India buyouts: Ceding control

One of the largest buyout deals in India - Apax Partners' $420 million acquisition of GlobalLogic - is a typical secondary transaction. Founded in 2001, the company has evolved from a US-based entity with an Indian delivery center into a fully-fledged global outsourced development services provider.

Along the way it raised capital from New Atlantic Ventures, WestBridge Capital, New Enterprise Associates, Goldman Sachs and Sequoia Capital. The VCs were looking to exit when Apax approached them about a sale.

Five of the 12 India-related control deals in 2013 have involved sales between GPs: GlobalLogic; KKR's acquisition of Alliance Tires from Warburg Pincus; Baring Private Equity's Hexaware deal with General Atlantic and ChrysCapital Partners; SAIF Partners, Goldman Sachs and Sierra Ventures' exit of CSS Corp. to Partners Group; and Multiples Alternate Asset Management's purchase of a majority stake in Vikram Hospital from ICICI Venture Funds Management.

Cyrus Driver, managing director at Partners Group, says there are a lot of deals on the table where a PE investor, often with a minority stake, has rights that precipitate the sale of a majority of the business, or is able to convince the other shareholders also that it is time to monetize. The lack of IPO exits over the last few years has encouraged corporate M&A for exiting PE funds and also opened up opportunities for funds wanting to buy into assets.

"This is a trend that will be around for 3-4 years, just because of the large number of deals that happened in the boom years of 2007-2008 that are now at the stage where they need an exit," Driver adds.

Emerging opportunity

Secondaries are only part of the reason for the rise in the number of potential buyouts in India. The 12 transactions completed this year add up to more than $1.95 billion, a record sum in a country where control investments have previously crossed the $1 billion threshold only twice - in 2006 and 2007, at the peak of the pre-global financial crisis boom.

"We're seeing early signs of a buyout market emerging," says Devinjit Singh, managing director in The Carlyle Group's Asia buyout division. "It's still not the bulk of the deals that we see, but compared to five years ago there is a greater level of activity now."

The drivers also include a combination of generational change at the head of businesses, divestments of non-core assets by conglomerates, or monetization driven by the inability of an entrepreneur to scale up beyond a certain level. Opportunities cross multiple sectors.
Both the Hexaware deal and iGate's Apax-backed acquisition of Patni Computer Systems in 2011 are examples of the first driver at work.

As for corporate divestments, it would appear there are plenty of potential sellers in India. A recent Credit Suisse report found that gross debt at 10 of the largest and most indebted Indian conglomerates topped $100 billion for the first time during the last financial year, increasing 15% as compared to the previous year. These conglomerates include cement maker Jaypee Group, Reliance ADA Group, and PE-backed GVK.

Earlier this year a consortium of investors led by Gaja Capital acquired a majority stake in preschool chain Eurokids for more than INR1.7 billion ($27.5 million) during debt-laden parent company Educomp Solutions' selling spree. As of March 2013, Educomp's total stand-alone debt was INR9.6 billion.

However, the number of such deals is still low according to Driver: "We expected to see more carve-outs, given that leverage in corporate India has risen and a lot of conglomerates do need to de-lever. But the banking system in India doesn't really punish over-leveraged borrowers in the same way that it does in the West and therefore conglomerates do have an ability to hold on."

Yet the availability of control transactions from multi-business family conglomerates sat at the heart of Kedaara Capital's operationally-focused strategy when the GP launched its debut fund last year. And LPs clearly bought into the idea as the vehicle closed last month above target at $540 million.

Manish Kejriwal, founder and managing partner at Kedaara, claims he is seeing far more interest in these deals than anticipated. Some of this interest is coming from first-generation entrepreneurs who want Kedaara to bring its expertise into their businesses.

"They usually retain a significant minority ownership but hand over the day-to-day running of the business to us, and exit along with us after 4-6 years, creating much larger overall value," Kejriwal explains.

Vivek Gupta, partner at BMR Advisors, adds that there has been a change in attitude towards selling out. Ten years ago it carried a stigma, but now there are potential deals to be done with entrepreneurs who run INR5-10 billion businesses and are not able to ramp them up to the next level, or make them large enough to compete with global rivals.

The slowdown in India's economy and lower growth in a number of markets could be part of the reason why. "Entrepreneurs looked at their likely personal return from hanging on and growing with the market 4-6 years ago," explains Shashank Singh, partner and head of the India office at Apax Partners. "That personal return now is probably lower now if they were to do the same analysis."

The structural decline has also contributed to more reasonable valuations, which means deals have a better chance of closing, although there is still an expectation of a premium for control.

