Edited excerpts from an interview:
Private equity has been on the comeback in India over the past three years. We are seeing a lot more commitments to India from several global funds, and local funds have also launched new vehicles. Big picture, what have been the drivers?
Big picture, we have seen renewed interest in India across multiple levels, and there are several reasons.
First are the reforms by the (Narendra) Modi-led government. I am not passing a judgement on the Modi government, but in terms of policies and reforms, India has seen relative stability; people know what is happening and investments have begun to flow in again. The uncertainty that happened immediately post-election has gone away. Whether growth is at 6.5% or 7%, it will be in a steady state, and the clarity in policies, and a more certain macro environment has brought a lot more international financial investors back to the table.
Second, we have seen a significant amount of capital get recycled in the past 12-24 months. A bulk of this has been challenged capital, and these were deals that were done pre-global financial crisis (GFC), or just around the GFC, when several firms had acquired minority positions in Indian companies with very little control. That had resulted in some challenges to the holders of those assets. These PE firms had to spend time making sure they could return capital, or else they would never raise funds again. The bulk of that has happened. There are still some legacy deals.
A significant driver of interest in India has been recycling of capital. For a long time, there were no good distributions coming out of Indian PE and VC (venture capital).
The past couple of years has seen a lot more money changing hands, and we have seen a couple of good IPOs (initial public offerings), and some good deals in the tech space, too. People are seeing recycling again with healthy returns.
Everyone had believed in the Indian economy, the fundamentals, and consumer growth, but we were not seeing people actually make money and return money. Now we are seeing this happen. Fundamentally, those are the key reasons why people are going back in.
Then there is China. The prospects of China have been less encouraging of late. Against this mindset, for investors looking at Asia, some of them have decided to refocus their attention on India and South-East Asia.
So who is looking at India? Who is driving these deals?
First, the global PE majors are putting more money in India because they are starting to see buyouts happening there. They are seeing a path to controlled deals. And these are fundamentally late-stage growth and buyout investors.
Second, LPs (limited investors, or contributors of capital to PE and VC firms) around the world are saying they want greater allocation to Asia. So, South-East Asia and India are the beneficiaries of greater diversification in Asia.
Third is the consumer story that is seeing a real boom—whether it be the $50 mobile phones or mobile wallets or ride-sharing, and whatever be the industry, we are now seeing that the middle-class and lower middle-class is translating into an opportunity.
You could always visualize the population, but could not visualize the monetisation of the population. Now investors can actually visualize the monetisation of the population and that is a key feature. This is what interests the global majors.
For large Asian funds, the consumer story remains absolutely the same. For them, it is massively about diversification, and it is the right sweet spot to play in.
The Asian funds are willing to go in and do $25 million-to-$150 million equity cheques. These guys have found a sweet spot where they can go in and replicate what they have done in many other Asian markets like China and South-East Asia.
The global guys tend to get called in on massive scale and often competitive deal flow. Asian funds are finding a lot of proprietary stuff—they have guys on the ground who are building relationships with the business owners and promoters and so on.
And the third one, as you know, are local funds. Local funds are gaining the most—(the ones) that don’t have any legacy issues pre-GFC.
Exits in India have always been an issue for PE. With renewed PE interest in India, has the exit scenario changed? Many of the new deals we are seeing are minority interests similar to the legacy deals. So what changed?
Vintage one minority investing in India was, ‘I have a 10% stake’. That’s it. No board seat, no path to control, no rights on management changes, no say on dividend recaps, cash flow-out, or anything else.
The promoter had the final say on all those things. The PE firm was just a 10% equity investor, and if you had a different opinion on how the company you had invested in should put the money to use, or what it should do during an economic crisis, or whether it should be investing or not at a low point in the cycle, you could share your views with the promoter, who would then say that it would be his decision, and if you don’t agree with that, he would say that you could go and find a buyer and sell your 10% stake.
But today, the funds and others who are coming in have learned from the previous experience—so they might on paper be buying an equity stake that is still 10%, 14%, or 19%, but it is a very different equity stake, because it comes with convenience around change of leadership clauses, limits on how much dividend recap can be done, or how much cash flow can be taken out without approval, and also often one to two seats on the board.
Then there are clauses on meeting the KPIs (key performance indicators), path to control or increasing their stakes, and so what we are seeing is a much more learned way of doing minority investing than the last time around, when investors went in with just the India story, and believed that the rising tide would lift all boats.
But when it comes to the buyouts, are such deals available?
The deals are definitely available, and they are happening—we are seeing a couple every year. Why is it not more than just a couple per year? Fundamentally, it is hard to convince Indian promoters, especially if it is a family or entrepreneur-led business, that they should sell out, because these promoters believe their companies are going to be doing well in the foreseeable future.
Their view is that the company’s value will only rise over time—so if at any point in time, they are selling out control, they are of the view that they are leaving money on the table.
So that is the number one issue. It is really hard to get promoters to sell a 50% stake in their companies even if you were to tell them that the deal will help their company get global know-how, global market access, bring in new capabilities… So 50% now is a lot better than 100% ten years from now—but this is not an easy sell.
It happens more in markets such as South-East Asia because you have second- and third-generation family owners that have children or grandchildren that don’t want to take over the business.
They have succession issues and things of that nature. You have increased competition in some of the other economies. In India you don’t have a lot of that.
The technology scene in India has still largely been a VC play. When do you see this evolving into a PE play?
Globally, it has moved from VC to more of a PE play. But even globally, it started out as a VC play, but then moved to PE because the gestation period of those assets are long.
You have to go through that cycle.
I think the tech scene in India is the same as in South-East Asia, where a lot of it is still early-stage investments.
In most of these companies, it is hard for PEs to get into the game. Private equity often looks to enter growth companies—you need to have five years of steady earnings, and a lot of these tech companies don’t. They have great concepts with strong revenue growth, but most have negative cash flow.
PE investors ultimately have to answer to their LPs. And their LPs didn’t go into the PE asset class for the prospect of either a 10-20x returns or zero returns.
If LPs had that in their mind, then they would have done VC allocations.
Therefore, you don’t see PE funds doing those kinds of deals. LPs view private equity to deliver IRR (internal rate of return) of 12-15% and low volatility around that, and so PE guys have got to be careful. They might come across these deals but they can’t really be doing them. So I think it is about asset class segmentation and LP choices.
But direct investors and sovereign funds like Khazanah and Temasek are getting into tech deals because they don’t answer to LPs—they only have to answer to themselves. They are happy to go into these deals, which is why you are seeing sovereign wealth funds enter ride-sharing companies and the big China e-commerce players.
Across the region and India, are valuations a barrier to entry for PE? And if they are, why are these many deals happening?
It is a million-dollar question. At the moment, you’re seeing what I call positive restraint. People are doing deals, but they are not being crazy. They are trying to find creative ways to manage downside, to not overpay, and so on and so forth.
But deals are getting done and the asset class is growing. You know it is a simple mathematical formula at the end of the day.
If interest rates go up, and leverage is helping to boost the returns on a number of these deals, then you can have a view on a number of these deals.
But if interest rates go up, and valuations remain as high as they are now, we need earnings to grow to generate the same returns.
It is a multi-variable equation. If earnings do not grow greater than the valuation levels at which deals are being done right now, and leverage is still being used on deals with higher interest rates, returns will come down.
I cannot predict the future, but something is going to give.