After five awful years, things are finally looking better for the private equity industry in India. But Amit Chandra of Bain Capital says the PE investment cycle will take atleast another year to kickstart in full earnest. It will ofcourse depend on economic turnaround and whether the buoyancy in the Indian equity markets can continue.
He believes despite the indices hitting new all-time highs every other day, retail participation in the market has been low. However, he adds that these all-time highs cannot be linked to valuations.
Chandra says the Indian corporate sector is coming out of the sluggish earnings cycle that it has been plagued with for some time now. He is a big fan of investing in mutual funds.
Below is the verbatim transcript of Amit Chandra's interview with CNBC-TV18's Menaka Doshi.
Q: Would you say we are in 2014 at a turning point for the private equity industry given the five awful years that we have had in the past that a new investment cycle is may be beginning to kick off?A: Yes I think so. I think private equity if you look back today in India, is really a tale of two cities. Pre 2007 it had a great run and I think people expected a lot more out of it then potentially existed from a potential perspective. Post 2008 has been fairly difficult period for the industry and I think things look particularly weak in the last three-four years. But I think it wasn’t as good as it seemed pre 2007 and it certainly wasn’t as bad as it felt like post 2008. Q: I am surprised you say it hasn’t been as bad as we thought it seemed like on the face of it because I was reading a report out by Bain Consulting and they said that the impression with limited partners is that it is tougher to raise India specific funds. Now I know Bain doesn’t necessarily operate that way but it has gotten very tough to raise India specific funds and that if viable exits do not happen in the next couple of years, you could expect to see a shakeout within the private equity industry as tenures of funds come to expire. It does look as if exits have not been an opportunity available over the last few years and money that was invested 10-12 years ago is struggling to get out. A: You are absolutely right. I think exits have been probably one of the weakest parts of the industry as has been the entire impact of fx on portfolio valuations. I think those two have been two very big macro challenges that the industry has faced. But I think to some extent the shakeout that you are talking about has already played itself out. If you look at India specific fund raising in the last couple of years, it has really come down to a trickle. There have been very few India specific funds which have got raised. But I think that is little bit of an issue which has got to do with model than simply country. I think in general people realise that private equity functions in a volatile macro economic environment and actually being hostage to a particular country lands up being very limiting. You are forced to invest even when you do not want to invest and you cannot go overly aggressive when you want to. Therefore the industry more broadly is reallocating itself towards regional and global funds. So that is a little bit of an industry phenomena. But your point is absolutely right, LPs do feel that India specific fund is a challenge and I think that is manifested in how many India specific funds have been raised in last couple of years. Q: So we are seeing the equity markets pickup, infact we have had some record levels in the last 8-10 months thanks to the Modi wave so to speak. Do you think that is going to pave the way for more exits because some of the data I was looking at for instance last year we saw exits to the tune of USD 6.8 billion, that was a flat number versus 2012 and the impression is that a bulk of them are buybacks. So it is actually the promoter of the company buying back that equity which defeats almost virtually the core purpose of bringing private equity into a company really. So do you see the number of exits rising exponentially over the next two years? Are we at a place in the equity markets where confidence has come back?A: I don’t see it rising exponentially but I see it rising materially. I think the revival of the equity markets does provide an opportunity for a lot of deals which essentially - lets step back and look at the last three years. We have had years in which there have been virtually no IPO activities. Secondary market activity also really came down to a trickle and therefore if you look at the average position it has got stretched well beyond what people anticipated. I think the recovery in the macro and therefore the recovery in the stock market will provide an opportunity for a lot of that backlog to get cleared. But I think it is important to recognise that there is a chunk of that backlog that may never get cleared because fundamentally investments got made in some cases in companies which are never going to come to the IPO market in the next five-seven years. Those stories have just not played out. That is particularly true in the small and medium size enterprise segment. Part of the reason LPs are upset with India is because in their own portfolios when they look at the value of Indian investments, lots of cases there have been impairment over the last three-five years. So it is not just an issue of liquidity, it is also an issue of carrying cost and that carrying cost has got impaired because of everything that has happened in India in the last five years. Q: But some of the data seems contrary to what we are discussing for instance about 150 funds from 2012 engaged in deals last year, 160 funds that did not make any investments in 2012 engaged in deals last year. So there are some funds that have started coming back to the market last year and now probably prompted by what has gone on in the elections in the last quarter or so. So on one hand you have all these dire forecasts which say LPs have run out of time and patience and then on the other hand you have this resurgence of private equity and then you have Amit Chandra saying we have way too many private equity players in India to begin with. What is 2015 going to bring?A: For important than 2015 is what 2016, 2017 and 2018 are going to bring. I think in terms of real deal activity, private equity essentially bets on the investment cycle and the investment cycle got broken in the last two-three years. For private equity to really go up in India, you need to see the investment cycle resume. We are just seeing early signs of resumption of the investment cycle. My suspicion is it will gather most steam in the next 12 months or so and once people have confidence they will come back with new projects and that is when you will see the next wave of opportunities becoming available. So I think 2016-2017 if the momentum persists is when you will begin to see activity which was comparable to what we have seen in the past. I think 2014 will be a better year than 2013 but marginally so. I think 2015 will probably get a little bit better because remember private equity essentially invests in two kinds of opportunities, fresh capacity creation or buying an existing asset from its old owners. If you look at what is happening right now, broadly about 50 percent of the deals are essentially where an owner who has been there very long and wants to exit, is essentially selling the asset and another private equity person is stepping in their place. That activity logically has to follow what has happened in prior years with investment activity. So that cannot run away and become extraordinarily large. The investment cycle has to resume for the rest of it to really pick up. And may be we will start seeing signs of that in 2015 but the real benefit of this will come in 2016 and 2017 when industries begin to get capacity constraint and need to raise fresh capital.
_PAGEBREAK_Q: I want your view on the stock markets not only because you were a keen follower of the stock markets till about 7-8 years ago but also because the buoyancy in the stock market is essential to any kind of private equity exit and therefore reinvesting of funds. Where do you think we are in the Indian equity markets at this time, overvalued, undervalued or at good value?A: It is fascinating because the extent of fundamental based knowledge even among relatively educated people about how stock markets work I find is shocking at times. Q: Shockingly low? A: People carry biases which are just extraordinary. You just got to ask 10 people you know about how their financial asset portfolio is comprised to get really a sense of how people work. It amazes me because you go back and you look at India over the last 25 years and you look at any five year rolling cycle, the best thing you could do in an economy with all the volatility that India has had is put your money into safe instruments in the stock market. By safe instruments I mean I am a big fan of mutual funds, and that is how I invest as well. However, that has outperformed everything else and yet people like to invest in gold and they like to buy real estate. This is important because participation in the stock market by Indians is running at historic lows.When I came back to this country in the early 1990s, at that point of time people used to talk about how equity participation as an asset class by Indians in Indian companies was low, but actually could double or triple, that number has actually gone exactly the other way round. It is less than a third of what it used to be in the 90s. So, while this great India growth story is panning itself out, we as Indians directly or indirectly via insurance, pension funds etc have actually not participated in this growth.Q: Are we overvalued, undervalued? Have we moved up too fast? A: Every headline is screaming that we are at all time highs. Should all time highs be linked to a particular index number or on a valuation number. Logically, when you step back it has got to be valuation. This is a market where historically you have seen when it gets overheated trades at 24-25, but the 10-15 year average for India forward earnings generally is about 15-16. Q: I am going to draw a conclusion from both your comments, a) we are under invested as Indians and b) we haven’t reached peak valuations. So, you expect that there is much more to go when it comes to equity values.A: Third point as well, which is India is probably close to its long term trading average on multiple and that should in normal circumstances address the issue whether the markets are overheated or not. However, I think there is another broader point which is where are we on the cycle? We are coming off a 3-4 year terrible period for corporate India. The earnings cycle has been badly decimated. Companies have had what you call profitless growth by and large because inflation was high, there was margin pressure. So, growth was anaemic, inflation was high, margin pressure was high, therefore RoEs got into trouble with balance sheets getting more heavy. So, if you step back and think about if you believe we are going to have a good cycle then logically what should happen is you should have better topline growth, you should see margin recovery, you should see as the unclogging of corporate India happens on various projects you should see better balance sheet utilisation and all of that to me means better earnings growth than what you have had in the past and better RoE. Therefore that is very typical of a cyclical recovery. Therefore, if we were sitting on the peak of a macro economic cycle and you would have told me that markets are trading at long terms averages, I would have said we got to be careful. However, we are sitting at the cusp of an economic recovery and markets are trading at long-term averages, that to me is the data that should drive the discussion on is India hitting all time highs or not.Q: I want to now talk about Bain. If you think that the recovery or the signs of the cycle picking up are going to manifest itself in the private equity industry in terms of investments in 2016-2017, are we going to see the pace of investments at Bain pick up because in the last seven years, you have done only five investments and that by all measures is a very slow pace.A: Yes, I agree with you.Q: Why is that? Are you overcautious?A: Maybe we are overcautious. But the macroeconomic environment worried us. I think that is another issue that impacts us and probably impacts a couple of our peers as well particularly the large investors which is we focus on a segment of the market where we are looking at large deals and if you go back and look at it, there haven't been many large deals. For us, it has been particularly severe because we do not invest in real estate or infrastructure. Some of the larger opportunities were in real estate and infrastructure in the last three-four years.Q: Though in hindsight now you should probably be grateful that globally Bain does not invested in these sectors?A: That helped us enormously.Q: But the only reason you don't invest is because globally Bain does not and there is no other reasons specific to India?A: We do not understand regulated industries and how to factor in that and also there is another point which is a lot of these investments essentially target a return profile which is very different from what the charter of Bain's funds are and so Bain doesn't basically do that but that has in restrospect helped Bain enormously. But I would say, would we be more bullish on India at this point of time, do I feel more confident that we will make more investments here, I think so.Q: I want to go through some of your investments not to get you specific comments on those investments but just to talk about how difficult it has been. So you invested in Himadri at that time in the market capitalisation was about USD 350 million, currently it is around USD 130- million, so it was half, Hero has done well for you, you have done a partial exit, that stock has done well but that stock is a stock that is in the top five list of every mutual fund, portfolio investor in this country, so you don't get too many brownie points for