The complexity surrounding transactions in relation to mergers and acquisitions can never be underscored. Such transactions undergo a prodigious milieu, which involves discussions, proposals, negotiations and most importantly, regulatory approvals.
HDFC Standard Life Insurance Company Limited [See end note i] (HDFC Life), a joint venture between HDFC Limited and UK based Standard Life PLC established in 2000, with HDFC owning circa 61% and Standard Life owning 35%; the remaining being held by minority shareholders, proposed to merge with Max Life Insurance Company Limited (Max Life). The proposed merger itself was a testament to the challenging landscape of the M&A in a sector that is tightly regulated. Talks surrounding the proposed merger were first made public through a Press Release dated June 17, 2016 [See end note ii]. Had the merger concluded, the combined entity would have created a Rs. 255 billion annual premium company, with scale, differentiated portfolio and a wider reach in a growing life insurance sector. However, the merger faced a number of roadblocks which has resulted in the deal currently being put on hold, and HDFC Life opting for an Initial Public Offering (IPO). The article provides an overview and analysis of the key reasons behind the fall out of what would have been the largest M&A transaction in the Indian insurance sector.
Structure of the Proposed Merger
The Insurance Regulatory Development Authority (IRDA/ Authority), which is the nodal body for regulating the insurance sector in India, raised critical regulatory concerns with the proposed merger and consequently struck it down. The merger was proposed in a three-step process. The first step involved the merger of Max Life with its holding company - Max Financial Services Limited (Max Financial Services). The second step was to cause this merged entity to demerge its life insurance undertaking into HDFC Life. Subsequently, in step three, Max Financial Services (holding non-life insurance business) would merge with Max India Limited (the listed entity) [See end note iii]. The resultant merged entity being the holding company of Max India from the proposed merger between HDFC Life and Max Life, would then become a listed company.
Life Insurance Corporation of India (LIC) currently dominates India’s life insurance sector while SBI Life Insurance Company, a JV of State Bank of India and BNP Paribas, and ICICI Prudential Life Insurance are the top two private sector life insurers in terms of premium income. This merger aspired to create the second largest life insurer in India, after LIC. The merger would have seen the promoters of Max Financial Services getting a considerable amount of non-compete fee with an upfront payment of Rs. 501 crore, followed by three equal instalments totalling to Rs. 349 crore in return as consideration for its business, as well as the goodwill accumulated over the years. The entities had taken the requisite approvals from their respective shareholders for the proposed transactions. The court-convened shareholder meetings of HDFC Life, Max Life, Max Financial Services and Max India had also resulted in approvals being granted by the shareholders for all aspects of the transaction. In addition to approvals from shareholders and IRDA, the merger would have also required approvals from inter alia the Securities and Exchange Board of India and the Competition Commission of India.
Rationale behind the Merger
HDFC Life in its press release listed out certain objectives which the proposed merger was to achieve. Along with a more diversified distribution network, the proposed merger was to see a considerable rise in the market share of the merged entity vis-à-vis the erstwhile companies. The merger would facilitate a wider product base along with an enhanced access to bank assurance channels. In addition to the resultant entity being made the largest private player in the insurance sector, it would have carved a path for similar future transactions to take place. Further, the company stated that along with an improved employee value proposition, the proposed merger would result in synergy of revenue and cost to enhance the shareholder value [See end note iv].
Bone of Contention
SEBI and other stakeholders raised their concerns over payment of a high non-compete fee of Rs. 850 crore to the promoters of Max Financial Services as such payment could be detrimental to the interests of minority shareholders. The current regulatory mechanism in case of mergers does not prescribe a limit on payment of non-compete fee as opposed to takeovers wherein such a limit is prescribed. Although, SEBI gave its approval to the proposed merger, it later started revaluating the existing provisions governing the schemes of arrangement to plug such loopholes.
Further, the main bone of contention stalling the deal surrounds Section 35 of the Insurance Act, 1938 [See end note v] (Insurance Act) which only permits mergers between insurance companies. Section 35 broadly states that no life insurance business of an insurer can be transferred to any person, or transferred to or amalgamated with the life insurance business of any other insurer, except in accordance with a scheme prepared under this Section and approved by the IRDA.
Consequently, IRDA expressed its concerns with respect to the last stage of the proposed merger between Max Life and Max Financial Services stating that this would result in violation of Section 35 of the Insurance Act since this meant merging a financial service holding company with a life insurance company. The lack of precedent on the matter led the IRDA to approach the Attorney General of India through the law ministry, who declined to give an opinion on the matter [See end note vi].
However, the representatives of the merging entities maintained that the proposed structure should be considered legally valid per the composite scheme of arrangement of the Companies Act, 2013 (2013 Act) which specifies that such amalgamations can be possible if all the stages of the arrangement process are done simultaneously. Being a composite scheme governed by a single order of the court, any stage of the scheme should not be looked in isolation as all steps of the amalgamation process need to be necessarily completed for the implementation of the merger. Chapter XV of the 2013 Act read with other applicable provisions lay down procedural requirements with respect to a composite scheme of arrangement.
While putting the merger on hold, HDFC Life through a communication made to the stock exchange, has decided to opt for an IPO instead. The Chief Executive Officer of HDFC Life has stated that the option of a proposed merger has been kept open [See end note vii]. Max Life will now file an application with the IRDA for an IPO. As proposed, the two JV partners will see a 20% dilution in their stake as a result of the IPO. The decision of HDFC Life to opt for an IPO doesn’t come as a surprise as the move has been hinted at before [See end note viii].
As for the merger, the Chairman of HDFC Limited has stated that the merger has been called off at the moment and HDFC Life is completely focussed on the IPO which is likely to come in by late November or early December, 2017 [See end note ix]. However, HDFC Life will still have to file an actuarial report and obtain permission from the IRDA as a part of the IPO process. It is also expected that once the IPO gets completed, the entities may opt for the merger with a different structure.
Conclusion Insurance has always remained a sensitive and heavily regulated sector in India. The issue that new age India faces is lack of precedents as opposed to developed markets which have already had their experiences with complex M&As. In the wake of some of the largest M&As that India has seen in the last couple of years where market consolidation has led to increased business and market share, it has consequently resulted in enhancing shareholder value and better products in terms of goods and services to the consumers in India. India has over a period of time liberalised its stand on several aspects of investment and business including foreign direct investment, regulatory process for mergers and acquisitions including recently notifying provisions permitting an Indian company merging into a foreign company, subject to certain conditions. While these are measurable and significant steps to take India to the ‘next level’, the regulators have treaded cautiously in taking decisions. Although, the HDFC-Max merger may have gone on the back burner for the time being, HDFC is moving forward by taking up the IPO proposal. It would be interesting to see the revised proposal, if and when the two companies take it back to the Authority and the stand they take in light of the legal provisions.