MC Interview | ChrysCapital's Kunal Shroff sees bigger trend of larger stake sales and control deals

Kunal Shroff, managing director and partner at ChrysCapital

What is the 'precious' link between Greek, science and Indian private equity?

It's ChrysCapital! Stumped? Don't be!

The country's oldest and largest home-grown private equity firm derives its name from the word 'Chrysalis'. That's the Greek word for gold and it also refers to the middle stage of a butterfly's metamorphosis between the larva ( caterpillar) and the adult stage (butterfly).

That's enough of a trivia. Let's get back to business now!

Moneycontrol's Ashwin Mohan caught up with Kunal Shroff, the Managing Partner of ChrysCapital for a rare and exclusive interview on the firm's India investment strategy, top sectoral bets, and trends in key markets and deals.

Shroff says India has become more attractive for overseas investors with many entrepreneurs across sectors gearing up to sell larger stakes and cede control in their firms. Reacting to the spate of block deals in the markets, Shroff believes the viability of block trades has increased, and the route provides flexibility for exit strategies. He also weighs in on the funding winter in the Indian startup ecosystem and expects more portfolio companies to make debuts in the next two years.

Excerpts from the interview:

I'm glad this interview with you comes after a rather active 2023 for ChrysCapital. Look at the range of deals that you have struck so far. The big one was the $1.3-billion buyout of HDFC Credila where you teamed up with BPEA EQT. You pumped in $100 million in top eyewear brand Lenskart. You also had a bumper IPO in Mankind Pharma and you recently picked up around 10 percent in listed engineering firm GMM Pfaudler through a block deal. Plus, the buyout of IT firm Xoriant. Looking back, how would you say the year was, so far, for ChrysCapital? Any key lessons or challenges that you would like to highlight?

We have been investing in India now for 25 years so it's hard to just look at one year in isolation. But if you take a step back, clearly 2023 has been a very active year for us to invest and I think there are not as many lessons as observations.

India has clearly completed the exit from the Covid blues and emerged as a strong country. Macro resilience has been robust. Debt-to-GDP ratio has returned to the level seen before the global financial crisis, whereas it would have doubled at least outside India, with little to show for that debt. And so, the macro stability, along with corporate stability, will continue to drive the country forward for the next decade or so.

We saw a couple of things in 2023. One is that India is more attractive to most investors. We see the private equity market grow pretty substantially as companies need capital for growth, or even in certain cases, succession issues drive entrepreneurs to say, 'Hey, I need to professionalise. Maybe I bring in private equity as a change agent, maybe I sell out completely.' So, 20 years ago, what used to be a very difficult discussion for entrepreneurs to part with their equity, is not the case anymore.

On the investing side, the domestic investor has started getting used to investing in equity. You can see that in the SIPs, but also in alternatives. So, increasingly, you see family offices investing in venture funds and private equity funds. On the global side, I think the global funds are actively looking at India, partly because some of the other emerging markets may not be as attractive and they have raised money for Asia. India may have been a smaller percent earlier, now it becomes a larger percent.

So, there's a lot more focus on India, which does drive up valuation, and you have to contend with that. At the end, LP base, the ultimate institutional capital, people have actually taken the lesson that it's better to be in their home country rather than in emerging markets, because whether it's China or whether what happened in Russia-Ukraine, there have been enough instances to kind of show them that they may be better off back in the US.  A lot of Asia-based LPs are probably warming up for India foray sooner. And, my guess is next year, you will see the western LPs also start looking seriously at India PE.

On that optimistic note, what are some of the key deal trends that you foresee from the Indian private equity universe? What are the factors that will drive the PE deals going ahead? The last few years have seen a whole host of big cheques being signed by private equity and strategics had taken a backseat of sorts. Of late, you can say that perhaps strategics are making a bit of a comeback with deals like Godrej-Raymond, Dabur-Badshah Masala and Sheela-Kurlon.

First of all, finance is very cyclical. Private equity is a cyclical industry as well. If you look at the last five years, Indian private equity and venture capital deals would have totalled about $40-45 billion annually. That's a big number. If you look back 20 years, it would have been closer to $10 billion. But at the same time, we have a lot of other structural forces that we think can propel it further. One is India's high GDP growth rate which needs capital as fuel. So it's going to attract more capital. Two, if you just think about the stake sales that are happening, people who were willing to sell 5-10 percent stake, are willing to sell larger stakes. The private equity penetration is expected to go up meaningfully as well. So you've got an extra kicker on top of that.

