Indian businesses grapple with the risks, uncertainties and opportunities presented by the euro crisis
Nandini Lakshman reports
Late last year, India’s finance minister, Pranab Mukherjee, admitted that the eurozone crisis was impacting growth and would hurt Indian exports. Data released by the government last month show India’s economic growth slipped to a three-year low of 6.1% in the third quarter of the fiscal year that ends on 31 March. Mukherjee said although the GDP figure was “disappointing, it was not unexpected” due to the poor performance in manufacturing, mining and agriculture.
The slowing growth at home coupled with the euro crisis, particularly the prospect of a financial default in Greece, is giving many Indian businesses and investors cause for concern. Indian companies have been doing business in Europe for decades and this continues today, even as India’s growth hinges on domestic consumption, unlike the export-led Chinese economy.
The euro crisis is hurting all constituencies. For Indian exporters, it means dwindling orders, payment delays or simply contracts being dishonoured. There is also the prospect of European banks being reluctant to issue new loans, or even reneging on earlier loans, which might force companies to rewrite contractual agreements.
Back to the drawing board
With the political and financial implications of the euro crisis, investors will have to gear up for a host of outcomes. For one, as Greece strives to restructure the €207 billion (US$270 billion) in privately held debt, there are fears of a eurozone debt fallout. Many questions arise. What if the sovereign indebtedness provokes Greece or other southern European countries to exit the union? What if some countries just disown the euro?
Such developments are plausible and could affect companies already doing business or planning to do business in the eurozone. If they were to occur, debts payable in those countries and companies with euro obligations in place might have to switch to local currencies. A currency conversion could trigger an alteration of the contract, or a contractually agreed mechanism for termination.
But Bahram Vakil, a senior partner at AZB & Partners, argues that this will not happen. “That’s not possible as the currency in any agreement in Europe would be in euros,” says Vakil. “And the governing law – English law – is neutral.” Adds Amit Jain, partner at BMR Advisors in New Delhi: “Trigger events like adverse change clauses, or default probabilities are largely part of contracts between parties, particularly financing agreements with banks.”
The risk is high when receivables – claims held against customers and others for money, goods, or services – are to be paid in euros. If a state exits the union, it will most likely issue orders to ensure that all payments are made in its new currency at a fixed exchange rate. “There’s no problem going back to square one,” says Suresh Talwar, senior partner at Mumbai-based law firm Talwar Thakore & Associates. “We are signing contracts with individual companies and not with countries, so we continue trading like we did before the euro came into existence.”
Others say that even if contracts take into account exchange rate fluctuations, international companies may still incur exchange rate risks as the new currency of the breakaway state could be traded on the free market much below the stipulated rate laid down by the state government. They advise that the impending risks need to be considered while charting new contracts and amending existing contracts, if required (see Euro contracts – Practical issues on page 16).
Luthra & Luthra partner Madhurima Mukherjee points out that when a state wants to strike out on its own, it will no longer have the cover of a strong euro. “In such a scenario, Indian investors are most likely to see significant erosion in the value of their investments and assets in Europe owing to severe devaluation of currencies,” she says.
Indian companies face another threat as the liquidity crunch puts pressure on European banks, which may be forced to temporarily withhold payments to stabilize the banking system. “In a crisis situation, banks and financial institutions which were previously in the habit of lending to Indian companies would turn risk averse, thereby substantially reducing the amount of money available to Indian companies,” explains Luthra’s Mukherjee.
The Sahara group, the Indian owner of assets as diverse as television channels and real estate, provides a good example. As part of the group’s first foray into the international hospitality sector, Sahara acquired the Grosvenor House hotel in London’s Mayfair district for £470 million (US$735 million) in December 2010. Sahara chairman Subrata Roy later pledged the hotel to raise foreign funds for his real estate business in India. But he has been unable to repatriate the funds. “It’s disgusting … for the past 30 days I’m trying to bring back £250 million from the UK and I’m not getting permission. We have money there and we can’t bring it back,” Roy told India’s The Economic Times recently.
Such concerns are also playing out in India’s exports to Europe, which include textiles, pharmaceuticals and information technology. Overall bilateral trade with Europe amounted to €87.3 billion in the fiscal year to 31 March 2011. Exports and imports both grew by 20% in the first 10 months of 2011 from the same period of 2010, with exports amounting to €33.4 billion and imports to €33.3 billion.
