Smart Cricket

Rajasthan Royals won the DLF IPL cricket tournament is old story. Now the champions are going public – not with their fame, with private placement and further on the stock markets with an IPO!

In January this year, Rajasthan Royals, the only foreign-owned team (investors include Lachlan Murdoch, son of Rupert Murdoch) among the eight IPL franchisees, made a bid for $67 million for the team, the lowest among all the DLF IPL teams. Led by Shane Warne, the Royals won the tournament. Reportedly the only team that is in the black — first-year expenses were estimated at $20 million and revenues are in the same range.

Wonder what other franchisees that are still licking wounds feel as they read this…

.

PE back in Realty form – at an entity level now

Gone are the days when PE players were interested only at a project to project level in their Realty exposures. Now the valuations are beaten down, they seem to be fairly interested in buying stakes in Realty companies instead of specific projects. Clearly their risk perception has come down. Another clue to me is what I see in the rising instances of creeping acquisition. Promoter holding in various companies has been going up sharply. Puravankara Projects and Akruti City have 89.96% promoter holding. If DLF was to go ahead with its entire buyback, it could have one of the highest promoter holding of 89.3%. I get to hear the “buyback” word more now.

Last week I’ve been talking to one of my friends working for a large Realty PE fund. I was surprised when he asked me if I have any interesting proposals from Realty companies. So far his tribe never entertained a hint if it spanned beyond a specific project. I gulped the drink in front of me and ordered another!

Today I read about the resurgence of PE interest in the papers. Now you know why I still call him a friend. He broke it to me two days before!

.

Market declines; off goes PE deals, but law firms connect….

ICICI Venture and Jaypee Infratech have terminated negotiations for the PE player buying close to 10-15% stake for $800 million in the infrastructure company, which is developing project worth $ 25 billion. Earlier Blackstone backed off from buying 26% stake in Hyderabad-based Ushodaya Enterprises (of Eenadu newspapers and television channels) for $275 million. Similarly, Future group’s PE fund Indivision cancelled its deal to buy 4.9% stake for Rs 250 crore in media house Zee TV’s DTH venture Dish TV following the market meltdown that saw Dish TV share prices sliding far below the deal price.

But as they say, lawyers never lose. Allen and Overy, a leading international law firm and Trilegal, an Indian law firm, confirmed their new arrangement involving client referrals, training, consultation and joint marketing.

Allen and Overy say they belong to a “magic circle” – now what is that? I guess it’s a law firms moniker akin to "Big Four" for accounting firms. At least magic circle is more overt a term – the client will realize he’ll be (financially) done in as if by magic….

.

Get your skin in the game

So I read this McKinsey report.

During the past two years, the flood of money into infrastructure funds has been an astonishing $130 billion. Take into account leverage, a billion dollars of equity funding could, in some situations, pay for up to $10 billion in projects. "Where will all the money go?” It asks. I am tempted to add an extension – “[with shrinking margins]”. The need for infrastructure investments in the emerging markets at present is about $1 trillion. I am at ground zero here in India. I can share a few insights.

PE funds here need a new approach – different from typical value creation through financial engineering and rising user demand. So far, they have acted less aggressively to improve operations; indeed, many financial investors still leave such issues to contractors and focus their governance efforts on financial metrics. This model is broken; it’s so yesterday.

So what should PE fund managers do today? I suggest -

a) Lay down norms of good governance. It helps assess risk in a structured way, avoiding unwarranted focus on a single category, such as technical delivery or regulatory compliance.

b) Brief project owners about the complexities by way of foot note to RFP itself. When they see reason, they might even expand their allocated budget. If you’d quoted thin, you’ll come to grief later.

c) Build alliances with Infrastructure specialists. Get some strategic skin in the game. Here’s the twin upside - a better chance of winning traditional deals and turn them around; and the ability to bid for operationally complex and less competitive projects. That’s how you learn to walk away from overpriced deals.

I quote an example. Macquarie and Ferrovial’s co-investment in the UK’s Bristol International Airport, for example, involved upgrading signage systems; renewing check-in, baggage reclaim, and catering facilities; rerouting foot traffic; and installing all-weather landing equipment. The investors also rejuvenated the airport’s retail offering, strengthened the management and sales teams, and even tweaked the system for booking parking spaces. In the four years after the acquisition, the number of passengers using the airport doubled—as did its EBITDA.

I find financial engineering can help PE returns only up to a point. With strategic competence added in, you can man up before the whole world, not just LPs. What do you think…?

.

I pat my back

One great upside to blogging as I see it is that you can pick up on a weak signal, apply your own logic, speculate outcomes, post it over the Web and attract comments. Then validate your foretelling skills against what appears in the mainstream media much later. So what’s so great about it? Date stamps. If your deduction of likely outcomes precedes the subsequent endorsement in mainstream media, your logic is flawless. You can rely on it and take critical decisions with greater confidence. It’s a great joy. I’ve had it on quite a few occasions before. Here and Here.

