India webinar: Relighting the fire

The participants: Mark Silgardo, senior managing partner at IL&FS Investment Managers; Tushar Sachade, partner and head of private equity tax at KPMG India; Vikram Utamsigh, partner for transactions and private equity advisory at KPMG India; and Mukund Rajan, managing partner at Tata Opportunities Fund.

On dealing with LPs and expectation management

SILGARDO: The idea that you can make quick money isn't always true, especially in India where there are cycles and periods of uncertainty. Being patient is paramount to creating good value. That said, the push back from LPs comes from the fact we saw heady times in 2006-2007, a lot of capital was raised, and a lot of deals were done at high valuations, and we are feeling the backlash from that now.

RAJAN: India was kind of coming back into favor and as a new fund we were getting a lot of traction in the first half of last year, soon after our first close. From July onwards, we have seen a significant drop off in investment sentiment. The big questions have really been about the market and the macro. Growth has been slowing in India, we had a whole series of governance scandals, and the government has been on the back foot in terms of certain reforms. Moving beyond the economy, there have been question marks over performance. Older funds have to defend their track records; newer funds have to explain how they have differentiated deal flow, whether they can maintain disciplined pricing, and how they can provide operational value-add.

UTAMSINGH: I would focus on the performance of portfolio companies and, if I've had a couple of exits, I would talk about where those deals came from, whether they were proprietary, and how they were successfully exited. I would also talk about portfolio companies that are coming up very soon for exit. I would also demonstrate that I have a stable team.

SILGARDO: It's also equally important to talk about the failures. Any fund manager that says they have no dogs in their portfolio I would regard with a high degree of skepticism. So you need to talk about where you went wrong, how you tackled those situations and what you have done to turn around those companies; if you weren't able to turn them around, what you have done to try and achieve an exit and protect capital on that investment.

On whether Indian GPs are pursuing operational value-add

UTAMSINGH: There is a huge question concerning operational value-add because most of the deals are growth capital investments in companies where the PE firm has a board seat and a 10-25% stake. There is debate as to whether you can provide operational value-add to companies where you are a minority shareholder. PE firms can help in terms of financial management, renegotiation of debt and obtaining working capital but it ultimately boils down to having that positive relationship with the owner.

SILGARDO: I think operational value-add is more talked about than implemented on the ground. Most transactions do not involve in control and then a lot of companies are entrepreneur-owned and these people understand the business very well. The way we approach it is more from a financial and strategic perspective: adding to management and building a good structure, offering access to markets that companies can't penetrate on their own.

RAJAN: Our experience is colored by the fact that our major playground is Tata Group companies themselves, although we do have a significant allocation for opportunities outside the group. We tend to rely on the availability of expertise across different Tata companies - we can pull in capabilities that are relevant to pretty much any situation a private equity portfolio company finds itself in. What investors like in addition to proprietary deal flow is access to operational talent. The days when you could be a smart financial investor, take a wheelbarrow down Wall Street and come back with an enormous fund, are over.

UTAMSINGH: The tables are turning. Promoters used to look only for money from financial investors. Now we find they are asking questions about what more a private equity firm can provide. Funds have to offer some element of differentiation.

On the implications of General Anti-Avoidance Rules (GAAR) for private equity

SACHADE: The law states that any arrangement whose main purpose is tax benefit and this results in an abuse of tax law, lacks commercial substance or is not for business purposes then that arrangement can be ignored. I don't think anybody in the market would object to the fact that India is proposing GAAR, the problem is whether the revenue authorities implement it in a fair and just manner. The government decided to postpone implementation by one year and then it set up a high-level committee chaired by Dr.ParthasarathiShome. The committee recommended that GAAR should be postponed by three years because the complexity of the legislation means revenue officers require a lot of training, and that there should be grandfathering of existing investments, so investments made before GAAR aren't subject to it on exit. We expect the government to implement these recommendations and this is very positive for GAAR. What private equity players need is a certainty of structure and regulations so there aren't prolonged negotiations on withholding tax. We are moving in the right direction.

SILGARDO: Some of the announcements that have come out previously about looking at things retrospectively spooked a lot of people. No one is opposed to a regime where there is a tax, so long as there is a policy in place that is transparent. Let's say we exit an investment today and the tax environment were to change, then in many cases the GP would be hauled over the coals by the authorities. It's in everybody's interests that there is a policy in place and everyone knows where they stand.