India’s weak currency should have boosted the export-oriented textile industry, but slower global consumption and higher input costs are weighing the industry down. Manufacturers say that apparel exports to Europe – which account for 40% of sales – have been hit doubly hard. Volumes have shrunk by 25% and buyers are demanding price cuts of 10% to 15%, they say.
“Some European buyers have gone bankrupt and defaulted,” reveals Rahul Mehta, the managing director of Mumbai-based Creative Group and head of the Clothing Manufacturers Association of India. Lead times to supply goods have shrunk from 90 days to 60 days, and orders and contracts are routinely cancelled. Many smaller companies are offering substantial discounts to retain orders.
India can ill afford a weak textile industry. The labour-intensive sector employs 88 million people, compared with just 2 million in the IT sector, and the 15,000 textile companies are vital to India’s exports. According to the Confederation of Indian Textile Industry, these companies account for US$20.5 billion of the country’s exports. To mitigate the risks, Mehta says companies need to select buyers carefully and scrutinize the terms of the letter of credit for any loopholes.
“Make sure that you are insured through export credit agencies, and also get your buyers rated by credit agencies,” says Mehta. “In the normal flow of business if you were lackadaisical, now make sure you read the fine print.”
Sudhir Dhingra of New Delhi-based Orient Craft, which supplies garments to the UK and southern Europe, says: “Our business is done on a case-to-case basis. Every day is a new day and new price, and suppliers generally avoid legal tangles.” With the euro crisis and declining volumes, Dhingra is increasingly focusing on India’s domestic market.
Meanwhile the automotive sector, which sold 230,000 vehicles to the EU in 2011, is seething against a proposed India-European Union free trade agreement, which would cut duties on vehicles imported to India from the EU. Import duty on vehicles is 60% in India while it is between 6.5% and 10% in the EU. The high import duty drove General Motors, Toyota, Ford, Honda and Hyundai to set up assembly plants in India, all of which have upped investments to ramp up production and introduce new models in the past two years.
German car maker Volkswagen recently announced it was investing US$400 million in India to boost capacity, launch new models and strengthen research activities. “There are huge opportunities to expand in India,” said the Volkswagen group’s chief representative in India, John Chacko. At the same time, Tata Motors, which purchased Jaguar and Land Rover from Ford in 2008, expects to double its India sales this fiscal year after slashing some prices. Sales have risen since Jaguar Land Rover began assembling the Land Rover Freelander in India, say dealers.
Tech companies too are feeling the heat. Infosys, for example, has operations in the UK, Belgium, the Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Norway, Russia, Spain, Sweden, Switzerland and the Netherlands. “Our top line will be affected, as the euro crisis will impact our [European] clients’ ability to spend. Our customers are highly cautious due to the uncertainty,” says V Balakrishnan, the company’s chief financial officer.
Companies could encounter trouble if they have chosen to put most of their eggs in one basket. “Tapping other markets is a must to minimize the exposure against any potential fallout in Europe,” cautions Seema Jhingan, partner at LexCounsel, a New Delhi-based law firm. Companies would be wise not to rely on contractual partners in a country that seems likely to exit the eurozone. This is particularly true for Indian IT companies, which still earn over half their revenue from the US and less than 30% from Europe, according to consultants.
The European market accounts for 23% of revenues at Bangalore-based Infosys but its business is largely concentrated in the UK, according to Balakrishnan.
“Even as Indian IT majors are expanding in Europe, their businesses are not very big outside the UK,” says Siddharth Pai, a partner and managing director of TPI, a global tech advisory firm operating in Bangalore. “They need another centre of gravity like Germany, or France which are [strong economies in Europe].”
Pai believes that Indian IT companies should focus on acquisitions rather than organic growth: “All the Indian IT companies are sitting on cash, and they could do well to invest more in Europe.”
A silver lining?
Indeed, the euro crisis has opened up opportunities for Indian companies across sectors to pursue inorganic growth, as distressed assets in Europe appear on the market at rock-bottom prices (see Fortune amid the fracas on page 18). Infosys and other IT firms are believed to be in talks to acquire European companies. Indian banks too are eyeing quality assets as European lenders seek to deleverage their books to meet new capital adequacy norms amid the sovereign debt crisis.