If you just look at PE to GDP, just the penetration, it's just a rudimentary metric, but India used to be (if you look at the last decade) less than 1 percent of GDP, the PE investment over GDP. And today, it's just about crossed 1 percent. In the US, it's 3 percent. So, you have a lot of potential for that 45 billion annual number to grow multifold over the next decade. We believe that is happening.

We are also seeing a bigger trend towards larger stake ( sales) and control deals. And that expands not just the need for capital, but it also expands the need for value-added capital. You're going to play a much larger role in the company, you're going to play a role helping the company get to a certain point. In many situations, entrepreneurs also realise they have taken the company up to a certain level and are open to bring on a value-added partner who can help them grow to the next level.  And I think that makes it very interesting for someone like us, because then you're valued not just for the capital you bring, but the knowhow, the value-add that you can bring to the table.

Let's shift focus to the Indian capital markets, specifically block deals. Block deals are clearly the flavour of the season. August saw a flurry of these trades by private equity funds and promoters. Last year, KKR exited Max Healthcare through a block deal, marking its biggest exit in India. It opened the floodgates of sorts. In recent times, BPEA EQT sold a big chunk in Coforge, its entire stake of around 26 percent for Rs 7,683 crore. Is this a trend that's emerging where you have PE funds with a significantly large stake in a listed firm not opting for the classical M&A auction exit route and going in for a couple of blocks, which are seen to be faster and easier?

Block deals have increased quite a bit. We did our first block deal probably 20 years ago, when we exited our stakes in some of our pipes, as well as companies after they went public, but those weren't controlling stakes. We weren't owners of those companies doing block deals. Today, some of the examples you've given me are of buyout firms who control the company, have taken the company public and have sold out, which shows you how deep the markets have become.

The one difference between our pipes and the exits and blocks that we did 20 years ago versus now is in those days you had to effectively look at foreign investors. You would appoint a banker. The banker would go and see who's interested among the global mutual funds and public market investors and build a book. Today, if you look at the same block deals that you talked about, you'll see a reasonably strong percent going to domestic as well. And so the viability of a block deal has increased quite a bit. So from our perspective, it is an interesting exit avenue for us to consider. You don't need to worry that, "Hey, how will I find liquidity five years later if I'm buying out a company?"

Is this a route that ChrysCapital would look to adopt more often while picking up stakes or when you dilute or increase your stake in your listed portfolio companies? Some of them include Eris Lifesciences and Mankind Pharma.

I will say that that whenever we make any investment, and you mentioned GMM Pfaudler earlier, which is actually a block deal where we were buyers, not sellers, it's always "let's understand the business, let's understand the management team and entrepreneur, and let's see if this fits with our investment objective. "

And, when we make an investment, we will create a base case, as well as alternate cases for how is it going to pan out in our assumption, how do we think we will get our exit, are we taking this company public, are we selling to a strategic, are we selling to a third party? And so, you evaluate those along the journey.

At this point, we don't have any firm ideas – you have to either follow a block deal, or not. But at the right point, we will always evaluate it. When I look at the 75-odd exits we've had, it'll be a full mix of block deals, strategic sales, private equity to private equity sales, and everything in the middle. What excites us is that this avenue is actually becoming a viable and a sizeable opportunity for us. You don't need to worry that if I've invested let's say, 100 million, 200 million in a company, and I've made a 3x, is that too big a nugget to be digested in the public markets? We don't think so.

What are some of the listed sectors that ChrysCapital is bullish on in terms of fresh investments? Right now, your portfolio is dominated by pharma and the sole engineering firm.

I would say that, again, we look at it as a sector and the same sector team looks at public as well as private opportunities. Honestly, we feel that the opportunities are a lot more on the private side than the public side, and that's been the case for the last 5, 7 years for us. Historically, you'd have seen us do a lot more on the public side. Why has that come down? For us, it's come down for a couple of reasons. One is obviously markets have run very high. Two is, as our fund sizes have gone up, it's been harder for us to find chunkier stakes for us to acquire, and most importantly, it's the value-add part that I spoke about at the beginning. Now increasingly, we're able to add meaningful value to the company, accelerating growth, improving margins, doing a variety of interventions alongside the company, and that becomes a lot easier in the private construct than the public construct.

