Tuesday, January 29, 2008

For PE funds, caution is the word

For long, PE / VC funds have been encouraging and rewarding innovations. But that’s just restricted to the creativity element in the DNA of portfolio companies controlled by them. Innovative business models, processes, productivity improvements and the like. But there are several culture / country specific factors that influence the metrics used to evaluate companies that meet the “investment grade” parameters set by the PE firm. Here I share some attributes that I have noticed for PE firms to consider while evaluating investments –

a) Value unlocking – Normally PE firms unlock value from portfolio companies through interests, dividends and divestitures. But most Indian companies have an umbrella set up, where the finished product of one could be the raw material for another and so on. Since all these companies are owned by the same family or group, by funding one company, the PE firms are doing a favor to those others giving the entrepreneurs more bang for the buck than the PE firm itself. Nothing wrong with that, if transactions between the various links in the chain are at arm’s length that often is not. They don’t surface in the MIS reports placed before the Board Meeting – being the only instance when the PE firm’s nominee gets to interact with the management. So, call for details.

b) Dance with masters of the game – Like most developing economies, Indian bureaucracy is riddled with nepotism, corruption and red tape. Now wait, don’t just head for the door. That way you are shutting down on opportunities that come with it. Local entrepreneurs have grown up in this ecosystem and they know their way around it. Some are deft players in shifting the right gears while others are still learning. See that as a “competitive advantage” and an essential management skill set. Do some fine combing and be with the adroit team.

c) Law is tight, enforcement is weak – So don’t take the functional judiciary and rule of law for granted. You have to do rigorous diligence on your target investments and check everything not just twice. For eg. while doing a real estate deal, don’t just look for the title to the property, see whether title-holder is in possession as well. Go one step ahead and release a public notice seeking other claimants, if are around. As far as possible, do business with entities that honor their contracts and obligations. That said, don’t see this as a weakness. Learn to duck. It also means if you'd crossed some line, don’t hurry to do term or pay up. Look for fixers first :-)

d) Provide for Exchange rate risk – This is playing out now. PE firms that hurried to buy stakes in companies at stretched valuations must be ruing their double whammy. They no longer command the same high valuations thanks to the recent market crash, a weakening dollar is hitting the export realization of these companies as well. The projections no longer hold. Their customers from US and Europe are reeling under heavy losses, especially banks and mortgage firms that make their future prospects even gloomier. Look for companies with a mix of sufficient domestic customers and export customers with wider geographic/currency spread.

e) Acquisition hurdles – Most Indian companies are family owned and controlled. They don’t let go off control easily no matter how sweet the offer is. It takes a lot of persuasion and coordinated effort to get all family members to agree to quit or even dilute stake. And the whole process has to be quick. Otherwise, it will be seen as a murky family squabble where some are for and other are against the deal; such a specter will demoralize the workforce and would force even competent executives to leave instead of dissenting owners. When good people leave, you may have to revisit the deal before it’s too late, especially if it’s a management `buy-in' you had in mind. So, do it quick; structure it uptight. No management, No deal.

No comments: