PEs show preference for controlled deals

In a recent deal, US private equity (PE) firm KKR bought 70 per cent stake in investment bank Avendus. In two recent deals, Fairfax India Holdings picked up 71 per cent in speciality chemicals maker Adi Finechem and 74 per cent in National Collateral Management Services. In August, Sequoia Capital bought a significant minority stake in Groupon India and re-branded it nearbuy.

The common factor in these deals is that they're all 'controlled transactions', where the PE investor has acquired more than 51 per cent stake or is the largest investor in a company with significant minority stake. PEs, who have been living with minority stakes in Indian firms, are increasingly showing a preference for controlled deals in India, hoping for faster exits and better returns.

"Minority stakes may have worked out (in the past). But today, we have so much operating experience. With controlled deals, we can control our destiny better and guide the outcomes (vision, implement strategy and exits) better," Sanjay Nayar, member of KKR and chief executive officer (CEO) of KKR India, said in a recent interaction.

According to M K Sinha, managing partner and CEO of IDFC Alternatives, who has done a couple of controlled deals, such deals provide flexibility. "You can drive the operations the way you want; you are not dependent on someone else. You can take the company forward with greater control, ensure better governance and outcomes."

 

This was evident in the PE firm's exit from Green Infra, a company incubated by IDFC Alternatives, where a subsidiary of Singapore-based Sembacrop bought 60 per cent for $227 million. "We had the ability to control that sale. We were not dependent on a partner (read promoter) on when to exit," says Sinha.

Globally, PEs do a buyout, turn around a company, and sell it. In India, they were forced to pick only minority stakes as Indian promoters were not willing to cede control. Minority stakes often meant limited say in operations and strategy, and in some cases, differences and disputes with promoters. ''When you are in minority, what do you say? You had cases like Lilliput, where the promoter went crazy with stores," says a PE manager, who doesn't wish to be quoted on this.

The problem with minority stakes is the degree of control. ''You are dependent on the majority shareholder for compliance, governance,'' says Sinha. While a PE firm wants to exit in five, seven, or nine years, the promoter may have a different horizon for an initial public offering. "Minority stakes imposes a lot of restrictions for PEs to influence strategy and outcomes," says Toshan Tamhane, partner, Mckinsey & Co.

"While India has been a minority growth market, there's a window of opportunity as the corporate world is over-leveraged and promoters pare stakes in companies to cut debt," Sinha adds. This provides opportunities for PEs to do buyout deals. The second opportunity comes from young entrepreneurs in information technology or start-ups, who are willing to sell out and think they can build something again from the scratch.

Tamhane feels both demand and supply side factors are aiding controlled deals. One, PEs are more established on the ground, understand the regulations and are not scared to do buyouts. ''They have learnt the lessons of how to do control transactions better," says Tamhane.

Two, in mid-market deals, control becomes very important: you can bring professionals or do a strategic sale. Nobody wants to buy a minority stake if the promoter holds 70 per cent stake. When PEs have controlling stake in a firm, they can leverage the same. While leveraged buyouts are common in the West and rest of Asia, Reserve Bank norms don't allow acquisition financing. "So, what many PEs do is lever up outside, say in Mauritius, where it is domiciled," says Tamhane.

There are a few supply-side factors at play. In some cases, the promoters want to sell as the next generation is not keen to run the business. In some cases, if it is a small business or not a core business of a large business group (like Mahindra Logistics), where promoters might be comfortable spinning out the company and selling to a PE. In some other cases, a promoter might not have the capacity to take it to the next level, and want to grow using a PE money (For example Avendus, where the lending business would need a large amount of funding, which KKR is providing.)

However, not all controlled deals have worked. Some like Paras Pharma might have provided big upsides to investors, but others such as Gokaldas Exports, Nilgiri, Nirulas have been a drag.