RAJAN: Some of our funds are planned out of Singapore. The limitation of benefits were defined by the Indian government and there is a sense that in places like Singapore that are well regulated - and where the Indian government was involved in the planning of the double taxation agreement (DTA) - are relatively secure. We just hope that some of the hiccups we've had over the last year are resolved.

SACHADE: A lot of PE firms use Singapore and Mauritius as a hub for investments in India. The Shone committee recommends that once you opt in and get a tax certificate then GAAR shouldn't apply. We have been working on several funds and a lot of people are still looking at Mauritius because they expect these recommendations to be implemented. However, if you look at the way the law is worded on GAAR, Singapore does make more sense as you can put operational presence there.

On the need for a domestic LP base to stimulate the private equity industry

RAJAN: I would really like to see the government focus on letting Indian capital into private equity. There are restraints on pension funds and charitable institutions, which can't investment in Indian private equity right now. There are also restrictions on insurance companies and banks are required to prescribe higher risk weighting for investments in private equity.

UTAMSINGH: The government will need to do a lot to encourage participation, but I think it's a very important point. To facilitate the development of private equity in India we need to have a domestic LP base that foreign LPs can turn to - they know that domestic LPs have a better understanding of the market and are better able to look after their interests. This will take time, five years, 10 years or longer. The PE industry has been quite successful in the last couple of years in coming together under the India Venture Capital Association and the Confederation of Indian Industry and making representations to the Securities and Exchange Board of India and the tax authorities.

SILGARDO: We do need a domestic LP base and apart from the fact we need government regulation, there is a lot of education to be done. We have seen domestic LPs invest in the past without really understanding the product. Equity itself is not a very well understood in India. If you look at savings and investment in general, equity forms a very small part. It's all about developing the equity culture, not just the private equity culture. Our markets are driven by foreign investment and they will continue to be driven by foreign investment for the foreseeable future. I'm not saying we shouldn't develop a domestic LP base but we can't rely on it to fund a large portion of the needs of the industry.

On the outlook for investment and exits

SILGARDO: The lessons of 2006-2007 have been learnt by the industry and the euphoria is not coming back. We are looking at consolidation. The high valuation days have gone and the current period will probably be a good time for private equity deals in India. Investor sentiment in general has been poor but now it's coming back, and so the economy will grow faster. We would like to see a more measured entry into the market. A lot of LPs coming back is not good for the industry because India can only absorb so much money each year - $17 billion is far too large and that is what we saw in the boom years.

UTAMSINGH: We are seeing some positive signs at this point in time, especially in the last three months with the government talking about reforms and actually passing some reforms. We have to hold our breath and wait and see if the central bank is willing to reduce interest rates, which could see the IPO market open up. We are all hoping this will happen early in 2013. However, I don't think the IPO market will change the face of exits; it is secondary transactions. There is a huge base of investments - 4,000-5,000 in total - and in some cases the private equity firms are struggling; it's not working out, but they have built the proper governance standards and the relationship between investor and promoter is positive. The larger funds that would typically want to deploy $50 million or more are looking at this base of investments and exploring buyout opportunities, especially from funds that are coming to the end of their life cycle.

RAJAN: There is a huge demand for exits and, while the public markets will be the major platform, secondaries have to be a major part of that equation. Ultimately, the issue with a lot of these exits is pricing. The entry price was so high that the investors are loath to exit at what would now be regarded as an acceptable price. It's a case of who blinks first. You'll see an avalanche of secondaries in the next 2-3 years, but there will also be a lot of blood on the streets. As a newer fund the advantage we have is fresh capital going into situations where there is more pricing discipline and more acceptable valuations.

SILGARDO: We are still a little bit away from valuations becoming reasonable in the private equity space - entrepreneurs may not expect a premium to public markets but they benchmark themselves against the top performing company in their market. A lot of the deals we have seen have not closed because the companies haven't been rushed into completing an investment. If there was a great need for capital then the deals would have closed at lower valuations, but instead they are willing to defer their investment programs. I think valuations will become more reasonable when the Indian economy picks up again and companies want to implement their capital plans quickly.

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