the onshore Indian company through a Mauritius-based special purpose vehicle. (The Indian Ocean island state is a favoured route for FDI into India on account of the double tax avoidance treaty between the two jurisdictions.)

David Roberts, a partner at London-based law firm Olswang explains: “You set up a company offshore and that is the company that’s listed. It then acquires all the share capital of the Indian company … which usually becomes a subsidiary of the Isle of Man holding company.”

In December 2005, Olswang advised India’s Great Eastern Energy on its £10.9 million (US$21 million at today’s rates) listing on AIM, one of the more prominent India-related transactions that followed this route. The London firm worked alongside Khaitan & Co, which was Indian counsel on the deal.

The first Indian company to have its shares listed solely in the UK through an Isle of Man holding company was KSK, a privately owned power utility. London-based law firm LG advised KSK on its AIM listing, and partner Sunil Kakkad, who spent February travelling around India with the Commonwealth Business Counsel and the London Stock Exchange to promote Indian entrants to AIM, is full of praise for this capital raising approach. “The AIM rules are quite flexible in terms of continuing obligations. The legal and regulatory requirements are good for companies that are growing rapidly. Not having to seek shareholder approval constantly for transactions is a distinct advantage,” he says.

Aiming high

“AIM is less onerous as to how much share capital should be in public hands. It’s good for Indian promoters who generally prefer not to suffer too much dilution [of their share capital],” Kakkad continues.

However, AIM’s standing has been somewhat diminished as a result of a series of ill-chosen listings that took place soon after its launch in 1995. These resulted in several entities trading well below their issue prices and many investors now treat the exchange with scepticism as a result. Nonetheless, Roberts believes that a series of successful deals will restore confidence.

“There’s a different class of Indian businesses coming to market,” he says, “ones with employees, income and a track record. They might think about the domestic exchanges, but in the end it comes down to valuation.

“The Indian market has been very hot and it’s sometimes hard to get attention unless you have an extremely high profile and you are a very profitable company. In London there’s a deeper pool of capital and people are looking for mid-term returns … with sensible valuation principles, there should be enough return.”

“The other advantage is that it gives the business a global base to roll out a global footprint,” explains Roberts. “By being listed in London, it can help them make acquisitions in Europe and beyond. AIM rules are quite [a] light touch. If you want to make acquisitions you don’t typically have to get shareholder approval. It’s a place to get money and grow the business as quickly as possible.”

AIM issuers benefit from a lighter regulatory approach than they would encounter on most other bourses because their prospectuses are not vetted by the exchange. They are not required to have three years of accounts – which many other exchanges demand – and investors benefit from lower capital gains tax. AIM, therefore, provides an easy and attractive route to capital, particularly for small to mid-cap companies, but in spite of this, its performance has not lived up to expectations.

New York, New York

One appealing alternative, especially for larger companies that have already listed in India, is the New York Stock Exchange. In the biggest issue by an Indian company in the last year, ICICI Bank raised US$4.6 billion in a follow-on listing on the New York Stock Exchange in June. The deal dwarfed Reliance Power’s US$2.9 billion domestic IPO. Law firms Amarchand Mangaldas and Davis Polk & Wardell acted for ICICI on the issue while Khaitan & Co and Latham & Watkins represented the manager.

But despite its headline-grabbing appeal, the New York Stock Exchange has some significant disadvantages and ICICI is one of very few Indian corporates to have achieved a successful listing there. The high thresholds for regulation and corporate governance have dissuaded many prospective issuers, especially since the enactment in 2002 of the Sarbanes-Oxley Act, which tightened standards of accountability for public companies.

“There’s a perception amongst Indian companies that the US market is more difficult from a regulatory perspective … issuers are nervous of class actions,” says Fitzherbert-Brockholes at White & Case. Furthermore, onerous reporting requirements demand additional legal compliance and effectively limit such offerings to large issuers with abundant financial resources.