This morning I had yet another. I find the lead editorial in today’s ET endorsing what I speculated three days earlier – on what Reliance Power `out-of-the-box bonus’ means to investors. When tallied point by point, I’ve a few extra points to my credit that’s yet to be spotted by mainstream hacks. Here is the next salvo from R-Power, just as I had guessed.

Meanwhile, I plod on… A sharp logic is indispensable in my line of work – private equity deal scouting and bug fixing :)

.

Update : Not sure if R-Power has execution capabilities on the power generation and distribution front. It’s current priority is bonus distribution :-)

As a Private Equity dealmaker, I would worry

The government today notified guidelines for Foreign Currency Exchangeable Bonds, that lets companies forming part of conglomerates to unlock some of their investments in group companies.

FCEB is a debt security offered by a company (“issuing company”) and subscribed to by investors living outside India and exchangeable into equity shares of another company (“the offered company”) of the same group, based on warrants attached to the security. Conditions include –

a) Companies to belong to the same group;
b) Offered co has to be listed, FDI/ECB compliant;
c) Not to use funds for stock buys/India real estate;
d) Five years for redemption but can exchange anytime.

This is yet another window for conglomerates in a hurry to monetize rich valuations in a booming market. I can explain. If a company has exhausted its FDI / ECB limits and still needs funds, it has to either raise fresh capital or resort to high cost borrowings. In both cases, the credit rating would suffer and that means higher cost of borrowing. By taking FCEB road, it can swap the FDI/ECB head room available for any other company in the group to raise more funds at the same reduced cost.

What would it entail? More companies from same groups, with or without ready projects would make a beeline to get listed. Now if R-Com has exhausted its FDI/ECB limits, it can raise it under Reliance Power, which is a shell now. Before that is exhausted, Anil bhai will float another company and take it public. One company always to be kept ready with FDI/ECB window open. Remember successive IPOs during early days of Reliance and the later consolidation? Even smaller players like the Modern group of yesteryears from the Ranka stable? Modern Sintex, Modern Denim, Modern Terry Towels – each of them were listed, their stocks rose and fell with little notice. Fundsraising was a chain reaction - one project was used to fund another till the chain collapsed during the late 90’s bear phase.

But then it’s an election year. Reliance has new oil strikes. Uncanny coincidence of timing the new law? Notice the relative calm even in the left benches despite the fuel price hike. Whatever happened to the elementary principle in Finance – every business should sustain by itself? Take life. How long would you stand on other’s legs?

.

As a Private Equity deal maker, I would worry.

.

Be the Stand-up guy at the gate

Ted Forstmann, a corporate raider immortalized in Barbarians at the Gates for his unsuccessful 1988 bid for RJR Nabisco, flew in on his private jet, presented his offer, and gave Reiman about 30 minutes to make up his mind, without bothering to spend any time with his family.

Now those guys (KKR, Blackstone, Carlyle et al) are here, will that stuff work in India? I say no. Here you have to please even the nannies in the household before you buy some stake. It’s not just easy to pump in excessive leverage, dividend recaps and ripping fees into their Indian portfolio companies and ask them to wilt and watch. Devise new methods. Innovate. I go for a successful PE fund to get going here, it has to have a greater strategic involvement than pureplay financial. Use some hand to spin that wheel of fortune. You can have a killer instinct alright, but have some heart as well. Of the few PE business models that came close, Madison Dearborn scores.

.

The box needs fixing

So Deloitte runs a survey on the potential return for PE firms in India, going forward. It says Global private equity firms are expecting lower returns from India in the next six months as a booming economy and stock market drive up valuations. The basis ? Callow statements like this - “There is no more low-hanging fruit. India has been discovered. We will see more moderate – 20-25 per cent – returns going forward.”

The PE firms can do with a bit of open mind and flexibility. They have to innovate and adapt. You can’t make money in India by just transposing the same business process that are followed in the US or Europe. Result – they keep whining on their clichéd gripes (a) ban on leveraged buyouts (b) families that own businesses are reluctant to sell (c) restriction on issue of convertible preference shares and other regulatory impediments.

That puts me in a mood to quip.

Take gripe (a) – leveraged buyouts are banned. So what? That's why we didn’t have a credit crisis and points to a credible lending process that insulates Indian banks from global crises. The fact that doubtful debt can’t be bundled with a good credit risk and palmed off to unsuspecting bond investors is a sign of systemic maturity. [Indian banks faced a crisis 10 years back when most of our PSU banks had high NPAs because major borrowers didn’t repay. They siphoned the funds to build their personal assets even as their companies were going broke. Now that's plugged].

On gripe (b) families don’t sell out - because they feel one of them will be shortchanged in the process by the dominant share owning family member. Search for recent scuffle at Patni (computers) and Bajaj (Auto) families. The strategy here for PE firms is to get upclose with the family and broach the subject thro an investment banker that is close to the management. Choose the wrong messenger and you lose the deal. For that you need someone that is pretty much clued in… Why not me? Yeah, You can try.

The gripe (c) is on choice of instruments. Yes, convertible preference shares have been banned in construction and real estate since PE firms took that route to breach the FDI limits prescribed for the sector. PE firms lent against convertibles and the money was never repaid. In effect it was indirect infusion of equity since the loans were convertible into common stock. They used that to jack up their stakes in real estate companies that had huge land banks. You try to break a law and you're sure to be canned. But they can pitch for specific projects. Use a strategic investor, that is a professional consulting / EPC firm that can capitalize (thereby part-fund) the project cost. There are several other ways but then I can't blog everything here. I need to make a living too, pal....

If you are creative enough, there are ways to have the cake and eat it too… I’ll tell you what’s the problem. Investment banks don’t innovate. They just want to ride the coat-tails of their colleagues in the west. No, I am not asking you to start thinking out of the box. If one has to do that often, then the box needs fixing. It's a bit like walking between raindrops, agreed. Or a closer parallel will be learning to drive on a pot-holed road without getting a flat tire way too often. The day you get it right, you'll sight opportunities here all the more.

.

When a Private Equity deal goes bust

Buyout firms like to present themselves as a can't-fail combination of operational genius and financial support that can heal sick businesses and create thriving companies. But sometimes, as in the case of Aegis Mortgage, genius fails and bankruptcy is declared. The private investment firm Cerberus bought a controlling stake in the Houston-based mortgage lender in 1998, but despite an infusion of cash and talent, Aegis ceased operations on Monday, August 6. Now hundreds of employees have been laid off - all without health insurance. It's a reminder that risky turnarounds can mean real pain for more than just investors raising questions about how Cerberus will treat other ailing companies it has purchased, notably Chrysler.

In India, PE deals are on the rise. Over leveraged transactions be put on watch.

Grow up, Schwarzman

Stephen Schwarzman is a bad schmoozer. That’s a skill he’d rather have if Blackstone, the PE firm of which he is the CEO intends to do more deals in India. In particular, in sectors like media, telecom, real estate and energy where an FIPB approval is needed to relax statutory ceilings on PE investments.

Global private equity fund Blackstone’s proposed investment of $275 million (Rs 11.30 billion) in Ushodaya Enterprises, which runs the Telugu newspaper Eenadu and TV franchise, is stuck with the information and broadcasting (I&B) ministry seven months after the deal was announced.

This could mean trouble for the country’s largest private equity deal in the media space, which requires Foreign Investment Promotion Board (FIPB) clearance.

Arun Sarin of Vodafone learnt it the hardway. Indian politicians and bureaucrats are not so lightweights in that they have a reputation for jamming many a smooth deal. Equally important it is for him to be less of a gas bag afterwards.

.

"Go, use the wisdom of Arun Sarin, Mr.Schwarzman..."

.

Leadership menopause

The private equity industry is accused of poaching some of the best brains from the mainstream businesses. Corporate luminaries (Jack Welch of GE, Lou Gerstner of IBM, Jacques Nassar of Ford to name a few) have bolted in droves for private equity, the freewheeling world where investors buy slumping companies and try to turn them around to sell or take public, risking billions of dollars in the process.

All brilliant minds and high performers, no doubt. Their track records speak for them. Profligacy has never been their virtue and all of them balked at cost spirals. I often wonder how they approve of the clearly unsustainable leverage deals brokered by the private equity firms they end up working for, to finance bulge bracket acquisitions. Steven Pearlstein of Washington Post has this eye opener on the recent Avaya deal by Texas Pacific (where Millard S. "Mickey" Drexler, ex-CEO of Gaps Inc. works)

How can they fling caution to winds as soon as they switch to private equity? Has it got to do with the new found freedom from Sarbanes Oxley going to their head…? Or do they undergo a hormonal imbalance during the autumn of their careers ?

But come to think of it, Blackstone boss Schwarzman sure had that close call with change of life. How else do you explain his selling a stake to China, awful hurry to take Blackstone public and indulging like there are no tomorrows only to invite that Congressional tax slap…

.

The great PE bull’s tiring

What made me say that?

Last week US Foodservice, an American wholesaler being bought by private-equity groups, cancelled a $3.6 billion bond-and-loan deal when lenders balked at the lack of protection they were being offered. In Australia, private-equity firms pulled out at the last minute from the country's biggest takeover, complaining of the high cost of debt. This week the sale of a British retailer fell into confusion, after two private-equity bidders withdrew. The prospect of dwindling returns makes buy-out firms reluctant to club together to buy the big companies they covet; banks, meanwhile, are growing wary of offering their own capital as “bridge” finance. Shares in Blackstone, a private-equity chieftain that listed on the stock market last month, have fallen below their offer price.

Rising long-term interest rates have pushed up the cost of borrowing. Sensing a shift in the economics of the industry, creditors around the world have started questioning the easy money offered to private-equity firms, which feed off risky types of debt. The debacle in the US sub-prime mortgage arena has opened many eyes, or so it seems.

For Indian promoters betting on lucrative valuations fueled by PE bidding wars, it spells trouble. What an opportunity they missed…

.

New kid on the block

“When liquidity gets tight, innovate” – seems to be the credo for PE firms.

Imagine this new device. A Private Equity firm needs $300m to invest in a company but has decided to expose it to $100m only. It lures in a Bank with higher ROI bait and gets it to lend $200m on its behalf into say, 8% preferred stock/FCCB. The company is capitalized with $300m now. So the Bank gets $16m and the PE firms gets $8m. The PE firm turns over its return ($8m) to the Bank in return for stock appreciation / conversion benefits to which the Bank is not entitled. If the stock doubles, the investment is worth $600m which the PE firm sells and returns $200m to the Bank. PE firm nets a cool $400m upon its original investment of $100m and the interest turned over to the Bank. In the PE block, they call it “Asset Swap”.

Sexy…?

Shishir Prasad has elaborated it in The Economic Times.

.

Deal sourcing - the old fashioned way

Throughout my more-than-a-decade long career in Investment Banking, both as an external consultant and in my in-house avatar, I have tried several techniques to source deals. From leveraging close personal relationships, affiliated funds, Investment Bankers and industry grapevine to sourcing deals from other financial intermediaries or even participating in downright auctions through club deals.

What did I leave out ?

It is deal flow emerging from proprietary research, which stands out for its enormous value potential and distinct personality trait. I am far more clued in a deal that I have researched upfront, took time to get upclose with the management and have spent enough time studying their strategies translating into results. Well, to the argument that who has the time, my ready answer is “start scanning early”.

On an average, at any given point in time I’ll be tracking at least three prospective investments very closely. At times, not to lose sight I buy some stock personally so that it figures prominently in my portfolio which I keep a close weekly watch on. As a scrupulous deal maker, I get out of the position immediately before I start peddling the deal to PE funds – to qualify for the full disclosure. My previous post here was one such.

This is significantly better than getting into the rat race for more deals without a care for end result, value unlocking potential - that is. Perhaps even better than hiring star leaders or marquee name rainmakers like an Anil Singhvi or a Mohit Bhatnagar who have an exemplary track record in their respective domains. Here’s why. This very domain expertise could prejudice their vision over the prospects of other businesses, giving rise to missed opportunities or having to build an anti portfolio, like the one Bessemer has. As a PE fund manager, the demand on the individual is of a different kind – a pulse for an early opportunity over a broader spectrum and by extension, scope for an earliest, IRR optimising exit.

Longevity of PE as a long time, credible asset class amongst accredited investors depends largely on building outstanding deal sourcing and investment processes. Especially in times like these when there are several sophisticated HNIs and Institutional investors dotting the field, looking for interesting avenues to apply their wealth, brand building thro track record of consistent performance metrics matters all the more.

.

Some of the interesting http://www.knowledge@wharton.upenn.edu/ articles on related topics be found here, here, here, and here.

.

What price relationship ?

Ever since I had turned a freelancer 15 months back, I’ve been approached by partners from several Investment Banks each with different intentions. Some wanted to hire me, others wanted business to be channeled their way. It did not surprise me since most of them had read my blogs and had found something common, interesting and worthy of mutual exploration. I had always been open so long as it excited me, be it a position on offer or a strategic partnership on fair terms.

But one thing common in all these tete-a-tete has been the question on *relationships*. They invariably ask “what relationships you have or can bring to us ?”. It made a lot of sense since in I-Banking industry, ready relationships meant not having to waste time on introductions or cold calling investors or PE / VC fund managers, when you have a worthy client. Eventually we rattle out our acquaintances and the conversation goes on.

Some of them act up. They come up with some nondescript client having some hollow business plan with little fundamental strength and ask whether we can get them some investors. Without sounding judgmental, I ask for more information, a web site to search in and anything like an executive summary or some information memorandum or at least a business plan, on the basis of which I can form my thoughts. Some will have that ready, others will say they’ll send it across (mostly don’t come back).

There’s a third group which is more adventurous. They say, “we are putting together that information, but we need your help here”. Probe a little deeper what *help* they need, it would be something like a company in a deep mess, founder having a history of siphoning off funds, out to leverage the buoyant sentiment in the stock market by merely changing the name of the company and its objects clause. Anything goes here, a financial services company could be renamed into a clean energy company or a textile mill resurrected as an Infotech venture. Surprisingly they quote examples of many that have gotten away and they’d be right since I knew of some myself.

The relationship they seek is for palming off such deals. I had often wondered - how can these people be so naïve that just because you have a prior relationship with a PE fund, they’ll be ready to invest in a doubtful venture ? Every PE fund does a scrupulous due diligence on each deal that comes before it that it wants to invest in. I am yet to come across a PE firm that would invest in a business just because it was brought along by a reputed investment bank. All of them have their own internal well laid investment processes and every deal will have to go thro that filter. When that being the case, relationships don’t get you investments – it’s the fundamental strength of a business and how well it resonates with the PE firm’s objectives, in the way it stacks up as a sound investment destination.

If I were to look for a potential candidate or partner, I would look for independent research capabilities, ability to draw insights, the instant relationship building ability and sound knowledge of the PE industry in India, which firm likes what industry, domain expertise, latest rounds of funds raised etc. Asking for ready made relationships can only be of use if you have a superb client needing no introduction. For the rest, you need people who can look straight in the eye of the managements and tell them to get their things organized before seeking investor participation.

Wouldn’t you agree ?

Leveraging NIFTY 50...

Just finished blogging a management buyout op, I am dreaming up something else. When you keep getting wild ideas, why wake up ?

.

Often when PE activity is very high in any market, the first signal that emerges is that the stocks are underpriced and valuations are attractive. Scratch beneath the surface we stumble upon factors like low cost of funds, low gearing of companies, higher scope for dividends, better yields etc.

Currently if you look at the downturn in Indian equity market, a confluence of all these factors can be seen across the spectrum.

Let me start out by saying that I don't think that stocks are necessarily overpriced at this level, but I don't think the private equity deals necessarily signal massive underpricing anymore. Compared to the past, there is much more money out there in the hands of these investors, and it's all money that they have to get invested or they don't get paid.

Even with stocks fairly valued, with high yield and leveraged loan markets pricing risk so low in recent years, PE firms can still pay a fair price and make killer returns. The point is really seeing if the returns are that great on a risk adjusted basis. Leon Cooperman , previously strategist of Omega Advisors Hedge Fund did his own study back in the 80s which showed if you levered the S&P500 to the same capital structure of typical LBOs, it would beat average PE fund returns. I also believe Prof Kaplan at U Chicago has done some research questioning how strong PE returns really are.

PE funds just take the "market" aspect out of the companies they buy, add some leverage and wait for the returns to be generated. I think the biggest reason it's so easy for PE funds to take these cos private is because investors are so myopic and will take a 20% premium rather than allow management/company to continue doing what they are doing and ultimately wait for the market to assess a higher valuation.

Back a decade or so, with a couple hundred million dollars, they could sit back and wait for a fat pitch that they could knock out of the park. Now, with billions to invest and many more competitors out there bidding up all the really nice deals, it's tough to wait for the same types of situations. So what I think a lot of the larger firms will end up doing is taking private firms with a target return lower than in the past. They will likely end up looking a lot more like mutual funds that can take much more concentrated positions, and benefit from being the controlling shareholder. Also similar to mutual funds, in order to put their money to work they'll have to be more consistent buyers through various market conditions.

Don't get me wrong, returns aren't going to look like public market returns, they'll still bring in returns that pass that, but by less than in the past. It just can't be expected that with all of the money out there and the increased competition that the buyers can be as discriminating as they once were on the deals they choose or the price they pay.

So as these big buyout deals continue, I'm keeping in mind that “take-privates” might not be as solid a market signal as they once were. May be, a few months down the line, we can think of lowly geared companies in the NIFTY 50 to lever up a bit and be eligible candidates in the take-private orbit. Will they ?

Presently in India as the market unwinds, a few smart PE funds are even exiting quietly. ICICI Venture Capital has sold a 3.25% stake in Deccan Aviation for about Rs.32 crore to UBS securities Asia, thro an open market deal for around Rs.94 a share, bringing down its stake in low cost carrier to about 10-11%. As early as 2005, ICICI Venture had acquired around 19% in a pre-IPO deal, valued at Rs.65-70 per share. The Deccan aviation scrip closed at Rs.88 on Tuesday, while the 52 week high was Rs.162. It appears the sale has translated into a 40-45% RoI over a two year period for ICICI Ventures. Considering the volatility in the market and accentuated bad times for aviation sector as a whole, by not waiting for the tide to turn in its favor to higher levels, ICICI Ventures did make a smart move indeed.

Watch this space, just watch ( no noise, or else I'll wake up) for more fun.

Shall we hatch this ?

What could be the next move for a PE firm in India ? It got me thinking…! Without having to storm my brain too much, it just occured to me. A buyout…there are quite a few candidates that come to my mind.

.

What would it look like if a PE firm takes Wockhardt Ltd. private, add significant strategic value, impute explosive growth and then take it back public to make a killing in the process for all stakeholders ?

With that, lets take a look at this company that could sustain an interest payment and debt load required to take it private. I think it is ripe for a buyout by a mid-sized PE firm, and therefore, ripe for the purchase by value oriented equity investors.

Wockhardt [ source : Annual Report 2005 ]

.

[ Full disclosure - Neither I nor my close relatives and to the best of my knowledge any of my business associates have any shareholding or other interest in this company as of now. ]

It's amazing how Wockhardt, the Indian pharma player has created an integrated global business model with state of art R&D, manufacturing facilities and differentiated marketing strategy during this most difficult year for Pharmaceutical industry which terribly underperformed every stock index. The company is banking on billions of US $ worth critical drugs especially in US and Europe coming off patent in the near future. During the year, its consolidated revenue grew 12.82% to $ 321 MM and PAT at $ 58.43 MM grew by 20.42%.

While writing this now, I have also read the company has acquired Pinewood, the largest generic Company in Ireland helping it achieve a wider wingspan in Europe spread over Germany, UK and Ireland which geography accounts for more than 40% of its revenue growth.

Wockhardt generated $ 39.61 MM in cash from operations in 2005 and is likely to improve that number this year. The company's equity market cap ( as of 03/27/06) is $ 928 MM, with a net cash balance (as of Dec.05) of about $147 MM.

About 73.73% of the stock is held by the founders and the rest of 26.27% is held between Foreign and domestic institutional investors (15.72% ) and public investors ( 10.55%). Currently the stock is quoting at $ 8.48 ( Rs.373.30) at a P/E of 19.8 times. Let’s assume a PE firm offers to buyout the company at a 30% premium to market price ( allowing for bidding frenzy) at $ 11.02 (Rs.485.29) at a P/E of 25.74 times on current earnings. The total acquisition bill would be about $ 1.2 billion.

At a 7% interest rate, the interest payments on $ 1.205 billion ( assuming total buyout ) would be $ 84.35 MM, that is just 57% of $147 MM, which is what the company has consistently generated over the last few years. Since Wockhardt has significant net current asset cushion in its Balance Sheet and only needs about $ 125 MM in maintenance capital expenditures, it's a perfect buyout candidate. With some cost cuts and knocked down expenses, the company could easily generate enough cash to continue operating smoothly.

In fact, it presents an ideal case for a leveraged management buyout with Mr.Habil Khorakiwala and his team in tact, retained for its enormous savvy and experience over the industry besides the international expertise available from its European acquisitions in the recent past. If we can infuse a significant load of external strategic muscle as would help fuel the global ambitions of the company, we've got a multibagger in as much as 3 -5 years as could be relisted anywhere in the world. If the PE firm has a good pharma portfolio in sync with Wockhardt credentials, ah...!

Asking for orders now. [ One of the biggest secrets to dating hot women is having the guts to ask them out in the first place. That’s right. You’ve got to be a man of action, because all of the plotting and planning and dreaming in the world is going to get you nowhere if you don't dare to ask her out :-) ].

.

Alright Mr.Private Equity, shall we call this a mandate ?

.

Latest trends in Indian PE

A recent report indicates that the share of private equity (PE) investments in listed companies in India, which accounted for as much as a third of all investments in 2005, fell to 22 per cent in 2006. Some of the companies from which PE funds have exited partially or fully in recent times include Punjab Tractors, Simplex Infrastructures, IVRCL and Gammon India. A similar trend of PE exits from publicly-listed companies in the US has also been seen, though the reasons may be different.

In India, this development comes at a time when private equity is gaining currency. With an estimated 100 private equity funds swarming around for deals, India is now one of the fastest- growing private equity markets in the region. And although the stock markets have scaled record highs (despite the current volatility), the preference by private equity for listed companies seems to be changing. How is this to be explained?

Some of the obvious reasons include –

a) Indian market has been one of the best performing markets. It’s time they book some profits now that it’s late in the day.

b) India growth story is continuing and a little churn in portfolio will give every PE that extra % comfort in terms of RoI and enable fresh round of investments.

c) Average deal size in India is still small barring a few. As such it doesn’t justify longer holdings aiming at large scale returns.

d) Natural Indian scepticism wouldn’t let owners dilute substantial stakes in favor of PE firms as they are not sure of the value PE firms bring to its businesses.

e) Looming threat of Government scrutiny over buyout deals – Few examples are of Vodafone acquisition of Hutch Essar, Punjab Tractors exit by PE firm Actis (formerly CDC ) and Burmans, acquired by Mahindra & Mahindra. In the US, it’s the rigor of SOX Act compliance which eases PE firms out of Public listed companies.

As such, now PE investors appear to be more comfortable with a fund of funds model – invest as LPs in other PE firms who are already in the fray. One of my earlier posts explaining the advantages of FOF model is here.

Isle of Man-based Evolvence India Holdings is planning to raise $65 million (Rs 290 crore) through placement of shares on London Stock Exchange. EIH, a private equity fund company which principally targets investments in the Indian subcontinent would place up to 65 million ordinary shares of one dollar per share, a statement to the London Stock Exchange said. The public listing of EIH on LSE's Alternative Investment Market (AIM) will give investors access to a diversified Indian private equity portfolio, while mitigating issues usually associated with private equity investments, such as a lack of liquidity and relatively large minimum investment size.

Evolvence has already invested in Indian PE funds such as IDFC PE, Barings India PE, etc.

US-based Investment bank Thomas Weisel International is planning a $200 million private equity fund of funds for India. The company is also keen on rolling out its asset management business in India, focusing only on institutional investors. The fund of funds, which is yet to close, has already made two investments worth $25 million in IDFC and ilabs.

Sounds cool ?

.

PE funds – way to go in India II

Just after I’d finished writing my previous post on the subject, there still was this lurk. Have I said it all ? I owe it to the PE fund managers in India to drive home my point - by contrasting it with the US scene, where PE funds had their origin, the mistakes they made and the way they matured. We may still have to tailor it a bit to suit our businesses, the ownership fetish to be addressed, high quality CEO material will have to be nurtured and newer methods of value creation to be learnt.

Let's visit it then and look at the situation there. This will help us avoid the pitfalls if we are intelligent enough to recognize.

To give you a glimpse of the PE canvas, of the record $1.56 trillion spent on mergers and acquisitions in the U.S. last year, PE buyouts accounted for 25% of the action, up from 10% in 2005. PE's firepower has never been greater. Last year firms in the U.S. raised a record $156 billion in new capital. It is believed that the global buyout industry currently has $400 billion available to be invested. With leverage, that $400 billion represents as much as $2 trillion in potential buying power. (To put this in perspective, U.S. mutual funds have more than $10 trillion in assets.)

Private Equity funds, like hedge funds, are classified as "alternative investments," the two are often lumped together. And they do share common ground. Investing in both is limited to those with deep pockets, who can presumably handle the greater risk. Both feature lavish fee structures - variations on the "2 and 20" formula, in which general partners take a 2% fee for simply managing the assets they control and a 20% slice out of any incremental profits they deliver. Both soared in the wake of the 2000-01 market meltdown, which persuaded well-heeled investors that riding the market indexes (Dow 36,000! Nasdaq 10,000!) wasn't automatically going to make them richer.

But here's where they differ. While hedge funds mostly have individuals as investors, PE firms get the bulk of their money from institutions (roughly half from pension funds, another big chunk from banks, insurers, endowments, and foundations, and only 7% or so from individuals). Though so-called activist investors running hedge funds at times noisily pressure public companies into making changes to boost stock prices - think Nelson Peltz or Carl Icahn - most rarely end up owning companies; nor do they want to.

So what does this mean for those of us who don't wear pinstripes or dine where the elephants bump? Are we moving into an era when we have both a public and a private economy in the same way we have a public and a private educational system? Do Blackstone and its peers really take broken companies, mend their wings, and set them free in the public markets? And how big can PE get, anyway?

Cheap debt is the rocket fuel for this, but it's not the only driver. In terms of governance, management focus and strategic decision-making, the PE model is usually superior to that of publicly held companies. Otherwise they’ll end up holding the hot potato. There are only two ways for a PE liquidity event. Flipping the portfolio company to another PE or to take it back Public. On both options, the invariable question they face is “what were you doing with it so far ?”.

They had better show value. Unlike the quick-hit artists at hedge funds, PE is a long-term investor who succeeds only when its companies succeed. That's typically followed by the it's-all-about-the-talent chorus. “Today anyone can raise equity and borrow money," says the Carlyle Group's co-founder David Rubenstein. "What's rare are two things: a deal everyone isn't clamoring to get into, and people who know how to operate the companies we buy. Given a choice between hiring an experienced investor for our firm and landing a guy who's run a leveraged buyout, I'd take the latter."

Amen, adds Michael Milken, whose nearly single-handed creation of the junk-bond market in the 1970s gave rise to the first great LBO wave of the 1980s. "The concepts and financial structures that we introduced back then - and that were rejected as too radical and poorly understood - are now in every introductory textbook," says Milken. "But success then and now mostly depends on finding great people. The difference is, where I only backed strong individuals who wanted to start or buy a business - Steve Wynn in gaming, Len Riggio in books, Craig McCaw in cellular, and Bill McGowan in telecom - the PE industry today has the scale to first buy up assets and then match them up with the right managers."

Another difference between Milken's era and today is that instead of merely bankrolling entrepreneurs, private-equity firms are co-opting CEOs. There are the elder statesmen - Lou Gerstner, Jack Welch, Larry Bossidy, Jim Kilts, John Browne, and many more - who have joined PE firms rather than retire to the golf-and-board-of-directors circuit.

