‘PE to be net-gainer in the pandemic’

Sitting on unprecedented dry powder levels, private equity (PE) as an asset class has of late seen relentless growth. But an economic downturn coupled with the uncertainty of a pandemneric can test its resilience. In a video interview for the latest dispatch of Mint Insight, Siddharth Shah and Aakash Choubey, partners with law firm Khaitan & Co., open up on the future of private equity—an asset class sitting at the heart of deal-making. Edited excerpts:

What are the concerns in the minds of limited partners (investors in private equities), as our economic growth rate falls?

Shah: In 2019, even amid all the talk of slowdown in the economy, the private equity space still hit a high of around $45 billion in deal-making. This is the highest-level we have seen in India. Against the same backdrop, other emerging markets are also struggling for growth. When a LP (limited partner) sitting 10,000 miles away is looking to allocate capital across markets, they would compare the situation with other emerging markets as well. And here, based on our experience and what we have seen when it comes to fundraising in India, we have got a fairly good share of the global LP allocation.

As we enter the new decade, what are the key challenges for this asset class which would impact its future?

Shah: Uncertainties on the policy and regulatory side are definitely a big challenge. Factoring any risk due to massive overhaul of policies of new regulations being implemented into one’s strategy will require sharp judgement on the part of PE players selecting asset classes.

Whether the capital markets will remain sustainable is another uncertainty. The third would be global macros. Especially with the covid-19 outbreak, an indirect impact on how LPs look at emerging markets is expected.

Choubey: I would like to add some other challenges. Firstly, from the governance stand point, there is the conflict when it comes to the nominee directors, which the private equity directors would put. And we are seeing a lot more issues coming up now. Nominees of private equity to boards of Indian companies have a duty towards the company’s shareholders versus maximizing profits for their LPs. That balancing act needs more thought. We are also seeing co-investment happening and more LPs establishing on the ground. So, one is not chasing capital between GPs (general partners) and not competing with LPs as well. Some of them are even enjoying tax benefits as in case of ADIA (Abu Dhabi Investment Authority). Players must align and realign themselves to ensure that all involved parties are working in a cohesive manner to maximize growth going forward.

What do you think will be the impact on covid-19 on private equity asset class?

Choubey: The pandemic has quickly turned into an economic crisis, and going by history, deal-making in the initial days of an economic crisis is the toughest. Having said this, private equity will be a net-gainer in this period. While intrinsic value of businesses are strong, valuations are expected to lower. In times like these, be it a strategic M&A (mergers and acquisitions) opportunity requiring private capital or a creative debt /mezzanine solution or distressed opportunities, private equity will be the preferred source of capital.

Private equity already has solid dry-powder and is more nimble than we expect. GPs are already trying to negotiate changes in fund documents to adjust for the impact of the pandemic—be it flexibility to offer more solutions by way of expand investment strategy, or re-deployment of proceeds into portfolio companies to support them through this cycle.

There is no doubt that exits will be a challenge and many portfolios will find it hard to survive in this period, but investments made during this period will fetch higher returns than those made in an upcycle.

Though present level of activity is muted, we expect a rebound starting in Q2.