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Mezzanine funding a compelling long-term opportunity in India: KKR's Henry McVey

KKR also feels valuations have become much more attractive but multiples may not have bottomed out.

Private equity major KKR & Co feels that India's nascent mezzanine market offers one of the most compelling long-term opportunities. In a report titled 'India: Unlocking the Demographic Dividend' by KKR's head of global macro & asset allocation, Henry H. McVey, said Indian corporates would help expand this market as they look at more sophisticated instruments.

"Interestingly, of all the private initiatives we saw during our visit, we believe that the initiative by private equity and other financial intermediaries to develop mezzanine credit instruments, often with some equity upside, is among the more compelling long-term opportunities," said McVey's report, adding that investors have to tackle local currency risks in this market.

"We left Mumbai with the strong impression that India’s large and growing number of entrepreneurs and businessmen would help to expand this market quickly because they want to tap into a more sophisticated capital markets system that allows them greater choice beyond just traditional equity or bank loan products," it said, adding that even smaller entrepreneurs, who do not have access to bank, would also demand this product.

Also these investments should appeal to global investors, "particularly those who want to earn a meaningful recurring coupon and enjoy some equity upside without a lot of the volatility and misconfigurations often associated with traditional Emerging Market (EM) public equity indexes."

Elaborating on potential mezzanine and high-yield investments, it said "investors who want exposure to India and its currency can buy high-quality credit with yields that often dwarf what is available in the US and Europe after Quantitative Easing III (QE3) and Outright Monetary Transactions (OMT). Also, we believe the duration of these investments leaves investors less susceptible to the exit costs of volatile stock market indices."

KKR, which has $66.3 billion in assets under management, has been one of the first big buyout shops that started lending operations in India besides the staple private equity investments. The NYSE-listed buyout major, which set up India operations in 2009, lends through a non-banking finance company. It also received Sebi's approval under new AIF norms for a fund, KKR India Alternative Credit Opportunities Fund 1. KKR has invested over $1.1 billion in India and its PE portfolio includes Aricent, Avantha Power, Cafe Coffee Day, Dalmia Cement, Magma Fincorp and TVS Logistics.

Several fund houses have been gearing up for mezzanine investments in the recent past. While CX Partners is planning to raise a fund, Standard Chartered Private Equity started such investments last year.

Opportunities, valuations and challenges

The report points that in order to achieve its full potential, India needs to invest more in infrastructure, tackle its inflation problem and related inefficiencies and cut subsidies to help balance its fiscal situation and restore proper consumption signals in the consumer market.

But KKR sees opportunity in this environment. "At this low point in sentiment, we actually think there is a cyclical opportunity in India, including both public stocks and government bonds, to surprise on the upside. In addition, we think that the currency, which has been pummeled in recent months, is likely to shift from a liability to an asset, which could materially help the total return equation on India investments."

KKR also feels valuations have become much more attractive but multiples may not have bottomed out. "Rather, our research shows that, while we have likely reached a bottom, we still expect India’s trading multiple to vacillate somewhere between 12-14x over the next few years as the country works through some of its macro-economic headwinds," said the report.

KKR feels that India requires a flexible approach that extends across debt and equity, both public and private markets, majority and minority stakes besides the ability to build businesses. "It will also require the expertise to not only buy but also build businesses, given that valuations in India are traditionally expensive relative to other emerging growth countries,"

The report said that sectors like quick service restaurants (QSR), healthcare, financial services (especially housing finance) and education hold a lot of promise.

(Edited by Prem Udayabhanu)

(Kohlberg Kravis Roberts and Co.)

KKR India Advisors Pvt. Ltd. is a private equity firm with $101.6 billion assets under management. It provides growth capital to companies operating in Asia Pacific, EMEA and United States of America. The firm seeks to invest in logistics, energy, finance, pharmaceuticals, food and beverages, manufacturing, retail, healthcare, media, telecom technology, infrastructure and real estate sectors. The company was founded in 1976 and is based in New York with additional offices in Mumbai, London, Paris, Dubai, Hong Kong, Singapore and Sydney.