“Private equity allocations to Asia will increase,” declares Anil Ahuja, Asia head of 3i, a UK-based private equity firm. And perhaps that explains why the private equity major is raising a fund bigger than its last fund ($1.25 billion) at a time when the fundraising environment is far from flourishing. An industry veteran, Ahuja says that there will be a rationalisation of capital and also a reduction in the number of private equity players. Incidentally, the 3i India infrastructure fund is sitting on an uninvested capital of $300 million and means to close two more deals. In an exclusive interview with VCCircle, Ahuja talks about sector focus, cycles in the PE industr
and key drivers of returns in the PE business in the current environment. Excerpts:
There is much disappointment among LPs when it comes to returns exhibited by PE investors. What can one expect going forward?
Going forward, I would expect rationalisation of capital. A lot of people who have raised money in the past will not be able to do it again. Therefore, there will be rationalisation in the number of players. That may or may not result into capital reduction but the number of private equity players will surely come down.
Also, a lot of people are currently operating with very flexible mandates. They do whatever comes their way; some will go for private deals while others are after public deals and all kinds of stuff. Going ahead, people will focus more on their strategies. They will be able to clarify their strategies better and they will actually work on those strategies to improve them. That change will definitely happen.
So you are suggesting that some players won’t be able to raise capital and will be driven out of the industry. When can one see such tangible changes?
By 2013, I presume. You will see a more cleansed private equity environment by that time. If you remember, a lot of funds have been raised during 2007-2008 and most of them have a five-year investment cycle. That investment cycle will end by 2013. In fact, you can’t have a 2007 fund investing in 2013. At that time, you will mostly have new funds raised after 2007-2008. In 2009, no funds were raised (due to the collapse of Lehman Brothers and the global financial crisis). And 2010 turned out to be a difficult year for fundraising. Of course, funds were raised then but very selectively. Again in 2011, fundraising happens to be very selective. So when you go into 2013, you have actually done away with the old funds and basically dealing with the new funds.
Currently, the PE ecosystem is evolving and correcting itself. Where did the PE investors go wrong?
I don’t think they got it wrong. There was so much euphoria in the market to invest in India during 2007-2008. The whole world was on fire then. Now, it is the pre-credit crunch and all that money is getting washed out.
So it was a benign environment and past returns were mostly an outcome of a growing economy. But against a backdrop of a slowing economy and a difficult fundraising environment, what are the strategies that may ensure good returns?
A lot of people can ensure that – venture guys, buyout guys, infra guys and even the real estate guys, if they are really good. It all depends on specific strategies in segmented markets and in each segment, there will be winners. I don’t expect a certain strategy to deliver the goods.
In an ideal world, what’s the kind of strategy you would like to adopt?
We would like to go for small-to-mid cap controlled deals. There are many small brands or companies who have great distribution networks or offer something very strategic that is of value to people who want to enter a specific market or a specific region. Suppose you have a great distribution business operating across western India. It can be sold to someone in the eastern part looking for expansion. But you need to have control to do that. The big issue is – if you have a sub-scale company and you don’t have control, you have no exit.
Does it mean 3i will get into controlled deals?
3i is actually at the top end of the deal size. Most of the companies with whom we do business, can get listed.
How would you assess the LPs? What is their appetite towards India?
Undoubtedly, there is some disappointment but their appetite is still high. Let’s put it this way – right now, what are the options? Where will you deploy your capital? If you are a state pension fund and you have this money coming in every month, it has to be deployed somewhere. Therefore, allocations to Asia will increase. But people are also very nervous. So only a very few will be able to raise money.
You are a private equity veteran and must have seen many PE cycles by now. What are the key factors for successful fundraising?
First, you need a very clear strategy. Then you need to demonstrate that you will be able to deliver that strategy. It doesn’t mean any previous track record; that track record should be reflected in your strategy. It also means having a team in place that can help you implement that strategy. Again, it means demonstrating market opportunities specific to that strategy.
Are you raising funds? What’s the size you are targeting?
We are about to start fundraising and it will be a big fund. We haven’t decided on the targeted corpus yet but it will be bigger than our last fund. Incidentally, our last fund was $1.25 billion.
What’s the kind of dry powder you are sitting on?
The uninvested capital we are sitting upon is about $300 million. Our average deal size is $150 million, which means we can go ahead with two more deals.
Within the infrastructure value chain, what are the areas that look interesting?
Ports and power generation look great. Obviously, there are headwinds today but those have to be resolved. Road projects also look good but again, there are issues regarding land acquisition. In fact, the entire infrastructure space is facing such issues. Then, you have waste management and social infrastructure that look interesting.
What do you think of education as a sector?
I don’t know whether you can make money in that sector. Also, what do you mean by education? If it is just providing a school building, I would call it social infrastructure. If you are going to provide teachers, you may not be able to execute it properly.
The infrastructure ancillary space has seen a huge amount of funding from investors. But even these publicly listed companies have plummeted. What do you think of this?
The EPC space is actually a very difficult area to do diligence and the diligence has to do with cash flows. People were playing a capital market game here, which focused on order book, PAT, EBITDA – all those numbers. But nobody was focusing on cash flows. Therefore, you had increasing working capital for companies – capital that was working for years and years and not generating any cash. Then, if you look at most of the EPC companies, the promoter holdings are actually very slim. If the promoter owns only 10 per cent in the firm, all may not be well there.
We are witnessing a lot of investments happening via JVs. For example, Actis formed a $200 million joint venture with Tata Realty & Infrastructure to develop roads and highways while Morgan Stanley tied up with Soma. What do you think of this?
Actually, we have never done a pre-deal JV but we have two hot companies in our portfolio who have got about 1,000 km each. So we are a big investor in this space but not an investor on a pre-deal basis. If you win the road project, we will definitely talk to you. But we won’t get into a partnership in the first place and bid for the project together.
What are the broad trends that one may expect in infrastructure investing?
Well, there are many. For instance, we have a huge capital shortage. Since the government plays a key role in policy development, it should focus on the debt front. It can be something radical like significant correction to the CRR and SLR because there must be enhanced liquidity in the system in order to provide debt to these projects. Measures can be also taken to ensure the evolution of the bond market or to permit a significant amount of foreign capital. Also, to develop a trillion-dollar infrastructure, you need trillion dollars. But where will it come from? That question is being debated and that will result into a lot of fundamental policy changes.
PE firms are adding the debt side to their operations. In fact, 3i has also forayed into debt with the 3i debt asset management. How is that coming along? What is driving such motivations?
It is still being developed. I think people are morphing from pure private equity to broad-based asset management but that’s not a big trend. It is more selective, to be precise. People are not trying to occupy the entire space – their activities are just deal-specific. But that might be beneficial from a structure point of view.
You have a debt side to your PE play. Is that an advantage?
I am not sure if it’s an advantage. It really depends on whether that business supports your PE business or whether it is an independent one. If it is an independent business, it is going to compete with the IIFLs, Edelweiss, HDFC Bank, ICICI Bank and everybody else who is out there as a lender.
So PE players are broadening their services. Is that the way forward?
Well, financial services firms are always looking for broader platforms. But it’s very difficult to say whether debt is going to be the method. I think the current forays are very small and right now, you can’t make out a trend.