India distress: Workout window

Eshwar Karra, the CEO of distressed asset specialist Phoenix ARC, knows a good bet when he sees it. And right now a spate of major corporate failures has made the sector as good as bet as Karra has seen in years. Taking advantage of these opportunities is another matter, however. The sheer size of the deals that are available means that Phoenix and its sponsor, Kotak Mahindra Bank, have no hope of taking on most of them, and risk being left behind.

To get around this difficulty, Kotak has partnered with the Canada Pension Plan Investment Board (CPPIB) on a distressed asset-focused joint venture. The LP will provide up to $450 million - more than Phoenix has invested in its 16 years of operation - while Kotak and Phoenix provide local experience and connections to source the best deals.

"At the moment, the problem is so huge, and the opportunities are plenty. So it's just a matter of time before the banks have provided sufficiently, and I think the banks have started to provide, and recognize the problem," says Karra. "Going forward, all of the distressed players are going to have their hands full."

In the short term there's been a lot of pain for all these banks, because they've not been used to seeing the regulators crack the whip, along with the government – Eschwar Karra

CPPIB is one of numerous global private equity players that have recently shown interest in India's distressed asset space. Jim Coulter, co-founder of TPG Capital, recently told Bloomberg that the firm wants to invest up to $3 billion in the space over the next three years, while last month KKR received permission to buy a stake in International Asset Reconstruction Company.

Investors are drawn by India's current overload of bad debts, and the prospect of action to shake them loose. But while this rapidly changing market represents an enticing opportunity, those who seek to take advantage of it will need to understand the forces at work.

Clipped wings

Part of the new focus on empowering lenders stems from public outcry over recent business failures. Kingfisher Airlines, for example, has become a byword in India for financial waste and regulatory weakness. Founded by flamboyant liquor baron Vijay Mallya in 2005, the company had marketed itself as a premium experience, at one point becoming the second-biggest airline in India by passenger volume.

But rising fuel costs began to put a squeeze on India's airline industry in 2008, and Mallya's mismanagement further hindered the company as revenues dropped and losses mounted. In its last year of operation, 2012, the company reported a loss of more than INR40 billion ($600 million). Mallya himself left the country earlier this year.

Some see a silver lining to the Kingfisher debacle. The company's decline took place in the glare of a media spotlight and prompted withering criticism of the fact that banks had loaned Kingfisher nearly INR65 billion - money they are still fighting to recover in court.

"The media outcry is putting more pressure on the banks and the government," says Vikram Utamsingh, managing partner at Alvarez & Marsal (A&M). "There are some very large business houses that are facing the heat, much larger than Mr. Mallya, frankly speaking. For political reasons, these business houses would not normally face the heat from these banks, but now they are. It's a great development."

The banking industry's concern over non-performing loans (NPLs) goes far beyond the political fallout of high-profile failures. Problem loans are an increasing worry for regulators, with the Reserve Bank of India (RBI) estimating that the country's banks may have up to INR7 trillion ($110 billion) in NPLs on their books. Worse, these assets are taking up a larger portion of the total loans in the banking system, from 11.1% in March 2015 to 11.3% in September (and even higher in public sector banks, at 14.1%).

Additionally, the debts themselves are only part of the story. The RBI is considering requiring banks to set aside more capital - as much as INR300 billion this year - to cover the risk of default.

With banks under mounting pressure to clear distressed assets off their books and free up credit to loan to other companies, regulators and the government are indicating a fundamentally new attitude toward underperforming loans. Most important is a shift of focus away from the historic emphasis on keeping the management structure of underperforming companies intact; now a bankruptcy court will be able to appoint an insolvency professional or consultancy to make operational changes to the business.

"Currently the business model is somewhat mixed with less emphasis on reconstruction and revival," says Rahul Gupta, joint group CEO of Ambit Holdings, which recently announced a distressed asset partnership with US-based GP J.C. Flowers. "With the present strategic debt restructuring scheme and proposed bankruptcy code, it will be easier to do such revivals. These provide for change of owner management in a systematic way."

For many industry professionals, this attitude shift comes as a long-sought relief. Winding up a company in India has historically been a drawn-out process; according to the World Bank, it takes on average 4.3 years to resolve distressed assets from the date of the filing for insolvency in court. This figure, which has remained constant since 2000, compares with 1.5 years for the US and one year for the UK. Regulators in India hope eventually to allow companies to be wound up in as little as 90 days.

"In the short term there's been a lot of pain for all these banks, because they've not been used to seeing the regulators crack the whip, along with the government," observes Phoenix ARC's Karra. "Now that that's been done in the short term, I think there's going to be change."

