Mumbai: Zurich-headquartered Capvent AG started investing in India as a private equity (PE) limited partner three years ago in a bid to hedge against lower returns in developed markets such as Europe and the US. In the last seven years, it has invested more than $1 billion (Rs4,120 crore) across 70 PE funds globally, of which many invest here.
China and India constitute key target markets for the firm. Each year, it brings together limited partners and PE firms interested or active in the region at an invitation-only annual conference to brainstorm on issues pertinent to the community.
Varun Sood, managing partner, Capvent AG
This year’s Capvent China-India Private Equity Summit in Shanghai, to be held in early September, will attempt, among other things, to define a road map for investors over the next 10-15 years in these two dynamic markets. India is the venue for the event next year.
Capvent managing partner Varun Sood, who led the European leveraged buyouts team at Societe Generale before founding Capvent in 2000 with Tom Clausen, spoke to Mint about the broad objectives of the conference and the key issues and challenges in the Indian PE market. Edited excerpts:
Why did you start investing in India?
We started looking at India because the return expectations in Europe and the US were slowing down due to the huge capital over-hang. This, of course, is a cyclical situation in mature markets, and will all change again now. But three to four years ago, there was so much capital that investors were beginning to expect very low returns. We had to look outside because we had a target of 25-30% IRR (internal rate of return) and we could only get that by looking at some of the more under-served markets. So, we set up operations in India and China. PE is now 65% of all FDI (foreign direct investment) here. In China also it has started to become a big thing. The opportunity there is in buying the state-owned enterprises— there are 40,000 in China.
How do you read the PE opportunity in India?
When we started investing here, we sensed that it would just be a matter of time before PE caught on in a major fashion. We also knew that it would be a different kind of PE compared with the kind of investing prevalent in developed markets. Most people in this market don’t see the difference. PE is about risk on entrepreneurial capital. Globally, there are different models of PE that have evolved. The leveraged buyout system, works only in a mature business environment, where the game is about taking a stable business and leveraging it to the hilt. Then you extract value by synergies or marginal improvements to top or bottom line, or indeed, asset restructuring. That cannot happen in India for the next 15 years because we don’t have mature busin-esses yet.
At the other end of the spectrum, you’ve got venture capital. That only happens, technically speaking, in technology and biotechnology because you can hold on to something, that you can analyse to determine risk—in this case it is technology trends and developments.
Now what’s happening in India is neither here nor there. It is a kind of late-stage venture capital, multi-sector, opportunity. So, you have companies that have grown to a certain extent, they have proven that somebody is buying their products and even though they are Ebitda (earnings before interest, taxes, depreciation and amortization, a measure of operating profit) negative, you can take a view of the business and invest in the company. Growth rates in such companies are typically 20-30% and you take a minority stake, sometimes a large minority stake.
As a limited partner, what would be the criterion for the right fund to invest in?
The fact of the matter, to realize sooner than later, is that everybody does not make money in PE. From our (limited partner) perspective, it is only worth investing in a fund that, in retrospect, is in the top 20-25% of the funds that will turn in above market returns. Otherwise, you might as well not invest in PE as the differential between the top quartile and the bottom is huge. Also, there is a huge reporting bias in this sector, so the ones that underperform will just never report that they failed.
What’s happening now is that because everything is growing and the stock markets are buoyant, everyone is making money in this business. But India is still an emerging economy and the key thing about emerging markets is that stock markets are open some years and closed some years. When the primary exit routes, currently the stock markets, dry up, investments will also slow down.
Funds that will do well are those people who understand what businesses will look like 10-15 years later. You need people who have thought about the downside of the business, are less market dealer types and understand how to work with entrepreneurs.
At the end of the day, this is risk capital the cleverest money should go not to capital-intensive businesses but to capital efficient businesses.
PIPEs (private investments in a public enterprise) are a common investment strategy for funds here. Would such funds be attractive?
PIPEs are available to everybody. Now, PE firms must justify to us, their investors, why we pay them these very substantial fees. If I can buy stock off the market, why should they get such as huge fee? They have to prove to their investors why they are doing this (PIPEs). PIPEs that are driven by a very trading kind of mentality are not justifiable as speculation is one risk that limited partners like us do not take—good PE investors try to create value and not by hoping that stock prices will rise, as they could fall as well. You can do PIPEs as long as you apply a PE approach, which is changing governance, making it a professional company and planning growth. For this, you need substantial ownership. You don’t see too many deals of that nature now because anything goes in a booming market. When the market starts to turn, things will be different.