They have learnt it the hard way in US. We have a better template now that needs to be customized to suit local businesses. We must do better since they’ve committed a lot of mistakes before us which we must avoid. We may commit new mistakes, learning newer lessons while on the run. That learning capability should differentiate us. Are our PE fund managers listening ?

If not, watch out for the train wreck ahead. What do you think ?

.

Private Equity - Way to Go in India

As the markets continue their dance of death, I snuck a wistful glance at the PE funds which up until now were cutting deals by the dozen. Almost all investments now have declined by over 50%, construction / brokerage stocks in particular.

The deals still continue, but on a very selective basis strictly playing by the rules.

I’ve been watching global markets over the last decade with particular interest to Indian equity and its investor psyche. I don't claim any phenomenal ascension of knowledge over a space as dynamic as equity markets, where emergence of a credible pattern ever is highly improbable. I believe in open systems, randomness of life events ( would gladly throw darts on bulletin board any day ) and that markets are no exception.

“Why bother, then ?” - you might ask. Well, when has absence of definition or randomness of events stopped a blogger ?

I base my theories neither on historical movements nor on future trends. I use none. I neither get turned on nor off by the J-curves or sinking slopes. I’d rather use a more predictable element – that of management psyche. Almost 85% of Indian businesses are owned and controlled by business families, handed down over generations. There are occasional family feuds that erupt, but the fallout has seldom been a sellout to professionals or to Private Equity. The division has been among families themselves, ably assisted by professionals though.

The psyche of the family management has more or less been consistent over fairly long periods of time. Most of them are conservative and traditionalists. Even the younger generations that inherited the business, despite their Harvard and MIT degrees acquiesced as they slowly settled down in their business. They used the modern technology and other tools in their business, but never tried hard enough to dismantle the ancestral philosophies that stood translated as corporate culture. Amongst others, it gave absolute dominance over the Board, having the last word in everything - well, who wants to upset such a setting !

When something ain’t broken, why fix it ?

The downside is that capable professional managers felt stifled, came in and went after short stints. The ones who stuck around, willingly putting up with the drudgery, became deadwood, felt unwanted here and anywhere else. With no strategic inputs from the resigned-to-their-fate executives who ran the business, the owner often had to rely on external consultants for ideas, who served up ad hoc quick-fixes the owner `liked' than what the business `needed'. Besides being easy, it streamed them steady revenues. Did you say corporate governance ? You must be nuts !

So that’s it. Absence of strategic direction puts them at a clear disadvantage. I had done a little analysis and had quite a few insights. I found most of the family businesses characterized by –

a) low operational and working capital leverage that became a drag on their performance. Can be easily restructured and put on a high growth path.

b) fully depreciated equipments and other operational assets indicating the need for modernization of equipments. Besides affecting productivity, it is limiting the scope for tax savings offered by higher depreciation.

c) The adverse effect of owner and CEO being one. Decisions lacked the boldness expected of a non-owner CEO upon being influenced by the risk-averse nature of the owner.

d) Little or no focus on sales promotion, brand building or market expansion. While shipment volumes are higher, realization and margin pressures are glaring.

e) A claustrophobic mindset which does not allow for exploration of opportunities for inorganic growth thro strategic alliances / M&A with others having state of art technology and market access.

f) Adoption of sub-optimal capital budgeting techniques leading to accumulation of more debt for both short and long term resource requirements. Results : skewed debt equity ratio leading to bad credit rating and higher interest outgo. Dilution of equity being a strict No No even for capex.

This is not all. I have built my deal scouting and origination strategy around those deficiencies as I am thinking of associating myself with a PE fund shortly.

PE funds normally wait for I-Bankers to bring deals to them. I-Bankers depend on their *connections* to get deals. I’ve never seen a banker undertake proprietory research, identify a needy client, make that cold call to present a winning strategy which could culminate in a deal. Instead, I see them persistently knocking the doors of corporates which never needed them since already they were doing well. Recently in an interview, Subhash Menon, Owner/CEO of Subex Azure ( NSE-SUBEX-Quote ) was saying how I-Bankers never entertained him when he needed them most during his initial days and now when he built everything up himself, they are all over the place with deals and more deals.

In India, because of this situation of predominance of family business, PE funds should hire shrewd ones that think its cool to do proprietory research and having the capacity to identify those who need them badly. It’s time they stop hiring wet-behind-the-ear greenhorns with *connections*. It’s cool to say “I know Mr.X, CEO of XYZ Inc personally” having sucked up to him at some party where (s)he gate-crashed, rather than admitting her friendship with a startup founder who needed support.

.

It could be that Mr.X doesn’t need support because his personal portfolio resembles that of a leading mutual fund, or worse, he could be a limited partner in a PE fund himself !

.