While the new legislation aims to bring in FDI, what is not clear is whether funds will flow to companies or promoters’ coffers. Valuation and management control will be among the bones of contention, says Shilpi Sinha

There was a time at the turn of the 20th century during the technology bubble when in vestors bought shares of Larsen & Toubro enthused by the fact that it had a subsidiary which dealt with the software services rather than its construction or engineering businesses. There were others too, such as air conditioner maker Blue Star.

A time may now have come for them to chase bank stocks such as ICICI Bank and State Bank of India for their mystery insurance business, which the Indian market is still not clear on how to value. The passage of the insurance bill by the Rajya Sabha last week may well be the easier part of bringing in foreign funds into Indian companies as promoters and private equity investors burn the midnight oil on these companies’ valuations.

What is clear is that funds will flow into India in the form of foreign direct investment, but what is not clear is where. Will it be to companies, which were supposedly in need of capital to grow the business, or to the coffers of promoters who could move up the rankings of wealthy men in the country .

In fact, the new Insurance Act could open up a Pandora’s Box with the potential for many joint venture partners quarreling over the valuation of companies as has happened with many joint ventures in the past. The Act provides for a 49% stake in insurance ventures, up from 26%.

“It is a unique situation where foreign promoters are allowed to increase stake, but the bargain will happen on a price that is commercially viable to both partners,“ says Ravi Singhania, managing partner, Rajni, Singhania & Partners, a New Delhi-based law firm.“There will be conflicts. Foreign promoters will not like to remain passive investors and since management control is in the hands of Indian promoters, they will have more power to cash in on other rights.“

It is not unusual for joint venture partners or equity investors to get into conflict with promoters. There are plenty of cases of conflict in private equity investments such as food products maker MTR, or the ongoing acrimonious battle between food chain McDonald’s and its partner Connaught Plaza Restaurants.

The Insurance Regulatory and Development Authority has estimated an additional capital need of `44,500 crore in life insurance and `10,500 crore in the non-life insurance sector over the next five years. Life insurance penetration as a percentage of GDP is at 3.1%. Now, whether a higher FDI helps in higher penetration is yet to be seen, but some Indian promoters are going to see cash flowing in.

There are mainly two types of agreements. One, where the shareholders have agreed to the foreign partner raising stake to 49% at the face value of shares even though their market value, or fair value, could be a lot higher. The other being, where the Indian shareholder came in as financial investor to reap the benefit of investments rather than any strategic knowledge like the Burman family , which is into consumer businesses and not finance in a significant way . While the first segment could be a lot more smoother in finalising a new shareholding agreement, it could be troublesome in the second type.

Joint ventures like one signed between Bajaj and Germen insurer Allianz allows the foreign promoters to raise their stake to 49% in the life insurance joint venture at a predetermined price that is valid till 2016.

Deals can happen at a price higher or at par with fair value with the new rules, said industry executives.

“There are no agreed benchmarks, which is the biggest bone of contention for the insurance industry ,“ said Abizer Diwanji, national leader, financial services, EY. “In cases where there is an already registered agreement with the regulator with call options, Indian shareholders will have to find a way to honour the economic interest of the foreign shareholders within the ambit of the law.“

Bajaj may gain from Reserve Bank of India norms issued in 2010, which state all FDI deals have to happen on fair value. More companies could benefit from the regulatory changes since they agreed to sell equity at a predetermined price. “The very issue of issuance of shareholding going up to 49% from 26% is under the approval route subject to the prescribed pricing guidelines,“ said Vyapak Desai, partner, Nishith Desai & Associates. “This is no different to what happened to the telecom sector. Pricing for issuance of shares will always be subject to restrictions applicable at a relevant point.“

Some profitable insurance companies are looking for private equity placement and those will set the valuation benchmark for the industry , said Diwanji. ICICI Prudential is in the process of selling 5% stake to private equity firms. HDFC Life has sold close to 1% stake to Azim Premji Trust for market discovery of valuation.

Other than valuation, management control and powers are the contentious issues before the industry .

Under the proposed amendments, the management team in an insurance firm will have to function under the board, which is dominated by the Indian promoter. The industry has been lobbying that higher foreign limits will give them enough capital to grow the business. But the question is, how many companies are really in need of it?
Nearly three-fourths of the insurance companies operating in the country are `capital surplus’, that is, they do not need any fresh capital.

In other cases, foreign shareholders may not be interested in increasing stake because of trouble in their home markets. Indian shareholders will have to either rope in a new investor or list the shares on stock exchanges.

Two foreign promoters, ING and New York Life, have exited India. ING’s exit was done in distress, when it had to sell its stake at a discount.

There is little doubt that more greenbacks will flow into India, but the process could create some flutter in boardrooms. Overseas investors will not invest just to remain minority partners without management control over the business for a long time.

Further, there should be no surprise if murmurs of the need for 74% foreign holding in insurance get louder even before the ink is dry on the current bill

Source : Economic Times

Date: 18-03-2015


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