Introduction
Over the years, private equity (“PE”) has been a pivotal force in driving mergers and acquisitions, by facilitating capital requirements and allowing for value creation, hence, enabling firms to scale and restructure. PE refers to a class of investment where firms invest directly in private companies or engage in buyouts of public companies leading to their delisting from the stock exchanges. Its significance continues to grow as it has become a popular exit strategy for investors, providing liquidity and new opportunities for expansion and value creation, leaving a profound impact on industry consolidation & market competition. In this context, the article explores the rising role of secondary buyouts (“SBOs”) in PE as a key driver for industry consolidation and liquidity. It discusses SBOs as an emerging exit strategy due to their flexibility and efficiency, highlighting major deals across sectors in India. It concludes by emphasizing the continued growth of SBOs and industry consolidation while discussing regulatory developments.
Industry Consolidation
Every industry, of any nature, has an ‘industry lifecycle’ which is a cycle every industry goes through namely: 1) Opening 2) Scale 3) Focus 4) Balance & Alliance.
The process of industry consolidation occurs usually in the last stage. The industry has already reached its peak with several competing entities and now the entities within the industry acquire each other until very few key players remain. This generally occurs as each entity tries to cut a larger share of the pie and gain traction in the market. An example is the Indian steel manufacturing sector. The number of players over the decades has nearly halved and today over 60% of the steel in the country is produced by just 6 major players. Another feature of this industry is that now the major players of the industry are trying to enter other businesses to increase their profit and widen their portfolio.
However, despite what could be implied from the statements mentioned, industry consolidation at its core, is one of the major features of any industrial cycle. Some of the major factors driving it are:
- Economies of Scale and Scope – The primary, and often defining factor, behind any deal within entities that leads to industry consolidation is an improvement in efficiency. This goes beyond simple overhead reduction – firms can optimize their production networks, consolidate facilities, and leverage their combined purchasing power.
- Dynamics of Market Power – As fewer and fewer players remain in the market; it becomes important for each of these entities to protect their position and consolidate it further. This, not only allows the remaining players to increase prices but also, enables them to create high barriers to entry into the market.
- The Innovative Landscape – The players participating in any market are in a constant race to innovate. This is especially true for knowledge and technology-based industries and hence a consolidation in the industry would result in the sharing of costs in research as well as an elimination of investment in similar research efforts.
The biggest factor continues to be the market, which continues to mature and stabilize, firms often tend to protect their position in the face of drying profits and the best method to do it is through consolidation of the market.
Secondary Buyouts (SBOs) in M&A
A common exit strategy in private equity is the secondary buyout, where one investment firm sells its holdings in a private company to another private investment firm. Started in the 1990s as just another means of exiting from private investment, SBOs now account for more than 48% of private equity exits. This surge in SBOs has been fuelled by a rise in the available capital, and the rising concerns about primary buyouts that PE firms may be increasingly ‘recycling’ assets within the same class of investors rather than pursuing new value creation in untapped markets.
This favouritism to SBOs arises not only from the need for an efficient and streamlined exit mechanism but also as a new avenue for reinvestment. These transactions offer immediate liquidity, akin to an initial public offering (IPO) minus the burden of regulatory compliance that these IPOs entail. SBOs, even though smaller in scale, offer strategic flexibility when compared to IPOs. Investment firms usually opt for SBOs when they have already secured considerable returns or when the buying firm brings additional advantages to the acquired company. In some situations, SBOs are driven by distressed sales, where firms need to divest assets to avert financial distress, though such deals are generally seen as less attractive in practice.
The operational improvements post-SBOs are generally less impactful compared to primary buyouts suggesting that the true value of SBOs lies less in business growth and more in facilitating ownership transition. However, the value created in SBOs can be maximized when the buyer and seller possess distinct characteristics, enhancing the potential synergies of the transaction.
Motivations Behind Secondary Buyouts
The primary drivers behind secondary buyouts include motivation for strategic portfolio management and adaptation to market conditions as SBO offers flexibility to investors, and allows quicker exits, and liquidity when compared to traditional routes such as IPOs which can be time-consuming and uncertain. This is helpful in an environment where capital raising is tough as an exit via SBO can return capital to limited partners enhancing goodwill and securing further investment.
Further, it is appealable to PE firms especially when targeting slow-growth, small or niche businesses with strong cash flows that may not attract public investors, hence allowing these businesses to achieve value in less conventional market sectors.
After the PE firms are done with primary buyouts, they opt for SBOs for value creation and increase in efficiency which are the main strategic goals for investors as well as the firms. Investors often bring industry expertise, and operational improvements which help in diversification and, greater control and management. The alignment of value maximization goals for both investors, as well as, the PE firms brings them together and the transaction is hoped to benefit from this synergy, economies of scope and the company’s performance, which is the determining factor for capital allocation by the investors. Such efficiencies allow SBOs in turn to provide incentives of favourable return to exiting investors.