Speaking at the recent India Leadership Forum organized by the National Association of Software and Services Companies, Chanda Kochhar, managing director and chief executive officer of ICICI Bank, said: “Some European banks are actually shedding great quality Indian assets at very attractive prices. We will see many Indian banks coming forward to pick up these loans.”
Euro contracts: Practical issues
For Indian companies signing contracts with European entities, flexibility is the key
Indian businesses should consider the following points when signing new contracts or dealing with problems that arise with European partners:
Scrutinize the terms regarding reneging on payment, particularly if the Indian party is a provider of goods or services, advises LexCounsel partner Seema Jhingan. If payment is delayed, then offer the counterparty greater credit than is stipulated in the contract. If the desire is to continue doing business with the client, then be prepared to accept lower margins in the wake of the current crisis.
Check if it’s possible to revise or extend credit terms.
Monetary damages can be claimed if the counterparty in a sales agreement or a joint venture decides to terminate a contract despite its provisions, but such claims may not work in times of crisis, explains Madhurima Mukherjee, partner at New Delhi-based law firm Luthra & Luthra.
“The euro crisis could have the impact of rendering any such monetary claim redundant due to the inability of the defaulting parties to honour them,” she says. “Thus the contract itself loses flavour as the remedies under it lose teeth.”
Mukherjee says that in future, contracts should be negotiated such that in an event similar to the euro crisis, adequate exit clauses are in place to protect the interests of both the parties. “The repayment mechanism under these contracts may also be hedged in such a way so as to avoid a complete disintegration of the entity in a case such as the present crisis,” she adds.
Shalini Agarwal, a partner at Clasis Law’s London office, believes that in the case of joint ventures, Indians should not be finicky about gaining control. She suggests that Indian companies shift parameters while negotiating deals. “They should get down to specifics early on to avoid hassles later,” says Agarwal. “Indian companies need to be culturally astute.”
Others like Sergio Sanchez Sole, head of the India desk at Garrigues’ Barcelona office, argue that future contracts can be chalked up like before. “The euro crisis does not pose any specific threat to Indian counterparties,” he says.
This is in sync with India’s preference for strategic acquisitions. “The investments are either seeking new markets or buying advanced technology,” says Talwar. “Many companies use Europe to enhance their global footprint.” For example, in the past few years, Tata Tea bought Tetley, Tata Motors drove away with Ford’s Jaguar and Land Rover, and Tata Steel snapped up Corus. Pune-based forgings major Bharat Forge acquired outfits in Sweden, Scotland and Germany to shore up its business and be closer to its global customers. That’s also the main reason why the cash-rich Roy bought the Grosvenor House. “London will be the gateway for Sahara to introduce some of its new business ventures internationally,” he said soon after the acquisition.
Other Indian companies have purchased unrelated assets. More than a year ago, Pune-based poultry company Venkateshwara Hatcheries (better known as Venky’s) acquired Blackburn Rovers, an English Premier League (EPL) soccer club for £43 million. Venky’s became the first Indian company to own an EPL team. Following the announcement of the purchase, Venky’s chairperson, Anuradha Desai, said her company planned to “focus on leveraging global influence in establishing Blackburn Rovers as a truly global brand”.
Reining in subsidiaries
While Indian companies are playing their cards in Europe, their European counterparts are rethinking their strategies for India. “Many European companies that have invested in India will either want to repatriate high dividends, or sell their shares and monetize their Indian assets,” says BMR Advisors’ Jain.
Last year, Edinburgh-based oil explorer Cairn Energy sold its Indian assets to local mining conglomerate Vedanta Resources. Atlas Copco, the Indian subsidiary of a Swedish industrial equipment maker, delisted in March 2011. Another Swedish company, Alfa Laval, a provider of specialized products and engineering solutions, is in the process of delisting.
Not every company can pull off a delisting. In January, an attempt by BOC – the Indian subsidiary of German industrial gas supplier Linde group – to delist from the Indian bourses failed. Market analysts attributed the failure to growing shareholder resistance to multinational companies’ efforts to take their local subsidiaries private. BOC has tried to delist before. In 2011, BOC India chairman SM Datta said that the parent was not keen to increase its shareholding in BOC, as it wanted to invest in productive assets.
