Mumbai: Private equity (PE) firms are increasingly looking to invest in holding companies rather than operating entities, reinforcing a perception that they are being accepted as long-term partners by businesses than just fair-weather friends, say observers.

New deals: A Larsen and Toubro employee surveys a construction site in Mumbai. Group company L&T Infrastructure Development Projects received funding from private equity investors in April Adeel Halim / Bloomberg

There are others as well. International private equity firm TPG, for instance, is waiting for approval from India’s Foreign Investment Promotion Board for a stake in Shriram Retail Holdings Pvt. Ltd, the unlisted holding company of the Shriram Group’s consumer finance arm Shriram City Union Finance Ltd.

In 2006, TPG had also invested in the holding company of the group’s commercial vehicle financing firm, Shriram Transport Finance Co. Ltd (STFCL).

Shriram group chairman R. Thyagarajan said TPG was comfortable investing in holding companies of the consumer and transport finance business and “we facilitated (it) by transferring our stake in operating companies to the holding company".

He added that TPG’s investment was more an equal, strategic partnership, unlike other PE firms who have invested in the operating company and would look to exit when its share price appreciates.

A strategic partner would not have invested the kind of money TPG has because of potential conflicts of interest, Thyagarajan, 73, said in a telephone interview on Saturday.

TPG declined comment on the transactions.

“We expect TPG to stay with us for 4-5 years, through there is no exit clause agreement for the US private equity fund," Thyagarajan said. “Both partners want to grow this business as soon as we can."

“Wherever promoters are willing to treat buyout funds as almost equal partners, the holding company trend will continue," V. Jayasankar, executive director and head of the unit that advises PE deals at Kotak Mahindra Capital Co. Ltd, the investment banking arm of Kotak Mahindra Bank Ltd, had said in a recent interview with Mint. “This is in cases where there is a clear understanding between the promoter and the investor on a mutually accepted exit."

Such a trend in putting money in holding companies reflects greater alignment of interests between promoters and investors, while also making the investors’ exit path smoother.

For example, IDFC Private Equity Co. Ltd (IDFCPE), which in early 2004 invested in GMR Energy Ltd, moved its shareholding in April 2006 to GMR Infrastructure Ltd, the group’s holding company for the airports, energy and highways business.

“When we invest in a company, we’re always focused on how we exit," said Raja Parathasarathy, managing director of IDFCPE.

The only way investors, typically known as limited partners, can make money is when the fund exits investments, he said, adding that his firm has had a sevenfold blended return (they did not exit the company all at once, but at several stages) on its investment in GMR Infrastructure.

“If we invest in a single toll road, how are we going to get the exit? You can’t IPO (initial public offering) the company. But if you invest in a company that has 12 toll roads, then it’s got enough size and scale to be IPO-able. So the idea is to focus on what we call aggregation plays," said Parthasarathy.

He said it would have been harder for IDFCPE to take GMR Energy to an IPO because it had only three power plants. However, once it moved its shareholding into GMR Infrastructure, which aggregated the power, roads and airports businesses, the possibilities of making an IPO increased.

Investing in holding companies, even with lower promoter stake, allows promoters to retain effective control, while ensuring that the investor-promoter relationship is more of a partnership compared with merely investing in the listed company, said a person familiar with TPG’s deals with the Shriram Group, but declined to be identified as he is not authorized to speak to the media.

Like the Shriram Group, L&T-IDPL was looking for long term capital in the holding company.

“We wanted investors who would stay with the company," said Shankar Raman. “These investors participate in investment decisions, while the management control is with us," he said.

The arrangement also makes it easier for a holding company to borrow through pledging combined shares, and investors stand to get stronger rights, including on exits, said this person. For example, since both the investor and promoter have interests that are aligned, and both parties have an almost equal stake, the holding company of STFCL can raise higher levels of debt for expansion if the investor and promoter jointly pledge their shares.

Lenders will have have additional comfort while lending to operating companies of Shriram Group with a large private equity investor as partner at the holding company, who will stay with the company for a longer period than other investors who look at a short-term stay. The investor will give us more comfort as we borrow money for longer tenures, Thygarajan said.

In fact, the holding company investment model seems to be particularly attractive to PE firms in the infrastructure sector. Most infrastructure projects have a 30-40 year concession, which means that much of value creation will happen towards the end. But since limited partners typically want their money back over a 7-10- year period, the easiest way to do that is to invest in a holding company with a portfolio of assets that the private equity fund can take public.

Silver Peak Investments Mauritius Ltd (a wholly-owned subsidiary of JPMorgan Chase and Co.), and a consortium led by IDFC Private Equity, had inApril 2006 invested into L&T IDPL that lays roads, builds airports, ports and bridges and develops urban infrastructure. Since 2006, the company has doubled the number of projects being developed by it, to 40.

“Portfolio investors like private equity funds will continue to invest in holding companies that has a portfolio of businesses, said Shankar Raman, terming his venture as “risk sharing".

Typically lean operations, PE firms also need to ensure they create scale in a company so that their teams have sufficient incentives to manage investments.

“When you invest, you could put $10 million (Rs49.9 crore) into an energy business or you could put $30 million into the holding company, where some part goes into the energy business, something into the toll roads and another into airports. From our standpoint, it makes sense to coming in at the top level (holding company)," said Parthasarathy.