"ICICI Venture is lying"

Just finished reading this BS report – “PE firms to rethink India strategy”. I say, “they had better” !

The report quotes Vikram Uttam Singh, Head, PE advisory group of KPMG “The Subhiksha incident will make PE firms more cautious on how much of a free hand they allow to a promoter. Some PE funds are concerned that promoters have a wide range of authority in their companies and could look to establish structures that limit some of this authority”.

Here are my observations.

KPMG may have compulsions to take sides with PE firms as their survival depends on such clients. But why does it credit PE firms with so much of naiveté? ICICI Venture had an exposure of 33% in Subhiksha of which it off-loaded 10% to Azim Premji’s PE arm (Zash Investments) for Rs.230 crore – apparently without discussing with Subhiksha itself that was badly in need of cash.

If the same money (Rs.230 crore) was introduced directly into Subhiksha, (instead of buying out ICICI Ventures stake), the company could have been saved to an extent. But I-Ventures wanted to lighten its holding and thought otherwise.

While it’s ok for PE firms to cash out, they need not profess their ability to have long term relationship with their portfolio companies and the “strategic managerial edge” their presence in the Board offers to such companies. When that is the case, what was Ms.Renuka Ramnath (one of I-Ventures nominees on Subhiksha Board and CEO of I-Ventures) doing when she approved the proposal for massive scale up by Subhiksha? Now is she telling us she was not aware of it, even as I-Ventures had the rights to appoint majority of Subhiksha Board? Or does it mean she was too busy to attend Subhiksha Board meeting where such a critical decision was made? Or is she admitting I-Ventures had no monitoring mechanism over its portfolio companies? That’s a bit too much. If I were a LP investor in I-Ventures, I would have taken it to task and would proceed against them for dereliction of duty. A bit too naïve. She certainly can do with some education on sophisticated lying.

Just as in the case of Subhiksha, the first thing PE firms do when they sense trouble is (a) to quietly off-load their stake to an unsuspecting investor and (b) withdraw its nominees from the Board so that they need not defend lawsuits filed against them by unpaid creditors/ bankers / statutory authorities like EPFO in this case.

In simple terms, PE firms are pure fair-weather friends. All talk of strategic advisory services and expertise all are pure bunkum. They have none and they are here just to skim the profits. At the slightest sense of trouble, they chicken out – like the proverbial rats from the sinking ship.

Nothing wrong absolutely. Buy why not say it upfront? Why the façade of management expertise when you know you have none? Why not tell the portfolio investors - “Take the money and pay us back 10 x returns. In case if you goof up, you’re on your own” !

And lastly about KPMG and its ilk of PE advisory groups. How come all those transactions advised by these so-called whizkids yield a negative return soon after the transaction? Are they whizkids or half-baked, mother fucking scumbags that shamelessly face the media and talk ill of the companies they ran a due diligence on and arrived at a "fair market value"? If after all their “expert” due diligence, their projections go haywire, should they not re-examine their processes and find out what’s going wrong? How long should the investing community put up with such sobs that are ready to even chomp client carrots if there is the word "fee" at the other end?

Why would they? They have mastered the art of orifice-licking and carrot-chomping. That should keep them in good stead besides the standard disclaimers that insulate them :-)
.

"Enough of draw down"

say the Limted Partners (investors) in PE funds to the Fund Managers that let them down.

When I titled this blog as “General Partners V. Limited Partners” , it was pretty much apt for the situation then. General Partners that make the most critical investment decisions in their PE funds were held accountable for its outcome by the Limited Partners that funnel those funds. When investments don't yield desired returns, it's time for GP's to brace up for an LP interrogation, often that ended in LP deserting the funds and GP's earning a bad reputation. In the PE small world, word is out fast and that means near death for the GPs. They can't hop jobs so easily.

Now the situation has been upended. The new flip is that the Limited Partners are advising the General Partners not to press draw downs. May be, it's the liquidity crunch and absence of leverage that chokes many a LP funnel. But I like that in one way because somewhere the indiscretion has to end. The choice of investments they make is abysmal. Worse is the follow up supervision and near absence of timely strategic interventions. It’s not buy and hold anymore, buy and sleep seems to be the strategy for some.

PE funds need to talk straight

Private Equity can do with some straight talking.

“One of [PE’s] defining characteristics is never, ever, to admit to a mistake in public. By convention, most buy-out bosses maintain that they anticipated a recession and acted cautiously. In reality, the buy-out industry had its biggest-ever binge just before the bust began. Most big firms paid silly prices for companies using sillier levels of debt.”