Strategic imperative

However, buyout firms face a number of challenges in a business and commercial context, and also from a leverage, structuring and regulatory perspective. Competition from strategic investors is one of them.

The value of announced M&A deals involving Indian companies stood at $43.4 billion last year, up 12% on 2011, according to Thomson Reuters. But corporates, foreign and domestic, have won most of these.

Recent transactions where PE firms have lost out to corporates include Prizm Payment Services, a provider of ATMs and point of sales systems to financial institutions. Japanese tech giant Hitachi beat out financial investors to acquire Prizm from Sequoia Capital and other minority shareholders.

In February, GPs also lost out in the bidding for the injectable drugs unit of Strides Arcolab to Pennsylvania-based generic drug maker Mylan.

Strategics have the advantage of big balance sheets, in-house management capabilities and the ability to deal with long gestation periods. This gives them a comparative advantage particularly in the current environment.

"If it's a deal where a promoter is substantively exiting, which means he's selling more than 80% of his equity, then in most cases a strategic will win," says BMR's Gupta. "But if the deal is for between 51% and 75% of equity, where the promoter is seeing a definite value addition come from the private equity investor, then the PE is also in play."

Value addition and operational ability then is key to making the most of the current opportunity. While the likes of KKR and Apax have for some time been able to bring in specialist global teams to complement their on-the-ground presence, younger GPs such as Kedaara have to work quickly to build up their capabilities in this area.

Keen to use control as a means of differentiating itself, Kedaara wrote value-add into its DNA. A partnership with Clayton Dubilier & Rice (CD&R) helped the firm develop systems to bring in operating partners, and establish how they would work alongside portfolio companies. The firm's operating team includes Pramod Bhasin, Sanjeev Aga and Vindi Banga, ex-CEOs of Genpact, Idea Cellular and Hindustan Unilever, respectively.

"We will also do growth capital deals," says Kejriwal, "but I think our key differentiator is the fact that that we have highly respected CEOs as operating partners providing strategic and operating capabilities and as such, the majority of the deals in our pipeline are control deals."

New Silk Route Partners has also been bulking up in this area. Last year, it appointed a strategic advisory board to identify global opportunities for portfolio companies. It includes Supratim Bose, previously of Johnson & Johnson Services.

The emphasis on operations is further amplified because control deals in India do not follow the traditional leveraged buyout model of using debt to multiply returns on equity.

Buyouts of IT companies, where clients are primarily based in the US and Europe, have all used leverage. This is driven by the fact that if there are cash flows overseas they can be used to service overseas debt which is US dollar-denominated and therefore cheaper. But adding leverage to a purely domestic company is difficult - offshore money can come into India only as an equity instrument, and there are restrictions on the lending ability of Indian banks.

Past deals, such as KKR's 2006 buy of Flextronics Software System, used structures to push down the overseas leverage into the Indian company, but that was under a different set of regulations. It is much harder to replicate this approach under the current rules and as such domestic deals tend to be all equity.

However, Partners Group's Driver notes that people are increasingly finding new ways to get leverage in. "It may not be the leveraged buyout structure of overseas, it may just be increasing the leverage used to fund the growth of the business, but effectively some leverage will be required for investments to make their target returns," he says.

For his firm, this is an added bonus on top of the economic and generational factors that are making India are far more attractive market than it has been in the recent past. "We've actually invested more in the last 12 months than we did in the prior four years," Driver adds.

SIDEBAR - Regulatory obstacles

The acquisition of a majority stake in a listed company is made more complicated by the Securities and Exchange Board of India's (SEBI) takeover regulations. Any acquisitions resulting in entitlement of 25% or more of voting rights in a listed company triggers a mandatory open offer for another 26% from public shareholders, on terms that are not inferior to the terms on which substantial shareholders make their investments.

After the initial threshold, acquisition of voting rights exceeding 5% in any financial year triggers open offer obligations. If an acquirer crosses a 75% stake, they have to sell down to 75% before launching a delisting offer.

When The Blackstone Group bought a 97.9% stake in Agile Electric Sub Assembly in July for INR3.3 billion ($53 million) it also got a 62.8% interest in Agile's listed subsidiary Igarshi Motors. It had to make an open offer for another 26% stake of Igarshi Motors at INR65 a share, a premium of 8.4% to the last traded price, which cost it as much as INR517 million.

SEBI amended these takeover rules in 2011 to bring them closer to global practices. The stake an acquirer can buy in a listed firm without triggering a public offer was raised from 15% to 25%. This trigger threshold is 30% in Singapore and Hong Kong.

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• Topics
• Buyouts
• South Asia
• Buyout
• buyout
• India
• Partners Group
• The Carlyle Group
• Apax Partners
• Kedaara Capital