'Buyouts can give a big fillip to growth'

Q&A/ J M Trivedi

Private equity (P-E) fund Actis Advisors has been active in the emerging markets with a total of $55 billion assets under management.

In India, Actis has made investments in excess of $500 million, including investments of its previous avatar CDC Capital. J M Trivedi, managing director of Actis Advisors, spoke to Kausik Datta and Reena Zachariah about his view on the Indian market and the fund's strategy for India. Excerpts:

There is a raging debate on whether the stock markets are overheated. What is your take on this?

To answer the query, we have to take a call on the earnings growth that we are anticipating in the medium to long run. If we assume that the GDP growth will be maintained at 8-9 per cent in the next threefive years (being a P-E fund, our investment horizon is three-five years), and hence the earnings growth momentum will be maintained then we can safely say that the markets are fairly priced.

In case of an economic scenario where the growth rate hovers around 7-8 per cent, we may expect some correction in prices. But it would be a concern if the economy slows down to 5-6 per cent rate of growth. My personal view is that economy will continue to grow at 7-8 per cent.

But valuations are higher now...

Yes, P-E valuations have increased in the last two-three years. One reason for the increase is that the liquidity(funds inflow) even in the P-E space has increased significantly due to new entrants in the market.

During the last two years, we have witnessed a lot of new entrants in the market who were lured by the success of the existing ones and the growth potential of the country. They can be categorised in two distinct groups.

Those which are established P-E players in other geographies but did not have a presence in India and the new players (first-time fund managers) who forayed into the P-E space after having successful careers in other disciplines.

As more players enter, the liquidity increases and the valuations also increase. However, the market has also grown nearly three-fold in the last two years. In 2005, the P-E investments stood at $2 billion which galloped to $6.5-7 billion in 2007.

So the market is expanding and the valuations are going up. This means the competition is also hotting up. Does it mean that P-E funds will now target lesser return on investments?

P-E funds, globally, eye at least 25 per cent IRR on their investments. The investors of these funds do not dilute their expectation because the market is hotting up. They will migrate to other countries if they do not get their expected return here.

But there is a basic difference between P-E investment and stock market investment. P-E funds are not short-term players. They want to hold on their investments for three-five years. Again they expect most of their returns to come from value addition to the companies they get associated with, resulting in top line growth as well as improved profitability.

But there are companies that don't like outsiders interfering in their operations.

Yes, there may be companies which believe that P-E funds do not add value. At the same time, let's face it "" all investors are not capable of adding value. Only those funds which have sector/operational expertise can add value. We have sector experts in our London team and operational experts in our Indian team. Our advisory panel has industry leaders who are very well respected and our investee companies seek their advice.

When a P-E fund adds value to the investee company it not only increases value (return on investment) for itself but for all the stakeholders in the company. The value for shareholders of many of our investee companies has multiplied during our investment period. Glenmark Pharmaceuticals and UTI Bank are some examples.

What view does Actis have on the Indian market?

Actis has been investing in P-E in India for more than a decade; and has seen economic cycles. The investments made and the funds under management exceed $700 million in India. We have a very positive view of the Indian market.

What is your investment strategy?

We invest in growth capital as well as buyouts. In growth capital deals, we take a minority stake in fast growing companies and back the promoters/the management team.

In buyout deals we acquire non-core assets from MNCs/large corporate groups or from families which do not have succession or where the second generation is not interested in running the family business. We partner with entrepreneurial management to grow the business to the next level.

Normally the focus that is brought to the business combined with the entrepreneurial energy of the new/well-incentivised management team results in much faster growth and increase in value for all the stakeholders. Buyouts can make a tremendous contribution to the economy by tapping the entrepreneurial energy of the professional managers to build value.

For growth capital deals, we chalk out the growth sectors first and then the targets. We have a big research team of 18 people in three offices. We do a lot of proactive work like research about the sector and companies before we make our investments.

Paras Pharmaceuticals and Veeda are recent examples of our growth capital deals while Pheonix Lamps, where we bought the promoters, and Nitrex, where we bought a business from ICI, are examples of management buyout.

Which are the sectors you find attractive?

The healthcare services sector is one of the areas we find interesting for investment. There is huge scope in this sector as the infrastructure is inefficient. The quality of infrastructure is also a problem.

The consumer goods sector which is benefiting from favourable demographics and higher disposable surplus also has a huge potential. Many manufacturing sectors where India is emerging as a global hub (for example, the auto component sector) and sectors that are servicing the fast growing infrastructure also have good investment potential.

Don't you think foreign P-E investments need to be regulated?

Foreign P-E funds are treated as foreign direct investment and are subject to FIPB and RBI regulations. If they invest in quoted companies they are subject to Sebi regulation. I think it is well regulated.

Do you see a further scope of liberalisation for P-E funds?

Holding companies owned by foreign P-E funds are not allowed to raise debt to fund buyouts in Indian markets. This is one area that needs more attention from policymakers.