doing well with Hero, Genpact you bought at about USD 15 per share, the price has moved up to roughly USD 17-18 per share, so you are making a bit of a profit there. Emcure is unlisted, so I don't know what is going on with the valuations and the fifth investment that you did; Lilliput has gone sour for you for entirely different reasons. You have been very slow and yet, you might have avoided some spaces but this is not necessarily the best private equity portfolio you could have built?A: No, it is not. We would have loved to make more investments, in retrospect we are glad we did not. We were sceptical about both the macro environment and also the quality of deals that were coming through because India did go through a spot where quality of deals began to suffer and lots of private equity players have burnt their hands with more companies than they should have. All of this obviously has coloured our thinking. I don’t think it has permanently damaged our thinking but I do think for us to be more prolific we do need to see more macro stability which is coming back but we look at the portfolio and the portfolio has done good, not great.Q: Good, mostly because of Hero?A: Hero and Genpact have both done well.Q: Three out of five investments are in listed companies. One of them is the most evident investments that any investor in this country can make in the country’s top two wheeler manufacturer. I am just curious, what sets apart private equity from any other portfolio investor or a mutual fund if at the end of the day you are also going to invest in amongst the top 100 or 500 listed companies?A: The problem really is that there is a structural issue in India which forces private equity to look more aggressively at listed companies than it does in other markets. The barriers to listing in other markets, China is a great example, is pretty high. As a consequence of which there is a much larger pool of unlisted investments available for people to go out and make investments; point number one. If you look at developed markets the thesis there is to actually do the reverse which is take a company private and then work with to improve its performance and potential and then come back and relist it.Q: I am not even talking about buyouts because they don’t exist in India.A: Well, you have started seeing a trend of more buyouts but it is still nascent. But in India both those opportunities unfortunately don’t exist. Our regulations in fact, in my view, unnecessarily so, push companies to go down the listing route very early on. Often these companies are not at all ready to perform as listed companies.Q: So that reduces the pool of unlisted companies?A: That reduces the pool for unlisted companies that private equity can invest in but the next thing that it lands up causing is, the market i.e. listed market and a great example was the point we were talking about on IPOs. It opens and closes for sometimes long periods of time and what private equity can do as it did if you go back and look at what happened in the last five years is be around as a stable source of capital when the capital market is not willing to do deals. Also do deals which the capital market cannot do at points of time. So for example it would have been very difficult for the stock market to partner with the Munjal family to go and buyout Honda. It would have been very difficult for General Atlantic and Oak Hill and bunch of other investors to sell large position they had in Genpact into the stock market and if those options existed obviously people would choose to go one way.Q: What do you make of Flipkart’s USD 1 billion valuation? Have they over capitalised themselves?A: You will get a better answer from someone who has hair than someone who doesn’t have hair, I meant it.Q: Looking at it from a conventional private equity ways, have they over capitalised themselves?A: This is why lots of the conventional P/E guys have not necessarily focused on these spaces and it has really been some of the newer funds or some of the e-commerce specific funds, some of the hedge funds who have actually gone into this space the traditional metrics that you use to value your company unfortunately don’t work.Q: But we have been there before. You have been there in the capital market cycle in 1999 in India.A: Absolutely right and I could not understand it.Q: But you sold many of those companies to investors.A: Well, we sold one; not the best one to sell but. So my view is that I have no doubt that e-commerce is going to be transformational in India. In fact the case for e-commerce in India is even stronger than the case for e-commerce in the west, the reason being that we are a developing economy with real estate costs of a developed economy because of terrible regulations in real estate. Real estate is a big part of retail and completely distorts therefore the whole return profile for retail. Therefore I feel there is a strong case specially as everyone is getting a cell phone and is beginning to get more and more comfortable with it. My view is that that theme will really play out.Q: At USD 1 billion would you have invested?A: I would not have.Q: Now if I told you there were shares of Flipkart available would you invest.A: I would not, I would also not have invested in Infosys at the peak. My point is that we saw this, Infosys is a great company which paid out awesomely but it took a long time for the shares to get back to a level that they had got to when things were really crazy and my point is that it does seem like there is a little bit of a rising tide in that space at this point of time and valuation seem to be getting heady and in some cases you can’t understand those valuations based on any financial metric. So, we and me personally struggled with that enormously.Q: So are you going to be an e-commerce investor in India?A: We are looking at e-commerce opportunities. Again for us unfortunately because we invest at a particular scale those tend to be larger plays and so there are fewer opportunities available but we are trying to get educated. I have no degree of conviction in telling you that we would have invested in day one.Q: But you are looking at the space with interest?A: Yes, the space is very interesting.
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