India leveraged finance: Debt delivered

The leading Asian jurisdiction for unitranche-backed leveraged buyouts is unquestionably Australia. India ranks a distant second in the region – with unitranche making its debut barely a year after Australia – but the very availability of the structure underlines how transaction financing is developing in the market.

“Sponsors are increasingly moving to control and complexity,” says David Irvine, a partner at law firm Kirkland & Ellis. “The market is definitely growing. Banks are more and more willing to participate, unitranche players are coming in, deals are getting bigger, and there’s more volume. The deals in China tend to be bigger, but India is more active in terms of volume.”

Control deal flow has certainly dropped in 2019 – Alexander McMyn, a partner at White & Case, observes that activity is rebounding, having slowed in the middle part of the year – but it comes on the back of steady increases in volume and value. Last year, for example, a record $9.7 billion was committed across more than 40 transactions, according to AVCJ Research.

From an offshore financing perspective, there remains a preference for companies that have substantial US dollar revenues from subsidiaries outside of India, which makes it easier to take security and removes the need for a foreign exchange hedge. This was the case in each of India’s three unitranche deals – Healthium Medtech (Apax Partners), AGS Health (Baring Private Equity Asia), and the recently announced Bharat Serums & Vaccines (Advent International).

“We tend to get involved where the companies have massive operations in India, but are technically, legally or practically US or Western-domiciled, with predominantly US-based customers and cashflows,” says Edward Tong, head of private debt for Asia Pacific at Partners Group, which provided financing for AGS. “If there were performance issues, we would, as a lender, assess on a look-through basis, and we think about whether we could enforce if we needed to, where would we enforce, what type of business would we be left with.”

Willing lenders

Unitranche represents a step along the risk curve because it rolls senior and mezzanine debt into a single structure, offering more leverage, lighter covenants and longer tenor than traditional bank loans as well as bullet repayment on maturity rather than gradual amortization.

For the most part, leverage financing in India remains a bank-led market and the terms and pricing are much like those available elsewhere in Asia ex-Australia: leverage of 4-5x EBITDA, two covenants, five-year tenor, and pricing of 350-450 basis points above LIBOR. And with Indian banks barred from doing conventional LBO financing, most activity happens offshore.

Several recent deals have involved companies with a larger portion of rupee revenue, suggesting that lenders are more comfortable hedging currency risk, despite a relatively volatile rupee. This corresponds with accounts from GPs about the availability of financing.

“Nearly every GP will have used some financing on both public and private market transactions, for control and minority investments,” says Rupen Jhaveri, a managing director at KKR. “The financing market has exploded in the country – in a good way – over the last few years. There are ways to do it onshore and offshore which provides some flexibility.”

This applies to a growing cohort of local managers as well as global and pan-regional private equity players. For example, Gaurav Ahuja a managing director at ChrysCapital Partners, notes there is now some form of leverage in every deal the firm does, although debt tends to account for no more than one-third of the overall deal and seldom if ever exceeds 3x EBITDA.

“More global banks are open to some of these structures, and as the availability of leverage rises, demand rises as well,” he says. “But these are things you do on the margins to help returns; they are not going to be game-changers for you because you aren’t taking massive leverage risk.”

ChrysCapital divides financing into three categories. First, subscription line financing, which enables the firm to delay capital calls and boost IRR. Second, operating company leverage – the purest and cheapest kind, but only available for businesses headquartered outside of India. Companies might also be encouraged to make accretive acquisitions using leverage or balance sheet cash. Third, holding company leverage, typically taken out by a Mauritius or Cyprus entity or an Indian subsidiary.

Taking hold

The holding company approach is most widely employed within the industry. While it might be as simple as a loan against shares in a public company, it can also be expensive. There are two forms of leakage: a dividend distribution tax (DDT) of 19-20% is levied on payments from subsidiary to parent; and if the subsidiary is listed, dividends must also go to minority shareholders.

There are ways of minimizing exposure, though they might be costly and complex in themselves. One course of action is to create an onshore acquisition vehicle and capitalize it through instruments such as compulsory convertible debentures. Cash is moved offshore to service interest payments and issue dividends to these instruments – or to repay the principal – without incurring DDT.

“At the same time, if you have minority investors in the structure between the offshore entity and the onshore target, you don’t suffer pro rata leakage on dividends on ordinary shares because you only pay it on the preferred shares,” says Irvine of Kirkland & Ellis.

Not all managers are won over by such propositions. Tata Opportunities Fund doesn’t use subscription lines; its performance is entirely driven by low entry multiples, earnings growth, margin expansion, and deleveraging through value creation. Bobby Pauly, a partner with the firm, observes that challenges around hedging and financing costs still often make leverage unworkable.

“If you are trying to hedge offshore borrowings, either the market is not there for the tenor you want to hedge at, or it’s very expensive,” he says. “And then without some regulatory leeway, borrowing itself is expensive. Borrowing rates for loans against shares are well into double digits, which takes away a lot of the upside.” 

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• Topics
• South Asia
• Financing
• Buyouts
• India
• Partners Group
• KKR
• Tata Capital
• ChrysCapital Management