While AIM has simplicity and momentum on its side and New York has scored India’s premier overseas listing, both now face competition from Singapore, which launched Catalist, its own growth market, in December 2007.

As a result of Singapore’s deepening nexus with India, its close proximity and shorter time difference, it certainly represents a viable threat to AIM’s India aspirations.

Back in India

Such competition from less-regulated growth markets abroad has not gone unnoticed by India, which has responded by introducing a lightly regulated model for capital raising.

In 2006, SEBI introduced the qualified institutions placement (QIP), a method by which issuers can reach a select group of up to 49 Indian and international investors without having to go through the arduous processes of an IPO. “It’s a short cut method of raising capital, because the process normally takes six to eight weeks,” says Parthasarathy Srinivas, a Singapore-based partner with Allen & Overy who joined the firm from the Mumbai office of J Sagar Associates last year.

Anecdotal evidence suggests that with a full SEBI review, an IPO can take four to five months; but there is no SEBI review for a QIP.

Baumann at Dorsey & Whitney says that QIP deals are strikingly similar to US 144A institutional placements. “It’s the same type of document and you are the sole judge of whether it’s right or wrong. People can sue you if it’s wrong, but it’s your choice,” he says.

In common with 144A placements, companies must already be listed before raising money through the QIP method. The approach limits the issuer’s potential investor base, but this hasn’t hindered a series of high-value transactions. In June last year, UTI Bank raised US$654 million through the first combined QIP and GDR offering.

“QIPs have transformed the Indian market,” observes Jeff Maddox of Jones Day.

Maddox, who is based in Hong Kong and co-head’s his firm’s global capital markets group, says that QIPs now account for about half of Jones Day’s India-related business and that they have to some extent replaced traditional GDR transactions, hindered as they have become by the 2005 SEBI rules.

A private alternative

With so many of India’s leading companies run by families or individuals with no desire to cede control to others, a domestic or international offering remains an attractive option.

The AIM market, unlike many other exchanges, has no minimum requirement for a public shareholding, allowing issuers to retain as much control over the company as they wish. “Many Indian companies are controlled by families and any fund raising would dilute their holding and put a strain on their ability to manage or control the company,” says Thakore of Talwar Thakore & Associates.

But this fear of losing control hasn’t dissuaded a number of prominent Indian corporates from accepting investments from private equity houses. After recent market volatility, company valuations have become more attractive to private equity funds and, assuming that these investors can sidestep the credit doldrums, Indian corporates may well further embrace the capital and management experience of the private equity arena.

According to Asia Private Equity Review, India was the most active private equity market in Asia during 2007, with 290 deals and an aggregate deal value of more than US$9.9 million. During 2007 and the early part of 2008, Bharti Infratel absorbed some US$1.3 billion from eager investors such as Temasek Holdings and Kohlberg Kravis Roberts, illustrating its willingness to cede a measure of control to those willing to finance its growth ambitions.

“The experience of these guys allows you to reach a level where you are competing with the best,” says Anand Mehta, a partner at Indian law firm Thakker & Thakker.

“These days I do a lot more transactions involving private equity and investment funds,” adds Nandan Nelivigi, a New York-based partner at White & Case. “It is an area where Indian issuers and borrowers have been raising a lot of money. Companies need to think about their business objectives, how much control they want to retain and the type of partnership they want to operate.”

For those company owners who wish to keep their hands firmly on the business tiller, this may not be a suitable course of action. From the onset, the private equity house will be thinking of its exit strategy and how best to get a good return on its investment, whether through an IPO or by selling its stake to another buyer.

As the markets begin to settle after a precarious few months, Indian companies will certainly look for more capital to finance further growth and expansion. They will have to negotiate a tight regulatory regime, but can console themselves in the knowledge that domestic and foreign investors are still eager to be part of India’s emergence on the global stage.

It’s just a case of selecting the right transaction to suit their ambitions – and their wallets.

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