I have solid data on PE investments in Indian companies at obscene valuations. Some of them were mandates that I had turned down because the asking price was too high. But there were ambitious investment bankers / fee hungry brokers that went ahead and goaded their PE clients to invest in. Result - every company in PE portfolio has its valuations deep underwater. Recognizing their liberty to keep it locked down for several years, the PE fund managers get away without marking their investments to market. But the pension funds and other investors in the Funds, have regulatory mandates advising them to mark down their investments and disclose the level of erosion.

Now I have mandates from three funds that badly need to reshuffle their portfolio. Tell you what? There are no takers even at this down to earth valuations, not even the owners and majority shareholders!

.

When balls choke up your lungs, hardly can you talk

Candid admission by KKR. Given that the buyout firm has not yet gone public, that frankness is quite refreshing. Yet unusual by Indian PE fund manager standards, huh?

.

Yet it is. More to follow.

”The lack of credit has materially hindered the initiation of new, large-sized transactions for our private equity segment and, together with declines in valuations of equity and debt securities, has adversely impacted our recent operating results,” KKR said in its SEC filing.

.

The firm’s total investment loss for the first half of 2008 compared with a total investment profit of $3.4m in the first half of 2007. Its net loss for the 1st half 08 totals $1.1m, compared with a profit of $667.4m for the same period 2007.

.

KKR, which has made investments in numerous household names such as Toys R Us, mattress maker Sealy and asset manager Legg Mason Inc, said its fee income in the first half of the year was $135.3m, compared with $115.4m a year ago.

.
Imagine the fate of India investments of PE funds. There is far less swagger in their gait and I hear them talking a lot less these days. When balls choke their lungs, they just can’t talk; let alone getting candid ;-)

.

The PE bland dish

In the spiceland of India, nobody likes a bland dish!

.

But that's what PE funds have lately become. I revisit their fundamentals. Private equity investing may broadly be defined as "investing in securities through a negotiated process". The majority of private equity investments are in unquoted companies. Private equity investment is typically a transformational, value-added, active investment strategy. It calls for a specialized skill set which is a key due diligence area for investors' assessment of a manager. The processes of buyout and venture investing call for different application of these skills as they focus on different stages of the life cycle of a company.

This is the world view of PE and the reason why savvy investors buy into private equity funds, classifying them as a premium asset class and crediting its managers with superstar status.

But in India, the superstars hardly sizzled. Strategic input? My foot! They whimper and whine and take refuge in quoted equity. They settle for minority stakes, wield no great influence in the board and look no different from passive public market investors. So do their dull and dreary strategies and they do what an average investor does – see how they follow Rupee cost averaging.

I think the investors in these funds will fare far better buying Index funds. They can at least save all that management fee and the carried bonus they pay for bobbing up and down with the market sentiment.

.

Et tu Sanjiv Kaul...?

Oops...I mangled the Bard! For good reason though, so he should forgive.

.

It seems Ranbaxy-Daiichi Sankyo deal has stirred up the PE nest. I quote Sanjiv Kaul, MD, Chrys Capital from BS –

“The Ranbaxy-Daiichi deal is expected to make PE firms review their positions on investments in acquisition-prone industries like pharmaceuticals. PE companies invest in a company if they feel that its promoter can deliver goods. If the promoter changes, then its a different ball game. If such acquisitions are going to be a trend, a precondition factoring in such reverse-acquisition possibilities will have to be factored while making an investment decision."

My first reaction was why did Sanjiv - of all the people, find it so surprising. After all, he has moved to Chrys Capital after spending over a couple decades at Ranbaxy. I’ll explain why it stumped me.

PE term sheets ordinarily have clear clauses that protect the rights of PE investors. Tag along rights that effectively force the majority shareholder to include the holdings of the minority holder in the negotiations for likely exits on identical terms. Drag along rights that help a majority shareholder drag a minority shareholder also into a deal where the acquirer insists on a 100% buyout. Besides there are different forms of anti-dilution clauses (Ratchet clauses) where the founders agree to compensate the PE investors by topping up their stake so sacrificed, if any, as and when a new investor is allowed in.

Even in Ranbaxy deal, SEBI (SAST) Regulations don’t permit Daiichi to acquire more than 5% in Ranbaxy in a year. There are continuous disclosures to be made and especially if a PE firm is an investor, it has an automatic right to get notified, assuming that it doesn’t have ROFR. But these are all standard clauses and the fears at best, according to me, sound childish. Still if it is true, it speaks volumes about the quality of PE managers – but certainly not of the caliber of Sanjiv Kaul.

