Q&A: Samena Capital's Pavan Gupte

Q: The India credit strategy was launched in 2013. How has it evolved since then?

A: It has been positive in the context of what has been going on globally and in India. Prior to 2011, it was difficult for foreign investors to buy into Indian debt meaningfully due to the central bank's restrictions on cumulative debt that foreign investors could own. From 2011 onwards, as India went through a difficult economic cycle, these limits were slowly raised and the local currency debt markets began to deepen. That was the genesis of the current fund: it provides access to the entire range of opportunities in the Indian debt market, from liquid to illiquid. Fast forward to the current environment, yields at the liquid end of the market have compressed a lot. They are not as interesting for foreign investors to access, especially through the more expensive, closed-ended structure that we have relative to, say mutual funds. That is why we are transitioning our investment focus entirely towards the illiquid end, where the gaps remain large.

Q: What sort of illiquid opportunities are you interested in?

A: The sweet spot for us is direct lending and private debt opportunities in the corporate lower middle market, which offers equity-like returns from fully secured loans. India's traditional banking sector tends to focus on the larger blue-chip clients, mid-market companies and then they goes straight to the retail client end. A lot of companies in the lower mid-market strata therefore get left out. There are an estimated 28 million small and medium-sized enterprises in India, and although approximately 90% of these are mom-and-pop shops, that still leaves a universe large enough for us to bilaterally negotiate and underwrite three to five loans per year. We have historically underwritten loans as small as $5 million and up to $20 million - and tactically evaluated some much larger transactions as well - but we like the $10-20 million space. Once you go above this segment, there are all kinds of interested investors, not just alternative lenders like us, but also equity, mezzanine and structured equity providers.

Q: How is the competitive landscape changing?

A: The alternative financing space accounts for 20-30% of the total Indian debt market. Within that, until three or four years ago, 80-85% was real estate financing by the NBFCs. However, since all of the NBFCs rely on getting rated to raise debt, they have had to aggressively diversify into other sectors to reduce their reliance on real estate, thereby improving their ratings. This has increased competition in our space where we've seen the bigger players looking into our lower mid-market lending space as well as the traditional corporate lending space, often with a very little margin for error. On top of the yield compression in India of 175 basis points in the last 18 months, we've seen yields compress more than that in our focus areas due to this competitive dynamic.

Q: To what extent is equity an alternative to credit solutions in the middle market space?

A: Private equity is always a potential alternative to our credit solutions. However, in India there is always a valuation gap, a bid-ask spread where the entrepreneur thinks his business is worth, say 15x EBITDA and the prospective PE investor is only willing to pay 12x. Often it is hard to bridge this bid-ask spread without putting in some kind of ratchet or structure. Whether you define that kind of deal as structured equity or mezzanine - and to the extent it falls within our opportunity segment - yes, it does represent competition. But we've seen that happen at the larger end, not so much our end. Our competition is primarily from the NBFCs.

Q: Within that middle market sweet spot, how do you expect the opportunity set to develop?

A: In emerging markets like India, the sweet spot keeps evolving over shorter time frames relative to developed markets. This evolution could be in the form of distressed debt opportunities because multiple positive structural drivers are getting aligned - tightening regulations, rising non-performing loans and increasing willingness of the traditional banks to sell at a sensible price. Alternatively and perhaps even concurrently, this evolution could be that GDP growth is back on track at 7-8% per annum, leading to an increased demand for growth capital. I have observed that every two to three years there is a shift in the sweet spot so I don't believe in being too narrowly focused - one needs to be nimble enough to adjust based on how the market is evolving. If you look at our portfolio over the last three years, we went long on the financial services sector, where the risk-return paradigm was the best and our returns to-date have validated that approach. Going forward, we believe the opportunity will shift more towards the consumption space. While the gaps in the lending market are large, we don't know where the sweet spot will be three years from now, and that is why we want our fund offering to be of an appropriate duration that is in sync and fully aligned with our visibility on the underlying opportunity.

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

• Topics
• South Asia
• India
• Samena Capital
• NBFCs