Starting in 1998, Rahul Bhasin has seen the evolution of private equity in India. In an interview with Ranju Sarkar, the Managing Partner of Baring Private Equity Partners India talks about his investments, outlook and regulations for gold loan companies.
Can you give us an update on your first fund? What percentage of it has been deployed? By when do you plan to invest the remaining amount?
Our first fund was set up in 1998 and was fully invested by 2001. Over twelve times the corpus of the fund has already been returned to investors and approximately $50 million of assets still needs to be divested. We also have a $600 million fund; we have invested roughly two-thirds of it; we have a third to invest.
What the size of your new fund? Will it be an offshore fund or domestic fund? What will be your investment strategy?
We would look at raising another fund sometime in the beginning of 2014. It will be roughly the same size as our last fund around USD $600 million and like all our previous funds, will be raised from global institutional investors.
You are stuck with your investment in Kochi-based broking firm, JRG Securities. How do you plan to exit?
This is one of those cases where our own diligence process was not good. We goofed up on it. We are committed to making this work. There have been challenges, and there have been attempts at every stage to disrupt what we are doing. We are putting together a team and doing all the right things. The industry is also challenged. But we are committed to making this work. It is happening, but it is rather slow.
What were the mistakes?
Our own diligence process was inadequate at that point in time. Being a public company, we could not do a proper diligence. The accounts were not cautious—if you see the balance sheet for the last two-three years, you will see a lot of write-offs subsequent to our investing. But here is a strange thing: I, now as a director of the company, liable for them. We bought the assets in good faith; it’s a public listed company so I should be able to believe what I see. Here is a case where theoretically all the regulations exist, but in process it does not get implemented. So, we have learnt from it—even if it is a public company, you got to do your home work.
Are you planning any exits? Exits have been difficult.
Nothing is on the anvil. We recently had a small exit, and made some decent returns but my colleagues have not announced it yet… Exits have been difficult in India as enforceability of contracts in India is so poor. If companies have not done well, then they are always difficult to exits. If you have overpaid, then there is a reluctance to exit, and in most transactions in India, private equity has overpaid. It’s a function of the maturity of the industry as a whole. It’s a new industry.
Are people willing to take exits with whatever they can make?
Ultimately, that’s what will happen. Right now, there’s no panic anywhere. You have to understand one thing in lots of parts of the world, returns are driven by leverage. In India, private equity uses no leverage. So, your ability to ride through a downturn is that much higher. Returns are lower, but your ability to take shocks is that much higher.
You have invested in Manappuram and Muthot. What was the thinking?
Short term retail loan, especially at the low end of the society is not available. Two-thirds of Indians still don’t have bank accounts. Where do they get the short term money from? From the neighbourhood money lender, who charge exorbitant rates... In lending against gold, these companies are catering to a different segment. They were taking away share from the money lender. Even though they are charging higher than banks, for the customer it is significantly less than what they are used to paying. The vegetable vendor borrows money at the mandi with 1% interest per day.
Unlike banks which are opened from 10-2, these companies are open 9 am – 9 pm, they are open on Saturday, Sundays. There’s a work ethic, there’s a customer service ethics. My own believe is that RBI’s rules and regulations on them is completely misplaced, and stems from RBI not having done their homework. If their average loan duration is 100 days, what is the systemic risk? Then, the RBI has a different set of rules for gold loan companies, and banks doing the same activity. Basel III has said lending against gold is a zero risk-weighted activity. RBI says if you lend against gold, you keep 12.5% capital adequacy---this applies only for these private companies and not for the banks. If you see everything, RBI has done is to ruin these folks, but they are still surviving. Why? Because there’s a huge unmet need. The distribution they have created are larger than ICICI Bank and Axis Bank today. Mannapuram and Muthot. Their IT systems are phenomenal; their risk-management systems are phenomenal. If you go and do your homework, you can find out these things.
Will the outlook change for PE with Shome panel’s views on GARR, retro tax?
Of course, the sentiment has improved dramatically. But to address the fundamental issues (of low returns), you need to enforce contracts. The World Bank, in a study of 183 countries, ranked India at 182, on contract enforcements. Returns will increase when that changes. In retro taxes, my mind the entire incident is an issue of good faith. A government has got to behave like one; it can’t behave like an extortion agent.
As an Indian, I was very embarrassed about the Vodafone incident; what I was more embarrassed about was that no one in the Parliament spoke up about it. I can understand a bureaucrat getting carried away. I can’t understand how the Parliament of our country allows such a thing to get through. This is after the Supreme Court has gone into it in infinite detail, has heard the government. You can’t do this; it is acting in bad faith. Shome panel has done a fabulous job, but the income tax panel has put a claim on Vodafone locally. I think it is shocking. Cannot see how extra-ordinarily poor judgement could be there when the Shome Panel has recognised this is a goof-up.
My own take is that without Shome Panel having happened, a lot of people would have shut down. With Shome panel having come in, they think there was a goof up and the system itself corrected. It definitely restored confidence significantly. But they have to go through with the recommendations; Mr Shome voicing his opinion won’t do it.
You said in a seminar that going forward, returns will be lower across asset classes. What does it mean for the PE industry?
When I started in 1998, there were 40 firms. Then, there were six, and the general view was that you cannot make money in India. Then came the dotcom boom, and 74 new firms were started. And within two years, most of them had shut down, two survived. From eight firms in 2005 firms, we have 1000 firms today. The reality is that most people in private equity don’t know private equity. What they should be contributing to companies often doesn’t happen. The maturity of dealings with corporate is often not there; their judgement is often poor; so as a system, the returns will be poor. ...I would be surprised if more than 30 firms are left at the end of this downturn. It’s a ten-year cycle (the beginning of this cycle was 2007).
Is the industry already consolidating? What are the signals of that?
No, not yet, but it will happen…. It’s like any other industry. If you don’t deliver, you deserve to shut down. The other thing we desperately need is a good bankruptcy law. Assets lie log jammed in unproductive things in the economy for no reason.