Liquidity in the markets is still not as high as it is when we want to look at the private universe. When we look at our deal pipeline today and over the last few years, a vast majority of it has been in the private universe. On the public side, we feel the opportunity is there if you're long term and patient. People may argue that markets are always hitting highs and valuation seems stretched relative to other countries, but India is a high return on capital industry.

Any specific sectors that have caught your fancy on the public side?

We like IT services, for example. While it may be a little contrarian when people are worried about recession and what's happening with AI and other areas, if you take a longer-term view, technology investing is only going up, and a country like India, which helps in technology transformation is going to do well. Today, you're seeing a lot of firms setting up global capability centers in India. They're recognizing the value India can add. Now that may not get captured in the stock market, because these are captive centers, but it just shows the strength India has at the global level.

Even private equity firms are investing in technology. For example, Blackstone is investing a lot in AI.

Of course, absolutely.

Since you spoke about the private universe, let's talk about the startup space. This year has not been great so far as unicorns are concerned. Zepto, which raised $200 million at a valuation of around $1.4 billion, became the first unicorn in the last eight months. Compare this to an era when we were having unicorns, probably every other week. Unicorns had become the norm. So, a lot has changed. Many say the froth has settled. You have exposure to the startup space as well. FirstCry, Xpressbees to name a few. What's your take on this prolonged funding winter and how long do you think it will last? And what do you think are the key factors driving valuations in this segment?

Look globally, valuations have come down. I believe in 2021 and 2020, a lot of capital got raised, which gave companies enough runway. So when valuations corrected in 2022, if you didn't really need to raise money, you'd say why not wait for better times? And I think that's what you're still going through. My guess is next year, as companies realise, they may need to embark on a capital raise, they may have to decide, do they raise less capital because it's more dilutive? Do they lower the valuation? How do they handle it? But that hasn't really played out yet because most companies have been flexible about reducing the cash burn, preserving capital, and having raised a lot of money in the past, their moment of reckoning hasn't come. So this may take a little while longer to play out.

Our approach has been a little different. Our approach has been not to really spray and pray and invest in a whole bunch of companies. Each company for us is important. We want to spend time post investment with these companies as well. They may be unicorns, but if we can add value in some way, helping it go public, helping in governance, helping at the board level, helping in M&A, we'd love to do that. So for us, we won't make as many bets in this space. But because of that, we need to be careful about what type of company are we backing.

How much of a leadership position do they already have? Do they really need the next round of funding or are they already profitable, and it's more for expansion? These are the metrics we look at. And we are typically investing in businesses as opposed to business plans. We're not taking binary risks when we're investing in companies. So, our universe is narrow, but events like the funding winter don't bother us as much, because we're playing the long game with what we feel are established leaders in segments where competition is rational.

Lets talk about the bustling IPO market. Pre-Mankind Pharma, there was a lull of sorts in this space and ever since, of course, we've seen a lot of successful public issues, a lot of bumper public market debuts. The investors are sitting on solid returns. Utkarsh Small Finance Bank, Cyient DLM, ideaForge have done well since listing. You have a few firms in your portfolio, namely NSE, Hero Fincorp, Awfis Space and FirstCry. Can we expect ChrysCapital to hit the markets with an IPO of any of its portfolio companies, in the next 6 to 12 months?

I won't be able to comment on individual companies, but we really do believe…

You can tell me yes or no, without being specific.

... We do believe that it's a window that is accessible now. You mentioned Mankind, right? What is the lesson from the Mankind issue? First of all, you have to understand the IPO markets are fickle. The window can open and shut, and you have to decide whether you want to tap it, because once you go public, you have to live like a public company. So we often tell our companies, IPO is just one event in your long journey. And what you need to do is to make sure you have a governance setup, board setup, compliance set up. You know, a lot of things that you may not need to do on the private side, you will be in the public lair. So companies need to spend time before they go public with putting all of that in place. Now we took Mankind public in May, you're absolutely right. At that time, that was probably not a great time to go public.