.

invoking Caveat Emptor

Guess Indian firms lately have been waking up to global connections of Private Equity.

Noida-based Phoenix Lamps Ltd, in which UK-based Actis bought a controlling stake last year, is cashing in on a slew of global tie-ups with international lighting firms, aggressive forays into international markets including Europe and West Asia, and rapid ramping up of capacity.

Aurangabad-based Endurance Technologies, in which Standard Chartered Private Equity Fund picked up stake a couple of years ago has been on a roll ever since, acquiring three European firms and opening a Detroit office.

Gokaldas Exports, India’s largest garment exporter, decided to sell out to Blackstone Group for $165 million in August last year to leverage Blackstone’s financial muscle and contacts in the key US market.

Shaken but not stirred by impossibility of leveraged finance, the private equity barons have been looking to move on. Dismayed and disillusioned western investors will no longer play ball. In the leveraged loan markets, assets have been marked down by a fifth, so 80 cents in the dollar is the new par. Thus the financial alchemists have turned to the huge pools of money available in the Middle East and Asia.

.

The vanity of the PE model attributed to its strategic (besides financial) prowess has been significantly exposed after the recent liquidity crisis in the Wall Street – where PE firms and its I-bankers abused the inept regulatory regime and lax credit conditions to erect dubious financial structures. Nobody bothered about the obscene management fee charged by the LBO architects that maintained that a superior financial structure is worth it all. Time to get back to the original PE model – no debt, no leverage; just plain capital invested in a business that screams `opportunity’.

Hope Indian firms don’t call the PE bluff way too soon like their cousins in the developed world… I invoke Caveat Emptor ;)
.

"Ain't got no choice"

“PE firms in no hurry to exit” – reports Economic Times.

“Have they got a choice ?” I ask.

The report goes like this. With the primary market down in the dumps, the M&A route has become the savior of PE firms seeking exits. So far they’ve made 11 M&A exits in 2008 while during January-May 2007 the corresponding number of deals was 25. The number for 2008 also includes a few hypothetical exits – where there had been an IPO by a portfolio company yet the PE firm chose not to exit – in OnMobile Global, Shriram EPC, GSS America and Titagarh Wagons.

I see PE funds making the same mistakes like a retail investor does or worse. The only difference is the retail investor gets into the market at the peak of a bull market, listening to the Dalal Street sandwich/lassi vendor. PE fund managers do it – in much larger scales – despite their networked access, domain expertise and operational agility.

So much for Ivy league MBA, deal closing skills, street smart image and with a brain as shrewd as a sack full of rusty door knobs.

.

All floaters. No Directors in PE funds.

Private Equity players have been swimming naked. The tide went out and all of them are left clutching their balls. Will the reign of mediocrity in India's PE funds end with this? Or will they still fancy dim witted B-school graduates that acted worse than average Dalal Street operator?

DNA Money analysis shows that, of the 51 PIPE deals in India in 2007, 33 have lost money. That's more than 60 per cent of the transactions. It means two-thirds of PIPE deals are out of money. Check out the big names.

Baring India's stake in JRG Securities is the worst hit, its worth having eroded 71 per cent. Others that have lost more than 50 per cent due to the recent market meltdown are Nalanda Capital in Vaibhav Gems, Al Anwar Holdings in Almondz Global Securities, Fidelity in BAG Films and Media, Orient Global in India Infoline, ADM Capital in Rama Pulp & Papers and Macquarie and Credit Suisse in Sical Logistics.

Deals consummated in 2006 also tell a similar story. Almost 40 per cent of them, or 17 of the 41 PIPEs, have lost money.

Capital International's stake in McLeod Russel India, Carlyle's in Allsec Technologies, Future Capital's and Reliance Capital's in Maxwell Industries, Goldman Sachs Investments' and Voyager Fund's in Spentex Industries, New Vernon's in JB Chemicals and Unichem Laboratories, Clearwater's in Kopran, ICICI Venture's in Geometric Software and Gateway Distriparks and General Atlantic's in Hexaware Technologies, are some of the investments whose values have eroded over 50 per cent from the time the funds invested in them.

It’s time for Indian PE managers to get back to basics. They should shun fancy "Director" designations. They have so far directed nothing. They were all drifters with market sentiment. Should call themselves exactly that or "floaters" as aptly defines their passive roles. Time to unlearn B-School gibberish and start focusing on "uncool" stuff like production, distribution and profitability.

.