“India has too many GPs due to which the market is over-competitive and expensive. It is very tough for me to see how we can make great returns in this market,” a fellow LP remarked at a recent conference where the general mood of anyone who was investing in India varied from cautious optimism to outright doom and gloom. I have heard the same words, one way or the other, for many years and more so in 2011. Anyone, who has anything to do with the PE industry in India, has an opinion on this, and mostly, what you hear will not be good news. So, maybe to my own peril, I have decided to give my two cents on this much-discussed topic.
Yes, India does have a lot of GPs and in many segments of the markets; they may have more (at least on paper) than what is needed, given the deal flow. This is a fact. Now, I feel where a lot of people go wrong is the learning they take away from this. I would also like to argue that the next step to this ‘problem of plenty’ may be a good outcome, for the ones who play it right.
Anyone who has run a business in India knows that cut-throat competition is a given in the country, if a particular business is interesting enough to potentially make good returns and there are no regulatory barriers reserving the business for the big boys and the government. Private equity is possibly one of the least regulated businesses in India, with very low entry barriers. So, it is not surprising that anyone who thinks that he or she can have a go at it is really getting into the arena (or trying to get in).
Once this happened, it was natural that a lot of them got funded (especially in the boom years), at least for their first funds, since there was no real track record for LPs to look at (in many cases, it is still not there) and they are backing individuals who can potentially build up good franchises and make good investments. This has happened in almost all emerging markets, especially those who are dependent on foreign capital. For all these funds, the logical next step is to look for the best deals in the market and try to get into them. And since India is not a buyout market where fund managers can control companies and add value, competing on price is inevitable for most of them.
Ideally, the problem should end there. The best will, of course, be good at buying or will be much more disciplined in putting capital out. They will also be good at selling it right and may even add some value to the business in the process. The rest will be just trying to ride the tide with no real differentiator in their approach. Over the long term, these groups will segregate out and the best will come out as winners.
But then, there is no ideal world, given that the Indian market has some unusual characteristics:
Serious team turnover, even at the senior management level in Indian PE (a topic for another column, maybe).
Lack of good alignment of interests between GPs and LPs in many funds.
Lack of leverage of many GPs with their portfolio company management/entrepreneurs.
High level of market intermediation.
What caused the above was the vast amount of money which came into Indian PE, fuelled by very high expectations of international LPs who primarily focused on the macro story and completely ignored or were unaware of the micro picture.
But it’s not all doom and gloom. Actually, the opportunity also lies in the same problems. Like every other super-competed space, the best and the rest will soon (if not already) separate out. Tough times have always made Indian businesses innovate and private equity is no stranger to this. Business models will evolve and focus will become sharper for different teams which would be a positive thing for the industry overall. Already professionals are realising the importance of adding real value to the businesses they have invested in and learning their hard lessons by working out previous mistakes. More seasoned individuals in the space will come out and form their own firms with full alignment of interest and significant skin in the game. LPs can also be more focused on managers who suit their style and risk appetite, as against now where differentiation is less prevalent among most growth capital GPs in the country.
So, as an LP, I am cautiously bullish on India. It also brings back the question of investing in emerging markets where the difference between the average and the best can be vast and PE LPs, like all other investors, will have to have more eyes and ears on ground to know the best from the rest. I think the ones who do that will reap long-term reward from Indian market as it is still in its early days of development. It is a good thing to see that the ability to raise money just on resumes (and sometimes even on individual reputations) is reducing.
To clarify, I am not arguing that India is going to be the next China for PE. China and India were pretty much in even footing on PE investments and returns till around 2005. Post that, China took off in another trajectory, fuelled by robust public markets, which offered excellent exit opportunities for even the average managers in the country. This was made possible through the high foreign investor interest in Chinese stocks (having Hong Kong as a conduit really helped) and also the vast amount of domestic capital that China has, which can outprice even the most adventurous foreign investor. The well-connected PE managers in China were also able to get better entry valuations in private markets as they either had better access or could really change the fortunes of businesses through their networks. None of these things are usually possible in India, at least for the foreseeable future. Therefore, Indian GPs should look elsewhere (maybe in the basic textbooks of private equity) to see how wealth can still be created for LPs.
So it will still be really hard work to make money in PE in India. But the chance of that hard work bearing fruit and delivering outsized returns, for the select few managers, seems brighter than ever at this point of time. The coming few quarters of negative LP sentiment and even worse macro data can provide exactly that opportunity for those with patient capital.
(The views expressed in this article are those of the author and do not necessarily reflect the views of Squadron Capital.)
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