Private equity (PE) investors have traditionally invested in the Indian marketplace as ‘financial investors’, acquiring a minority stake in their target with negotiated contractual rights to oversee their financial investments.
The past few years have borne witness to the trend of acquiring “controlling stakes” in the target. Data gathered from public sources suggest that the total value of control deals in India went up from USD 4.8 billion in 2017 to USD 5.9 billion in 2018.
Some of 2018’s notable “control deals” include:
- Acquisition of 49.70% stake by KKR & Co. Inc. (KKR) backed by Radiant Life Care Private Limited in Max Healthcare Institute from the South Africa-based Life Healthcare Group Holdings, which would go up to 51.9% post restructuring of the entities.
- Acquisition of 60% stake by KKR in Hyderabad based environmental and waste management solutions provider Ramky Enviro Engineers Limited.
- Acquisition of 100% stake in Vishal Mega Mart Private Limited by the Partners Group and PE firm Kedaara Capital.
- Acquisition of 74.3% stake in Monet Ispat & Energy Ltd. by AION Partners along with JSW Steel Ltd.
Why this sudden flare up?
The year 2018 turned out to be the most successful year of exits for PE funds, mainly on the back of the USD 16 billion Walmart-Flipkart deal, with data from public sources suggesting that the value of PE exits in 2018 almost equaled the combined value of exits for the preceding three years and nearly doubling 2017 figures.
Some of the notable secondary transactions that took place include:
- Lighthouse Advisors Pvt. Ltd (via an affiliate, Lighthouse India Fund III Ltd) acquired the stake held by TVS Capital Fund (via TVS Shriram Growth Fund) in Nykaa.
- Sequoia Capital, SAIF Partners and Nexus Venture Partners purchased the stake held by WaterBridge Ventures in the Bengaluru based education start-up Unacademy.
- Partial exits were made by Accel India, Bessemer Venture Partners and Helion Venture Partners, from app-based cab service provider Ola pursuant to the acquisition by Temasek.
These exit trends indicate that Indian markets are maturing and the ability to control the terms of exit typically assure investors of better returns. This has been a primary driver for increasing interest of PE investors in ‘control-deals’ and their ability to determine ‘when’ and ‘how’ to exit the investment, independent of promoter intervention.
Volatility in public markets has impacted some PE-backed public offerings, but learnings from the initial public offerings by Aavas Financers Ltd, the offer for sale by Tata Opportunities Fund in the initial public offering of Varroc Engineering Limited and the offer for sale by TA Associates in TCNS Clothing Co., suggest that exits through ‘public markets’ for private equity investors are potentially lucrative opportunities.
Control deals are also attractive to a PE investor possessing significant sectoral expertise to operate, govern and manage businesses, thereby ensuring optimal value for the investment made. Along with their own sectoral experience, PE investors also engage independent professionals to manage their businesses, so that their ‘targets’ operate with higher standards of “corporate governance” and are typically immune to promoter biases.
Market studies suggest that many entrepreneurs and mature family businesses, who have past experience of working with PE investors, are not averse to ceding control over their businesses/secondary businesses in order to build a bigger and better managed company.
Stressed Asset Acquisitions
The new regime prescribed under the Insolvency and Bankruptcy Code, 2016 has also presented opportunities to many PE investors to acquire stressed assets along with partners they have past relationships with.
Some of the notable stressed asset acquisition proposals include:
- Acquisition of Monet Ispat & Energy Ltd by AION Partners and JSW Steel Ltd.
- Edelweiss Asset Reconstruction Company partnering with Oaktree Capital to purchase the debt owed by GTL Infrastructure to a consortium of lenders.
- SSG Capital Management purchasing the stake held by Future Consumer Ltd in Amar Chitra Katha Pvt. Ltd. (which had a negative net worth for the financial year 2018).
Several fund houses have also demonstrated keen interest in raising funds dedicated exclusively to the turnaround of stressed assets, for example: i) Edelweiss Alternative Asset Advisors Ltd.’s private credit fund has formed Edelweiss India Special Asset Fund-II; ii) Bain Capital Credit and Piramal Enterprises Ltd have established the India Resurgence Fund; and iii) Aditya Birla Capital Limited and Varde Partners have also formed a joint venture for this purpose.
Challenges Faced in PE ‘Control Deals’
In every PE transaction, there are always relevant issues associated with i) whether the PE investor had real control over the target and had permitted the promoter to run the business, or whether the PE investor was in actual operational control of the business; and ii) whether control over the board necessarily implied operational control over the business. The discussions around these issues become more complex where there are multiple investors with different horizons/objectives/exit timelines.
At the time of exit, where a company is operated by the management team/promoter, an outgoing majority PE investor may only wish to conclude an “as is where is” deal and not provide elaborate representations and indemnities to the acquirer (as the PE investor may not be in a position to verify those). However, an acquirer may insist on extensive operational representations and indemnities from the PE investor given that the PE fund was in “control” of the target.
In cases where the majority PE investor runs a professionally managed company, it may not be feasible to clearly pinpoint accountability for business risks. In such cases, PE investors could typically consider indemnity insurances, comfort letters from the manager of the funds for providing necessary assurances to the proposed acquirer.
When multiple investors are involved, inter se issues in relation to valuation, timelines for exit, and mode for exit also have to be ironed out prior to completing the stake sale.
Even during the growth phase of the target, when the PE investors are focusing on creating year-on-year value for the business, there are operational challenges that include, setting of appropriate performance parameters for its management, aligning operational processes with the investors’ best practices, dealing with regulatory authorities and mitigation of liability for professionally managed businesses.
If past trends are an indication for the future, it is evident that Indian private equity markets are maturing over the years and (in line with global practices) PE investors will continue to seek control opportunities for better value creation for their investments. This will result in better performing and professionally managed Indian companies.