Raja Kumar is the founder and CEO of Bangalore based Ascent Capital Advisors which manages $600 million worth of funds. He is one of the early leaders of the Indian private equity industry and recently raised a $350 million India focussed PE fund in a tough global environment. Prior to this embarking on the PE business, he served as a senior officer at SEBI. He is among the rare class of civil servants who have ventured successfully into the exciting capital markets domain. In an interview with Raghuvir Badrinath, Raja Kumar share his perspectives on the growing stature of private equity in India.
You have been a senior officer in the regulatory body, Sebi, and a former civil servant. Do you think the current regulatory environment is suitable for the PE industry?
Perhaps now I can say that it is relatively easier to regulate than being regulated.
Currently VC/PE funds are channelled into Indian companies through FDI, FII and FVCI routes. All these routes are well regulated and tracked. But regulators seem to look at the PE asset class with certain amount of mystique even though they are well aware that PE is long term capital that creates jobs, enables GDP growth, boosts taxes and facilitates R&D. Needless to say, today portfolio capital has a better regulatory regime and clarity than value creating PE capital.
However, two important proposed reforms are expected to bring much needed clarity. First, clear tax pass-through for PE funds in the Direct Tax Code. Second, the adjustment of the trigger rule from 15 per cent to 25 per cent under the takeover code. The latter is expected to bring significant change in the listed segment with many illiquid listed companies being able to tap PE capital and consequently improve corporate governance practices.
The outlook for PE in India is bright with a fast developing economy and favourable regulatory environment - PE has the potential to fund $ 70-100 billion over the next 4-5 years.
Do you think such robust PE fund flows are sustainable?
Global investors (limited partners) seem to be allocating capital based on the macro-economic outlook of India. There is investment demand from companies looking to expand, especially in sectors such as infrastructure. So, the capacity to absorb these inflows exists. The exit environment also looks robust, with supportive public markets and opportunities for M&A (mergers and acquisitions).
However, as of today, PE returns in India are nothing to write home about. To sustain this pool of capital inflows, investors need ‘PE kind of returns’. PE is still a relatively new asset class in India and few PE managers have a proven record of generating returns through exits. Many of these managers are first-timers who have not been through a complete PE life cycle. They seem to understand investing well; however, realising exits is a different ball game. Besides, entry valuations are already high, so PE managers have to generate expected returns only through earnings growth, which is not easy to realise.
What is your current perspective on the PE industry?
During the 1990s access to capital was limited and typically companies took the IPO route to raise capital. That’s why we are burdened with 6,000+ listed companies in our public markets. Today, Indian entrepreneurs have vastly improved access to capital with the presence of more than 300 VC/PE funds. This has shifted the balance of power to the entrepreneurs/promoters with more capital chasing few quality deals. It is a great time to be an entrepreneur now.
In the current environment the valuation differential between private and public companies is non-existent. Entrepreneurs of private companies expect public market valuations or even premium over their listed peers. Besides, unlike in China and other parts of the world, deals in India are heavily intermediated and aggressively marketed. In a majority of cases, the primary criterion of promoters is valuation. Promoters prefer raising capital at the heights of the public markets and defer it during down markets even at the cost of postponing growth.
What are the key challenges faced by PE-backed companies?
In the current environment, the biggest issues faced by companies are not the absence of a sizeable order-book or dearth of capital but execution challenges and the ability to hire and retain talent. This is where experienced PE managers can add value.
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What are typical issues you encounter when dealing with family owned enterprises?
Most PE investments in India are minority investments. Operating as minority shareholders and influencing entrepreneurs to create value is not easy. The majority of Indian entrepreneurs expect PE funds to be passive investors. We, being a local team, believe we have a better insight into dealing with family-dominated Indian businesses. We strive to establish a good working relationship with entrepreneurs and aim to complement them by adding value in evolving the right strategy, recruiting talent, assisting in inorganic growth, etc. The style of engagement is collaborative in nature, rather than the ‘control’ approach typical of PE funds around the world.
Why are PE funds more inclined to invest in PIPEs (private investments in public equity)?
PE funds are attracted to companies of a certain size. For example, to deploy $20 million for a minority stake of 20 per cent, the target company needs to be valued at $100 million. To justify this valuation, the company needs to have an Ebitda (earnings before interest, taxes, depreciation and amortisation) in the range of $15-20 million. Not many companies in the unlisted space have this critical size. Of the 6,000-plus listed companies, about 90 per cent are characteristically akin to private companies, with small revenues and profitability. Such companies need capital to grow and can be expected to produce ‘PE type of returns’.
Added to this, PE funds are finding cheaper valuations in the public markets than in the private ones. With the proposed change in the takeover code, where the threshold for making an open offer has been moved from 15 per cent to 25 per cent, we can expect more action from PE funds in the listed space.
Many captive fund managers are leaving to start their independent funds. Why this trend?
Independent teams coming out of captive funds commonly referred to as ‘spin-offs’ is not uncommon PE business. There have been series of spin-offs or management buyouts in well developed PE markets such as US, Europe and Australia. We have to realise and appreciate that PE is essentially a business dictated or directed by the limited partners — they tend to shape the structure of PE firms according to their liking. We, in India, who predominantly depend on overseas LPs for funds have no choice but to evolve a structure that gives them maximum comfort. Typically LPs preferred Independent teams to captive / affiliated teams for the reasons best known to them. Our spinoff as ‘Ascent Capital’ from UTI Ventures is one such win-win model between the team and UTI group.