India PE: Careful carving

Though unusual at the time, the sale of Tata Group’s Drive India Enterprise Solutions (DIESL) to TVS Logistics in 2015 increasingly appears to represent a new normal for corporate strategy in India: a sale motivated not by financial stress of commercial underperformance but by a recognition that divestment of a non-core asset made sense for both parent and subsidiary.

“Logistics was a small business in Tata Group and it was never going to move the needle – so it wasn’t a space they wanted to focus on,” says Bobby Pauly, a partner at Tata Opportunities Fund (TOF), a PE vehicle sponsored by Tata Group that supported the transaction. “However, it was important that the headline impact of a potential exit was positive: this was Tata and TVS coming together for logistics, and TVS was already the market leader, so the alignment was strong.”

Divestments are nuanced. The relatively recent uptick in sales to private equity in India does not just concern unwanted corporate assets. The introduction of an emboldened insolvency and bankruptcy code (IBC) and the emergence of a general liquidity crunch have revealed a seam of transactions in which distressed parents are offloading businesses they would prefer remained on the books. These black-and-white situations are surrounded by numerous shades of gray: from divestments by corporates under stress to those looking to become leaner and meaner.

“There’s a fair bit emerging from IBC processes and from the overleveraged balance sheets of industrial houses that cannot support multiple businesses,” says Pramod Kumar, managing director and head of banking for India at Barclays. “There is also an increasing trend among larger conglomerates to get a sharper focus on their businesses. Some are proactive, while others are still trying to kick the ball down the road to avoid selling plum assets.”

Shades of gray

KKR’s acquisition of a 60% stake in Ramky Enviro Engineers (REEL) for $530 million was in part driven by stress. A slowdown in Ramky Group’s infrastructure and real estate businesses meant that substantial investments in land and projects were not being monetized. Selling REEL helped ease the debt burden at promoter level. Similar motivations were behind Dewan Housing Finance’s sale of Aadhar Housing Finance to The Blackstone Group and Avanse Financial Services to Warburg Pincus.

Other situations do not sit at this end of the spectrum. Adani Group brought in Total as a shareholder in its gas business, while Reliance Industries formed partnerships with BP, Saudi Aramco and Brookfield Asset Management across retail fuels, chemicals and telecom towers, respectively. Bharti Enterprises did the same with Warburg Pincus in its Africa telecom unit. The sellers primarily sought third-party capital to support growth and greater financial flexibility.

The challenge for private equity investors is identifying potential sellers and building relationships that stand them in good stead if and when a competitive process is launched. Almost all carve-outs are complicated by negotiations with an assortment of interested parties.

For KKR, the REEL deal originated from a standard screening process. “We closely follow 200-plus conglomerates in the country and meet regularly with the chairman or CEO, so we know what is going on in the portfolio businesses,” says Rupen Jhaveri, a managing director at KKR. “Equally important is the industry view. We develop a thesis on the sectors we believe will shine over the next few years and those that have the greatest longer-term opportunity. We identify the top few companies within each of these thematics and look to back the best ones.”

REEL was therefore a thematic bet on company – anticipated growth in demand for environmental solutions – with a promoter that happened to need liquidity. But it still took nearly two years to close the deal. “Nothing is ever straightforward,” Jhaveri notes, highlighting the challenges presented by changing conditions within sectors as well as the need to build alignment across multiple stakeholders, including promoters and minority shareholders.

TOF has also experienced protracted processes. Tata Projects comprised four engineering and construction services businesses in which nine different Tata Group entities were shareholders. Seven of these entities had to apply for audit committee and board approval to proceed with the shareholders’ agreement that underpinned the carve-out. One document had to be signed off by 12 different parties in a single day with the end of financial year deadline looming.

Early movers

Negotiating obstacles involving governance, regulatory approvals, disclosure requirements, and the various political landmines that may lie in wait necessitates a skillset alien to standard growth equity deals. However, understanding the dynamics before the clock starts on a deal can ensure smoother passage to closure.

“The key is to get ahead of the curve and understand how these decisions are framed and proactively provide solutions that might help the corporate. They are not necessarily focused on getting the highest price,” says TOF’s Pauly. “Private equity managers must have a hypothesis on what is core and non-core, establish the right point of call, syndicate those ideas, and remove hot button issues.”

Identifying the most important decision makers in a group that may not have a history of divesting assets can be challenging. It doesn’t necessarily come down to the board, the chairman or the single largest shareholder. Moreover, it is not unusual for certain parts of the target business to remain with the parent, while carving out assets could involve a series of different transaction structures.

For private equity firms targeting corporate divestments, the stakes might be higher than the deal immediately at hand. Get it right and the process can be showcased to other groups considering asset sales; get it wrong and the reputational damage could be lasting. In this respect, action taken during the holding period is just as important as the minutiae of executing the transaction.

“Once you are in there, you must show there is traction in the business, the employees should feel good,” says Pauly. “After TVS acquired DIESL, it infused some equity into the company and didn’t change the name for two years. It also aligned the top management through an incentive plan.”

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

• Topics
• South Asia
• Buyouts
• GPs
• India
• Tata Capital
• KKR