Secondary buyouts in India: major deals across sectors
India’s buyout market is slowly gaining momentum, indicating increased interest from, both, local and global investors. Secondary buyouts, mainly in 2024, have become a key feature in merger and acquisition deals across various sectors in India reflected in sectors like healthcare, retail and technology.
One of the significant deals in the healthcare sector through secondary buyouts is the acquisition of Manipal Health Enterprises by Temasek Holding through its subsidiary Sheares Health. In this acquisition by way of SBO, Temasek increased its stake from 18% to 59% by acquiring additional shares from existing investors such as TPG Capital, which sold 11% of its original 22% stake, and National Investment and Infrastructure Fund (NIIF), that sold its entire stake. This transaction enabled the investors to reduce their exposure, helped Temasek solidify its position in the country’s healthcare landscape, and gave Manipal Health an opportunity for further expansion and capital for future endeavours.
Another prime SBO transaction is the selling of its entire 26% stake in SBI General Insurance (SBIG) by Insurance Australia Group Ltd. (IAG) for $432.38 million to Warburg Pincus and Premji Invest. The transaction allowed exit to IAG to focus on its core markets in Australia and New Zealand. The deal reflected buyers’ interest in SBIG due to its robust performance backed by a strong management team and a consolidation in the insurance industry.
Further, the deal between Grofers, Zomato and Tiger Global involves a $120 million investment. This deal will help Grofers, which aims to compete with its rivals such as BigBasket, by injecting capital into the company to strengthen its position in the highly competitive e-grocery market. Many experts speculate this deal is Zomato’s strategic move to acquire Grofers in the future.
Regulatory Considerations for SBOs
In India, the trends in SBOs and industry consolidation have been shaped by regulatory scrutiny mainly by MCA, CCI, SEBI, and RBI. The Companies Act, 2013 mandates that mergers and amalgamations comply with Sections 230-232 that require NCLT’s approval to ensure all consolidations comply with the legal framework. Sections 5 and 6 of the Competition Act, 2002 along with CCI Combination Regulations, 2011 outline the obligation to notify the CCI and secure its approval before finalizing any combination and keeping in check anti-competitive transactions.
The acquisition of Manipal Health Enterprises by Temasek Holdings was approved by CCI under Section 31 (1) of the Competition Act, after considering that the combined market shares of the involved entities were insignificant and the transaction posed no risk of competition foreclosure or adverse effects on competition in India under Section 4 of the Competition Act. Further, given Temasek’s status as a Singapore-based entity, the investment had to comply with India’s FDI policies and relevant health-sector regulations including sectoral caps under the Consolidated FDI policy.
Also, under the Income Tax Act of India, the sale of shares attracts capital gains tax liabilities based on factors such as the holding period and the nature of the investment. There are certain tax exemptions provided during the restructuring process involving SBO transactions under Section 47 and the General Anti-Avoidance Rule (GAAR) prevents SBOs structured purely to evade taxes.
Similarly, various regulations by RBI and SEBI ensure transparency through full disclosures for cross-border SBOs under FDI policies, and listed companies respectively. Under Regulation 3 of the SEBI SAST Regulations an acquirer is required to make an open offer if the stake crosses 25% or more voting rights in an SBO transaction involving listed companies. Further, there are sector-specific regulations such as in telecom and health sectors to ensure fair process in takeovers.
A recent development in this field has been the relaxation of the approval requirement via the CCI Criteria for Exemption of Combination Rules, 2024 that outlines the transactions where approval is not required from the commission, among them being the acquisition of up to 25% of the target’s shares. Overall, a great deal of due diligence is required in an SBO transaction ensuring compliance with legal and contractual obligations, including pending litigations and environmental aspects.
Conclusion
The future of private equity appears to be increasingly intertwined with secondary buyouts and industry consolidation. As markets mature and competition intensifies, PE firms are likely to continue leveraging SBOs as a preferred exit strategy, particularly in sectors with strong cash flows but limited public market appeal. The trend towards industry consolidation through PE-backed transactions will likely persist, driven by the quest for economies of scale and operational synergies. However, this evolution brings heightened regulatory scrutiny, particularly in emerging markets like India, where authorities are focused on maintaining competitive markets while facilitating necessary consolidation. The PE industry’s ability to balance these competing interests while creating value will be crucial for its sustained growth and relevance.
This blog is written by Meghna Pareek and Nilay Mishra, 5th year student of B.A L.L.B (Hons.), Institute of Law, Nirma University, Ahmedabad.