It was considered an acid test by many bankers.

Absolutely. And the reason we proceeded with it, the reasons even the bankers were confident is the business was really strong, and their point was, 'Look, this is a good company.' A good company should be able to have multiple avenues to explore, and that's exactly what Mankind has proven. Now the stock is up over 60 percent since the price of the IPO, right, which is a great IPO. It's excellent and like you said it has emboldened many more companies to tap the market.

So one or two listings from ChrysCapital before elections?

It's very hard to say that. For us, our job is to just help our companies, whichever company feels they want to be public, to help them prepare for it. But I would imagine in the next two years, you should see more companies from the ChrysCapital portfolio go public.

Pharma is one of the pet sectors of ChrysCapital. Since the firm's inception, ChrysCapital has made several exits in pharma, be it Curatio, IPCA, Torrent, Zydus or GVK Biosciences. Of course, we are all aware about the blockbuster exit of ChrysCapital from Mankind Pharma and the fairytale entry later which is part of the deal-making folklore. Currently, if you look at it, the Indian pharma industry is abuzz with a huge deal, and that is the proposed mega Cipla stake sale process. There seems to be a lot of competition, strategic names are being taken. Do you think we'll see more such mid to big sized pharma firms with promoters exploring the exit route going ahead?

Yeah. I do think so actually, and it's not just about pharma, it's just the overall trend we spoke about, where there's a generation shift. The next generation may want to do other things. This was never the case 20 years ago. You'd never think about entrepreneurs saying the next generation won't take it forward. But not just in pharma, we've seen it play out in other areas as well.

The question is that is somebody able to do the bigger exits? Because the smaller exits can always happen. And even to your earlier point on M&A strategics versus financial, the example you just quoted is actually talking about financials plus strategics, combining to do something. So maybe that is how you bridge the gap. But I would imagine that more entrepreneurs across sectors will be exploring strategic options, and I'm saying that because I see that in our deal pipeline, where almost 50% or more of our deal pipeline is of a controlled variety, where entrepreneurs are looking to cash out meaningfully.

All right. Specifically with pharma, do you think it's just merely a succession planning that perhaps is a single common factor across several companies, which may look at a scenario where the promoter may look at exiting? Or are there other reasons behind these mid to big pharma firms saying, 'Okay, it's time to cash out?'

I think each case would be different but we're still bullish about growth. Some 15 years ago, the pharma industry was growing at 14-15 percent a year. Today, it is growing at roughly 10 percent. So, as that number comes down, you need to bank on many other things if you want to grow your value in the 20-plus-percent range. We've seen that play out with Mankind as well, where growth has come down, but they've managed to really improve their margins, and so value growth has been tremendous for a company like Mankind. Sometimes I think slowing growth can be a lever, apart from succession issues that a company realises that, 'Hey, I'm better off diversifying.' Sometimes it also has to do with a broad family base that owns the business, but only one or two from the family can really run the business. And so it may make sense to create a trust and create a clear differentiation between ownership and leadership.

Why is it that ChrysCapital has not aggressively participated in many of the hospitals/healthcare auctions in recent times? Many assets have been on the block — CARE, KIMS, AMRI. Is it because there's a certain cap beyond which Chrys and its LPs are not looking to sort of sign a check?  You have KIMS. I'm just wondering, why not add to the hospital portfolio ?

I don't think those are the reasons. Our earlier view, which is also true today, is the return on capital in pharma is stronger than in healthcare delivery, but I think we have learned over the last few years is there can be a lot of money made in both sides. Pharma has worked out so well for us and we've been focused on doing that. We've realised it. KIMS is an example of that, but we've realised that India is under-penetrated massively on the healthcare delivery side as well, and there are very few assets of scale. So if you can build something or invest in something and grow something to a size, you will be valued. It is a segment that's valued reasonably highly in the public markets, and so we are quite bullish on the healthcare side of the business as well. You will hopefully over the years see us invest more dollars there.

What about the platform approach? Some of your PE peers have adopted this platform approach. Some of them have said, 'Okay, here's what we're going to do, we're going to club all our API assets on this platform.' Is that an approach that you would perhaps look to adopt?

