The onset of the global COVID-19 pandemic has created a dystopian situation for the entire world and their economies. The ensuing lockdowns have resulted in an economic upheaval globally, due to derangement of distribution and supply chains and alteration of consumer demand.
In India, the ongoing worldwide havoc has further been fuelled by the labour crisis, migrant worker issue, and the predominant growth and employment issue that has plagued the country before the lockdown.
Whilst the impact of the virus from a medical perspective is starting to become clearer, the economic impact of the pandemic is still largely unknown. Globally across most countries, businesses have been tested to their very limits by having to deal with often very stringent lockdown measures to control the spread of the virus.
We have tried to cover the impact of the lockdown on the Indian economy, especially distressed assets and the opportunities available to vulture funds.
Factors that make Indian companies lucrative for investment
Earlier this year and before the onset of COVID- 19 pandemic vulture funds and some strategic buyers stayed away from bidding for distressed assets undergoing the insolvency resolution process, delaying their impulse purchase and waiting for the right opportunity to grab these assets at cheaper prices when they go into liquidation.
Foreign institutional funds and investors are looking for safe-haven investment destinations that offer higher returns than their home country to diversify their supply chains and invest in well-grounded economies. India provides this platform through its friendly foreign investment policies and availability of inexpensive skilled labour. India is the 5th largest economy in the world and potentially the fastest-growing emerging economy.
India's administration is working with State Governments to change that as investors seek to reduce reliance on China as a manufacturing base in the aftermath of the Covid-19 outbreak and the resultant supply disruption. The land is being offered at favourable rates to foreign companies looking to diversify their supply chain processes to India. The Indian Government is in the process of identifying 4.6 lakh (46 million) hectares of land, of which 24% is in industrial areas in an attempt to lure businesses moving out of China. This, along with other financial incentives like tax breaks, tax holidays, etc., is being considered to attract foreign investment.
Understanding the opportunities present for vulture funds
A vulture fund is an investment fund that seeks out assets and buys securities whose prices have been severely depressed in the market. The objective is to identify assets that have been irrationally oversold below fundamental value, or where a positive turnaround is predicted. Thereby, vulture funds help accumulate distressed assets that typical strategic portfolio investors would shy away from.
In case of a distressed asset, once the National Company Law Tribunal process has been completed and a fund has invested in a distressed asset, the chance of any severe litigation is eliminated. Secondly, all the pre-construction risk gets eradicated. In India, there’s uncertainty around the approvals for running a factory after it has been established. All these kinds of risks are mitigated once there is an investment in constructed assets, and thirdly, the vulture fund is venturing into known territory, thereby reducing risk.
Legal considerations for vulture funds
The current market unpredictability, significant financial distress, and lowered valuations will result in many corporations not sustaining its business on a standalone basis. Such corporates eventually face potential insolvency proceedings issues. However, on the flip side, this scenario also creates business opportunities for corporates and private equity (PE) funds to invest in businesses facing liquidity crises and imminent debt commitments.
Vulture funds looking to invest in distressed assets will have a plethora of challenges. The primary test would be the diligence exercise, which the funds may not be permitted to undertake since most of the deals would be on an 'as is, where is' basis. Also, shortened time frame, limited access to diligence materials due to the pandemic, potential labour problems will add to the already existing pressure.
Moreover, there will be greater reliance on virtual data rooms rather than physical diligence exercises. Furthermore, the deal value of the transaction may be impacted due to limited timeframe for negotiations so that the targeted distressed asset’s business relationship is not affected. As already covered in the topic above, investment by a vulture fund in a distressed asset would deter any potential operational, regulatory, and litigation risks of the target asset.
Lastly, procuring extensive warranties from sellers of distressed assets may be impeded, particularly if a company is already in the insolvency process. Some of these challenges can be resolved if the funds adopt appropriate restructuring methods, assess the feasibility of options, obtain warranty and indemnity insurance, ensure adequate risk allocation, and obtain sufficient consent for transactions subject to change in control provisions.
To sum up, the pandemic provides a unique opportunity for vulture funds to expand their business by acquiring distressed companies to penetrate the market further, and an attractive investment opportunity to leverage the lower valuation of distressed assets. This situation may provide the much-needed impetus to the current business opportunities in India and worldwide and, in so doing, bring a certain degree of respite from the misfortunes of COVID-19.
—The authors, Prem Rajani is the Managing Partner at Rajani Associate and Pearl Boga us Principal Associate at Rajani Associates. Views expressed are personal.