What is the future of the Indian PE industry?

Mumbai: The private equity (PE) industry in India entered 2018 after chalking up a record year for deal-making in 2017, totalling more than $24 billion of private capital in investments in Indian companies. The exits, which were few and far between in India till a few years ago, remained strong in the past three years and Indian PE funds have returned significant amount of capital back to their investors.

As PE firms look to make bigger and bolder bets, as seen in the interest generated in Fortis Healthcare Ltd, Star Health and Allied Insurance Co. Ltd and Vishal Mega Mart, it brings up an important question—how will the Indian PE firm and the PE industry look like in the future? The second edition of the Mint India Private Equity Conclave saw industry stalwarts discuss this and more.

The participants for the kick-off session at a full-day event included Vishal Mahadevia, managing director and head (India) at Warburg Pincus Llc; Sandeep Naik, managing director and head (India and Asia-Pacific) at General Atlantic; Renuka Ramnath, founder, managing director and chief executive officer at Multiples Alternate Asset Management Pvt. Ltd; Manish Kejriwal, managing partner of Kedaara Capital Advisors Llp; Atul Kapur, co-founder and chief investment officer at Everstone Group; Kunal Shroff, managing partner at ChrysCapital; and Srikrishna Dwaram, partner at True North. The discussion was moderated by Shrija Agrawal of Mint. Edited excerpts:

If you were to give me the good, bad and ugly of the Indian opportunity landscape, what would that be?

Ramnath: The good part is that India provides a very large set of opportunities. The story that all of us here are playing for is that the Indian economy will become a $4-5 trillion economy in the next decade from the current $2 trillion economy. So $2 trillion-plus worth of value is incrementally going to be created in the next decade. The whole demographic dividend, consumption story and financial services opportunities, are all very big.

As far as the bad part is concerned, valuation has always been a challenge. Valuation is a challenge because everyone is playing for growth. However much careful and cautious you are, doesn’t seem to be enough. There is always somebody out there who deserves that valuation, but on the back of one or two companies that deserve that valuation, 10 other less-deserving ones also gets upgraded.

The ugly part is the diminishing governance both internally and externally.

Vishal, talking about governance, we are currently reeling under the fraud at Punjab National Bank and when you speak to your limited partners (LPs), do they really have concerns in this regard?

Mahadevia: Corporate governance is really important. We, being on the ground and having deep knowledge of entrepreneurs we work with, should ensure highest possible governance standards. Scams and corporate governance issues will happen not just in India but all over the world from the days of Enron to days even before that.

I think our investors are well aware of that, they count on us to do strong due diligence to understand entrepreneurs well and to be part of the governance of the company after we invest, so that we can be responsible managers of their money.

Can you give us some sense on the level of corporate governance in India vis-à-vis South-East Asia?

Kapur: On a relative basis, I would rank India at 7 and some of the emerging markets in Asia at 4. If you look at India in the last 10 years, the push from the government to put NCLT (National Company Law Tribunal) framework in place, revamp the companies law and get companies to be more accountable, on the one side.

On the other side, have the whole tax framework rigid so that people are held accountable. Third leg is GST (goods and services tax), which is also pushing people to be more accountable and restricting people from engaging in practices that they indulged for years.

National elections are due in 2019, from that perspective, what is your biggest concern? What are your expectations?

Naik: There is always a correlation between politics and business; and within that correlation if there are some things at the India level which will have an impact, we will find great opportunities to invest in pearl companies because these are companies where you always wanted to invest in but never had the right opportunity as things are going so well.

Within times of cyclical downturn, you will find and create opportunities within those pearl companies to go and deploy capital, which you never had in markets which is moving only in one way.

Shroff: We have been investing for 19 years and the government has changed multiple times and when we correlate that to our returns, there are no correlations. There are certain sectors which do depend on government factors like mandate for infrastructure spending and the wherewithal to really push it through. There, as a PE investor, you have to be careful about sector and portfolio selection.

But, if you look at where a lot of money has been made in India, it has largely been in sectors where return on capital has been good and overdependence on government has not been there. These sectors are IT services, pharmaceuticals, financial services and consumer durables.

Dwaram: We exist because it is our job to find opportunities, no matter what the situation is and there are lot of sectors which are not government-dependent. In fact, there was lot of euphoria that lot of things will happen on the infrastructure front but not much has happened. Honestly, we made some bets on the back of such promises.

Kejriwal: We invest in India not because of the government but despite the government. You got to move from annual budget to five-six years budget. You need a longer-term vision and not attacking and blocking every couple of years.

So I think the current government has done a terrific job on the economic agenda and if there is continuity, is something we all would prefer. But I don’t think LP sentiment gets affected on who the current government is and it is dependent on GPs (general partners).

There is some sense that we are living in an overheated market, we have so much dry powder and so capital is not a differentiator in the market right now. So why is there so much temptation to raise large funds?

Ramnath: Money is a big problem until you have it. I have argued for flexibility for 20-plus years I have been in the industry since I don’t like to silo myself to any kind of particular fund. Many changes are happening in corporate India.

One is generational shift where many families will sell their businesses and go. For a very long time corporate India had been an insular market where the father handed over the business to his son or son-in-law. This is no longer true. So many entrepreneurs want to move on and PE is a very interesting way to consolidate and run those businesses. These would require large amount of capital.

Kapur: Markets have evolved and greater opportunities in more mature companies will show up. It’s hard to chase big mature companies if you don’t have enough capital. It will be competitive disadvantage if you can’t play in that opportunity set.

Kejriwal: The size of the fund should be independent of the demand. On average the companies are growing larger and a lot of us are getting more comfortable doing control transaction. It is not only the equity valuation of the company but the equity we take has increased from an average of 5-10% to 15-20%.

Shroff: As we have researched the deals over the 15 years that have made money in India. Normally people say size is the enemy of the return, but in India we are still talking about $50-100 million deal compared to the $2 trillion economy. When we looked at deals that Warburg, General Atlantic and some of the larger funds have done in the range of $100-400 million in the right sectors, they made a tonne of money.

Naik: One big change we have seen on the ground is that Indian entrepreneurs’ ambitions have completely changed. In the past, they dreamt of building a few hundred- crore companies and today they dream of building thousand-crore companies. That’s a long-term horizon, a massive dream and that could take a ton of capital to build those companies. Today, when I interact with entrepreneurs, their aspirations and dreams are significantly larger than 10 years ago and hence the amount of capital you need to build those businesses is significantly larger. This is why you see larger deals and larger capital being raised.

What’s the one biggest challenge that you face in building your PE business?

Dwaram: It depends on what you want as an entrepreneur or managing partner of the firm. If your aspiration is to build Warburg Pincus from India, then you have to build teams and enable transitions in the management over a period of time because after a point of time raising capital is not a big issue.

Kapur: The biggest challenge is to bring out the talent. Everything from recruiting, training, retaining and compensating talent, is a real challenge. The industry is bounding ahead in terms of capital they are raising but I am not sure if quality talent pool is keeping track. This is not a business of genius, but a business of experience. Therefore, keeping teams together and continue to grow with them, is the toughest challenge.