I think that will depend on the depth in the market. The platform approach works beautifully in more established, more evolved markets. We used that in IT, for example, where we'll buy one company and then do a lot of tuck in acquisitions on top. It has worked out brilliantly for us. We would do that in pharma if there were opportunities. I just think you'll need a deeper base of potential acquisition candidates, but it has merit. The one thing to consider there is we're generally investing from a 5- to 7-year horizon. So the starting platform can't be too small because, otherwise, gestation time will be too long.

Your quick take on financial services and IT. You've had a long list of exits in both these sectors. Any deal trends that you think will pan out in the coming months in these two segments?

I missed talking about financials earlier, when you mentioned where do I see the opportunity. We actually see tremendous opportunity in financials and…

Mutual funds, small finance banks?

... Before we even go there, you know, when Covid hit, there was a lot of concern around how's India going to handle it? Financials are a derivative play on GDP. And so it was time to be cautious. But if you look at how India has come out of that over the last few years, we have actually turned quite positive on the potential for financial services. It's a play on overall economic growth, it's a play on under-penetration. I mean, you mentioned the HDFC Credila investment, that's a classic example of that. We feel that India has a long runway, given that NPAs are low, penetration is low, and the growth potential is high to invest in this space.

Now if you want to talk about the public markets, we feel there are enough opportunities on the lending side in the public markets, banks, where valuations are attractive. It used to be high, it has come off. We think overall, from a private equity lens, financial services offers tremendous compounding. So you mentioned mutual funds, we have an investment in Bandhan Mutual Funds. It's a great play on wealth creation, equity appetite for investor's going up, and you will have more inflows as a result of that, along with what the market growth offers. So we think those are plays where you're not playing a leveraged play on the economy, but you're taking a massive tailwind from what will come in the next 10 years.

What's your strategy with Clarus, the Category 3 AIF that was recently launched by ChrysCapital? What's the investment thesis here, typical ticket size of deals?

You asked us about investing in public markets and doing block deals, and I said, you know, that has come off quite a bit. We used to do a lot more of that, we do less now as our funds have scaled up. That's exactly the reason we launched Clarus, because we believe that there's a tremendous opportunity on the public side. But as our funds have scaled up, it's been harder for us to tap that. And as private equity has become much more of a value-add engaged player, we're missing out on opportunities where maybe you don't need to do the value add, maybe it's a great company at a good price, and we'd like to buy it. So that was the genesis for Clarus for us. We've been at it internally for 3.5 years now, and we just decided to launch it as an AIF in April.

As you know ChrysCapital has not tapped domestic money until now, and today, we have about $150 million, which is reasonably strong in a market where you can argue there are so many AIFs out there. The approach is to take a long-term view to investing in India and leverage what ChrysCapital knows in terms of our sectors, but also bring in other sectors where we may not be able to do a private equity deal, but it works very well for the public market fund. So the idea is 20-25 stocks, deal size will be small as a result of that. We're talking about $5 million or $10 million at this size. The key is over the long run, can you deliver good absolute as well as good relative returns?

More than two decades in India, since 1999, more than 100 deals, around $5 billion raised over nine private equity funds, $6.5 billion in returns. When's the next big fundraise?

It's been a good journey. We are in our third decade now. It seems like it's going to be India's decade. Private equity penetration is going up. We have a long track record. We want to definitely seize more of the market opportunity going forward. When you started, you talked about all the deals that we had announced or invested this year. So it's been a very active year for us. This year itself, we'll do more than a $800 million in terms of investing, and we feel that India offers tremendous opportunity for folks like us who are homegrown, committed to the country, have a long track record, lots of companies we backed in the past to attract the next entrepreneur, to attract the next deal, to even attract the next person who wants to work in private equity. And so our ambition is to scale up meaningfully over the next decade. We still have a lot of dry powder. We just activated Fund IX a year ago. So, we have a lot of dry powder still left, but we do believe that the next one will be larger and…

Fund VIII was invested in a three-year cycle. If you assume the same three-year cycle for Fund IX, we probably start investing that fund two years from now. So sometime next year, we'd have to hit the market for fundraise.

Any corpus in mind?

No, nothing yet. But we are debating just like Clarus whether there is a domestic angle to it or not.