Saturday, May 10, 2008

Why PEs are benign in India

So as I read the views of lawyers, I-bankers and consulting firms, I am convinced that the PE has dug its roots deeply into Indian soil. More importantly, why they are not the usual monsters they are feared to be elsewhere.

Some astonishing numbers before we go further. PE firms numbering 255 at the last count have pumped in over $25 billion into Indian companies over the last four years, with around $17.5 billion being invested in last 15 months in 487 companies. Their nominees fill the boards of over 1000 companies in India now. So far their growing clout has not been perceived as that of a wild beast (remember the book "barbarians at the gate" on KKR-RJR Nabisco deal?) as they’ve been monikered in the west. Perhaps they’ve just been careful or are saying to themselves “it’s a long road. Let’s not get a flat tire early on”.

But I see a few other reasons why PE firms are benign in India –

a) PE buyouts abroad were characterized by high leveraging (raising huge debts on target company’s assets) in the west; mind boggling debt/equity ratios of 50:1 literally did them in. Then PE firms recoup their own investment soon by way of dividend recaps. That reduces their risk to near zero from the start. This is not possible in India because Indian regulations do not permit a dividend recap so easily; neither do banks allow ludicrous leverage levels of the above kind. That makes take-private type buyouts less attractive.

b) Most companies in India are family managed and would like the family shareholding to pass over to the next gen as heirloom. They don’t let go off their holdings so easily. They are not easily lured by valuations. It’ll take a while for them to get there. It’s because most sellouts have a non-compete clause. The family has such a deep grasp of the domain, the intelligence gathered over the generations are irreplaceable. The PE firms that buy in invariably count on that domain expertise to get to their target returns. The pedigree rules in the end. [Update : here is the proof]

c) Asian values of business conservatism are so different from Western values of risk indulgence. That circumspection explains the relatively slow pace of businesses scaling up in India. The businesses having been seeded in tough regulatory environments, a slight easing up of regulations or easier access to bulk capital is all it takes them to leap into the big league as we are experiencing now. I think of ESSAR group – it was almost done to death in late 90’s when steel industry was down in the dumps (it defaulted on its foreign debt obligations) and when the fortunes of steel industry turned in its favor, it leapt back to glory. Its later foray into telecom paid off pretty handsomely in the recent Vodafone buyout of Hutch-ESSAR ($19b) and now it is a major player in a few other sectors like Shipping, Oil exploration and Heavy Engineering.

d) Political affiliations of business families are known to be deep set. Any new investor would view that as a great plus. Though it could be argued that business should flourish independent of politics, it’s always intertwined everywhere. May be to a lesser degree in the west, but it’s a force to reckon with. Remember the forces that came together against L.N.Mittal in the $43 billion Arcelor-Mittal deal? Their fear - Asian managements do not recognize European sensibilities. But it’s politics all the same if not downright racism.

e) General political / judicial dislike for raiders. I would put it as lack of instances of a raider doing a company and all its stakeholders substantial good. If a few buyouts result in explosive growth in shareholder returns, this perspective may change. But you can’t be a PE fund manager and not exit in a hurry. Chrys Capital realized it painfully. It got out of Bharti Televentures investment with almost 5X plus returns on its $300 million investment six years back. As soon as it got out, the sector fortunes turned and in another couple years, the market cap of the company rose eight fold. Chrys Capital is still licking its wounds. So did ICICI Venture exited Air Deccan in a hurry, at a loss. Soon came Vijay Mallya and Capt.Gopinath the Air Deccan founder got a lucrative exit within an year of ICICI Venture’s hurried exit.

So PE firms, it’s a mixed bag here in India. Tread carefully and you could be in for big gains. Try to be a smart ass, you’re in trouble deep. Know why? Entries are the easiest part in investment game; it's the exits that tell men from the boys.

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