What do we do? That is the question I am being asked by my portfolio companies. There is no denying that we are in an unchartered environment. I wish I had seen this coming. My personal view is that Indian public markets were relatively expensive over the last two years, trading at over 20 times the earnings. I did expect a gradual reversion to the long-term averages but not in the way it has played out.
Credit has meantime turned tight with banks holding back even already approved credit lines. Consumers too are seen to be refraining from most non-essential spending. To illustrate this, even until June, contemporary artist Subodh Gupta had fetched record prices at every auction but more recently a number of his works went unsold at the London, Hong Kong and Paris auctions.
Companies were also said to be reviewing their business plans, keeping a tight leash on cash in view of the liquidity crunch. Cash collections and management of receivables, other than cost-cutting measures, moved up their priority list, while expansion plans where possible were put on hold.
What are PE funds doing?
These changes notwithstanding, our job still is to find investment opportunities that render 20-25% returns within our investment horizon. In the past two years, many deals were seemingly done at expensive valuations. Our fund had not done any banker/auction deals as they were just too expensive.
That might not be the case now.
Funds are looking more closely at the balance sheet of companies. The focus will be on a strong balance sheet, manageable debt levels and strong cash flows. The days of using too much, often short term, debt to fuel growth are gone.
Funds are also looking for a special situation like the one induced by the issuance of foreign currency convertible bonds (FCCBs). Many of the FCCBs will mature from October 2009 and peak in 2010-11. Should the share prices of the issuing companies fall below the exercise price, the outstandings on account of FCCBs will become bigger than their respective market cap. Such companies would then be hardpressed to refinance their FCCBs without raising equity.
The ongoing correction in the stock market has also pulled down the valuation of many companies. Many a good company is therefore trading at very good value. I expect to see PE funds acquiring blocks in these companies where they could play active PE-type roles.
Funds are also working with their best companies to evaluate the emerging inorganic opportunities. The stronger companies are ideally placed to pick up assets, if any, at very attractive prices. I even expect to see some companies buying assets at less than book value as distressed sellers emerge.
How will this play out?
While some companies may believe a rebound is in the offing, I can only hope that they are right. However, in the midst of this we are bound to see a quicker evolution of companies. Good companies built on sound business models and sustainable business practices will survive.
Whereas, companies that managed to grow on borrowed money based on aggressive business practices might come down like a house of cards.
Deepak I. Shahdadpuri is Founder and Managing Director of BCP Advisors Pvt. Ltd, the India Advisor to the Baer Capital Partners’ Beacon India Private Equity Fund. These are the author’s personal views and not that of BCP Advisors or Baer Capital Partners.
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