Astrazeneca Pharma, the Indian arm of the UK-based pharmaceutical major Astra Zeneca, has tried to delist twice. In the past three quarters, the company has posted declines in revenue and operating profit. Market analysts say it is only a matter of time before the company delists.
At the other end of the spectrum, a troubled European player may ignore its Indian subsidiary by starving it of funds. “Organic growth needs good management bandwidth, is capital intensive and has a long gestation period,” says Talwar. “It doesn’t allow you to run from day one like joint ventures or M&As.”
Other exit options include selling assets to a third party, reducing land holdings and headcount in India, or shutting shop altogether. Dutch financial services major Aegon exited its mutual funds business in India in August 2011. A strategic review is underway at British financial services firm Fidelity, which has two captive research units, a private equity business and an asset management company (AMC) in India. One investment banker says that Fidelity is considering three options for its AMC – to exit India, have a tie-up with banks to distribute mutual funds instead of continuing to do it in-house, or just stay put.
Joint ventures could be the trickiest for Indian companies, says LexCounsel’s Jhingan, as the partners generally have “50:50 affirmative voting rights”. An Indian partner may want to call the shots, but any capital expenditure or expansions plans must be approved by the other joint venture partner.
What if one partner wants to invest while the other has no funds and does not want to dilute its stake? “There is no mitigation in these situations and the companies will end up in litigation or arbitration,” says Jhingan. Adds AZB’s Vakil: “In distress situations, changing the affirmative voting rights depends on leverage and negotiating power.”
Sales agreements and joint venture contracts, says Luthra’s Mukherjee, “envisage the performance of specific covenants, the failure of which, in certain instances, would entitle the parties to claim monetary damages.”
Fortune amid the fracas
Europe in crisis is a veritable treasure trove for Indian and other Asian buyers
As distressed assets are put on the block and takeover opportunities mount in the EU, companies of all hues are sizing up potential acquisitions.
For the moment, though, Indian businesses are still playing the wait-and-watch game. There are many reasons why the lust for European assets is muted in India, unlike in China, which has not masked its voracious appetite for global assets. For one, the Indian rupee is currently weak, making assets expensive for buyers, while income from European operations has been hit by the depreciation of the euro. In addition, companies are struggling to cough up capital to service or refinance debt.
Nevertheless, bullishness on the part of investors from India should not be downplayed. Over the past few years, a buoyant Indian economy saw companies amass huge assets in Europe. According to Dealogic, Indian companies have spent over US$31 billion on European acquisitions since 2006. The top 20 deals since 2010 were worth over US$4 billion. “Tier one, two and three companies are cash-rich in India and going out to buy businesses,” says Shalini Agarwal, a partner at Clasis Law’s London office.
Britain has been the largest target market with M&A transactions between it and India reaching around US$22.6 billion in the past five years, according to Dealogic. Lawyers say that sectors like oil and gas, hotels and tourism, football and car racing teams, and residential and office properties are a big draw with Indian investors.
European banks struggling to raise their capital cushion to become more resilient against future shocks are also eager to offload some of their bad loans. India’s ICICI Bank has said it is open to buying the loan portfolio of European banks, according to a Reuters report. “The opportunity to pick up some good assets at good pricing clearly exists. So, that’s what we are looking at all the time and exercising it whenever we see the right opportunity,” Chanda Kochhar, managing director and CEO of ICICI Bank, told Reuters. She said that ICICI had “picked up some India-related assets, but I would say not a very large number, because given the fact that on the other hand the ability to raise funds currently has also become more expensive.”
Kocchar’s move, say analysts, could spur more Indian banks to shop for bad loans in Europe.
The economies of Germany and France have remained fairly buoyant and continue to offer Indian buyers opportunities in aerospace, wind power, pharmaceuticals and healthcare. “There are no investment restrictions in France,” says Christophe Eck, partner at Gide Loyrette Nouel’s Paris office.
A favourite destination is Spain, which has attracted interest from India in the automotive sector, food, real estate, tourism, chemicals, packaging and film-related activities.
“Indian companies are not only looking at Spain as a market, but also as a way to access Latin America in a more subtle way,” says Jorge Marti, head of the India desk and director in the Valencia office of Uría Menéndez. Even as privatization has been put on hold, Spain has ushered in financial reform to boost banking and financial institutions, and labour reform to increase flexibility.
“The reforms will make investments in public assets more appealing,” Marti says.