Hugh H. MacArthur, partner at Bain and Co. Inc., is an annual visitor to India; he has been making the yearly trip since before the Boston-based consulting firm set up an office here. He spoke in an interview about the private equity (PE) business. Sri Rajan, MacArthur’s colleague and partner at the Indian office, contributed to the conversation on some India-related issues. Edited excerpts:
Investment scene: Bain’s MacArthur says there haven’t been a lot of proven liquidity events for LPs in India despite many opportunities. Ashesh Shah / Mint
You have been quoted as saying that PE is a cyclical industry. Do you think the cycle has now changed for the better and 2010 will be a far better year than 2008 or 2009?
The cycle has indeed changed. PE is a cyclical industry and the interesting thing about it is that the peak or trough can be very steep…as much as 60% to 80%, which we have seen in the past and also saw in 2009. We did see in the fourth quarter of 2009 the beginnings of a pickup in deal activity and that is continuing quite strongly in the first quarter of 2010.
The other interesting thing is that while deals came to a near standstill in all geographies at the same time in 2009, they have also all picked up roughly at the same time. It’s interesting because we talk of non-correlation of different markets or different assets around the world, but whether you are talking about buyouts that have credit constraints, or emerging market growth opportunities that seemed to stop right around the same time, they have all seemed to have picked up at around the same time.
Big-ticket deals in India are few and far between. Will the deal pipeline see a recovery?
The deal market slowed down during the past 18 months. But prior to that, the deal market grew very rapidly in India. Five to six years ago, the deal market was nascent. In 2006-07, India had overtaken China as the largest PE market in Asia. The slowdown affected all geographies similarly. I don’t think it was different or worse in India than what we saw in all emerging markets in Asia. But there will be a substantial recovery.
What about fund-raising?
Fund-raising is very challenging right now and will continue to remain challenging for the next several years. The LP (limited partners, or those who invest in a PE fund) community’s short-term ability to invest is constrained. Several things contribute to the constraint. One is, many LPs are already bumping up against their allocations to PE. Second, there is a trillion dollars of uncalled capital that LPs have in the marketplace and that’s going to exacerbate the PE allocation issue, and third, many LPs have liquidity constraints.
What is the biggest challenge that PE firms face in India?
The challenge for PE in India in 2010 will be liquidity. There will be a lot of players trying to find liquidity through a lot of investments. The vast majority of money that has been invested in the PE industry in India has been invested over the last four to five years and so there have not been a lot of proven liquidity events for LPs in this market even though there have been a lot of opportunities for LPs to invest. The long-term enthusiasm for the GP (general partners, who manage a PE fund) and LP community despite the demand of PE in India will largely be dependent upon seeing that there are real realizations of liquidity and large amounts of money going back to LPs. I think that process will begin in 2010, and will run for several years.
Many Indian companies are looking abroad for expansion or acquisition, the Bharti-Zain deal being one example. But most of the time, the funding is done by banks. Do you see a chance of PE funds participating more aggressively in this?
There is an opportunity for doing that. I think the challenge is the cost of capital for PE is much higher than the cost of debt. So from the corporate’s perspective, it’s easier to take bank funds and help acquisitions abroad than taking PE money because return expectations are so different. That said, there are always niche situations where perhaps a bank won’t lend because the risk may be higher or perhaps the PE firm has a global footprint and could make introductions or open doors in other markets, which makes strategic sense. I certainly wouldn’t rule that out, but I doubt it would be a substantial part of the market in the next couple of years.
It has almost been a decade since Warburg Pincus invested in Bharti Airtel Ltd, or Temasek in Tata Teleservices Ltd. Do you think PE firms will touch a telecom company today?
Telecom has been very cyclical. People made money and lost a lot of money in all geographies. But in the wireless space, the demand for wireless infrastructure will be very substantial. Wherever that demand has been in the past, PE has made good money, whether you are talking about transmission equipment, antennas, telecom towers; with regards to wireless service providers, we have seen activity in the past and we will see activity in the future. There is a degree of sobriety along the telecom space because of the bad past experience and that will cause an extra amount of due diligence to be taken.
As the representative of a PE firm, do you think the 15% trigger limit in the takeover code should be raised?
Sri Rajan: I think it should. It is one of the issues that is preventing meaningful PE activity in India. It can be raised to at least 26%. 15% is just too low a number for a trigger. If you think of the capitalization of many companies on the BSE (Bombay Stock Exchange), for example, the majority of them are fairly thinly capitalized.
What stops companies such as Tata Motors Ltd? They have been openly saying that they want to divest some of their investments. It’s been two years since they have been talking about it, but they could not reach any conclusion.
Sri Rajan: They probably have a valuation expectation they haven’t been able to get in the market. They are probably waiting for the market to come back. The market has come back. Valuation has gone up. I think a lot of exits that were planned, whether it was divestitures, carve-outs, IPOs (initial public offerings), everyone has been set back by 18 months. You will see now 2010 will be a year of exits by corporates, PE funds. I think the valuations have come back.