Means of access

Opportunities created by the distressed asset shake-up are spread across multiple sectors, which industry players say heightens the attraction. Investors are likely to find attractive assets no matter where they look. Phoenix, for example, sees opportunities in the infrastructure sector, while Alvarez & Marsal and EY have offered to help with the restructuring of steel producer Electrosteel.

Many private equity players previously held off on investing in distressed assets in India due to the time and effort needed to extract value from an investment. However, the changing regulatory attitudes and the RBI's direction to banks to sell off their problem loans have piqued their interest. In addition to the foreign GPs planning to enter the market, local player Everstone Capital recently announced a new special situations vertical, headed by former Advent International executive Avnish Mehra.

Industry participants have indicated a number of possible approaches to distressed asset investing. Some, like Everstone, appear set to take on the market alone, while J.C. Flowers and CPPIB are providing capital to local firms, who will source the deals themselves. The ability to draw on these large pools of capital is seen as an advantage by Phoenix, which expects the banks to try to sell off their most expensive assets first. Local firms without such backing may go after smaller assets, though it could take longer for these to come to market.

"There certainly are opportunities across the scale, both large and in the mid-market as well, but the banks are initially concentrating on the larger cases to see if a solution can be found through this route," says A&M's Utamsingh. "They will at some point come down to the lower exposure businesses as well." He believes the assets available initially will probably be worth $1-4 billion.

Private equity firms do not necessarily have to invest in NPLs directly. There are additional opportunities to be found in companies that have not yet become non-performing; GPs can help these companies to restructure and stay out of the distressed category, which also eases the burden on the banks.

Further deals may come from another new measure, which would allow creditors to convert their debt into equity in a company and take ownership that way. Lenders who would rather get rid of the asset than make the necessary changes themselves can look for a private equity buyer to pick up their stake and try to turn it around.

Industry professionals caution that a newcomer to the special situations space will need time to adjust to the different demands of this market. While the issues are broadly similar, the specifics of each sector require attention to different priorities and issues.

"Private equity experience in India can help provide familiarity with the operating environment, but the investment approach in special situations has to be very different," says one investor with experience in India. "In special situations, we focus on anticipating and solving problems while looking at downside protection, whereas PE is more about execution focus with an eye on growth."

Others note that while assets may be easier to acquire as a result of the recent regulatory moves, turning them around and establishing profitability will continue to be difficult. As with any investment, potential investors cannot expect the investee to welcome their input - and this may be especially true in cases where the purchase was not made with the consent of the company's management.

"Great asset management, in the private equity world, is still a challenge," says Rob Petty, managing partner and co-founder of pan-regional special situations investor Clearwater Capital Partners, which operates in India both as an investor and as a direct lender through its non-banking finance company Altico. "I don't think that this has really changed. I think what's newer is that banks themselves are willing to sell assets at closer to fair prices - that evolution has continued over the past several years."

Attitude problems

On the other hand, the changed regulatory environment could result in a better environment for control investors, though it may take some time before the implications of the strengthened hand for creditors become clear to company management.

While the proposed changes are working their way through the system, many industry players feel that the most important development in recent months has been the shift in attitudes by the government. Though historically reluctant to enable tougher actions by lenders, recent moves have shown that it is serious about the problem. As regulators move toward more stringent requirements for underperforming companies, the effects will likely be felt among the businesses themselves.

"The attitude of Indian businesses has been that you can take all these loans, you don't have to worry about paying it back, and you can always find a way to manage it," says A&M's Utamsingh. "I think that, as this pressure keeps on continuing, Indian businesses will become more realistic about the fact that they've got to keep up with the repayment terms and the payment of interest, and if they don't then they will risk action against them."

Despite these evolving attitudes, however, potential investors must remember that the proposed legal and regulatory changes have yet to be passed and may take several years to be fully implemented. Those who are considering getting into the space can take some time to form a strategy before they enter the market.

"India represents both challenges and opportunities. Navigating through these challenges will be tough and will lead to mispricing and misjudgment of risks," says Puneet Bhatia, managing director and country head of India at TPG Capital. "That said, the rewards will be worthwhile for deals that are structured well, which will generate solid investor interest. I expect capital raised to pursue these opportunities will overrun the attractive subset, and hence selectivity will be key."

PE firms that do enter the market will probably find the best opportunities in companies that are not officially underperforming, but have the potential to do so. Additional openings for investment in companies that have been through the turnaround process are likely to appear farther down the road.

"In this situation, to be honest, I think private equity is a little early," says Phoenix ARC's Karra. "I think first, the distressed funds need to come in, bring the debt down to sustainable levels, and put in further capital for either capital expenditure or working capital. After that I would think there would be tremendous opportunity in these situations where private equity could come in."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• South Asia
• Credit/Special Situations
• Restructuring
• India
• Clearwater Capital Partners
• Canada Pension Plan Investment Board (CPPIB)
• J.C. Flowers & Co.