Negative carry

The winter of 2006 dawned on India in a rather dramatic fashion. Li Ka-shing, the then 78-year-old big boss of the Hong Kong-headquartered Hutchison Whampoa, often referred to as Superman, set the ball rolling when he put his Indian mobile operations on the block. Hutchison Essar had a subscriber base of around 24 million in the world’s fastest-growing cellular market and was getting bids from some of the biggest names globally. Valued at over $20 billion, in just over a decade this business had become the jewel in Hutchison’s crown and Li knew he was all set to make a killing.

As the temperature dropped, the action around the Hutchison-Essar deal was heating up. With names like Vodafone, Maxis and Verizon doing the rounds, it was apparent that this would be the first really big deal of its size in India. A new entrant to the Indian private equity (PE) space, too threw its hat into the ring — but, given its stature in the investment and advisory space, it didn’t go unnoticed even in the midst of all this frenzy. The Blackstone Group had been in India for just about a year then, and figured this was too good a deal to miss. Media reports said it joined hands with the Anil Ambani-owned Reliance Communications to buy out Hutchison’s holding of a little over 50% in Hutchison Essar. The logic was simple — Reliance and Hutchison Essar together would have over 50 million subscribers, making the combined entity the largest mobile operator in India by some distance.

None of this came to fruition, however, as Britain’s Vodafone won the bid and made its much-awaited entry into India. For Blackstone and, in almost equal measure, for Reliance, this was an opportunity tragically missed. There could not have been a better start in India for the New York-headquartered firm. India was the next big opportunity, and it had been on top of Blackstone’s preferred emerging market destinations ever since it decided to enter Asia in 2005. Five years since that Hutch miss, the mobile operator’s eventual buyer, Vodafone, has grown to become the second-largest operator in India. For Blackstone, in stark contrast, it’s been a painfully bumpy journey with little to write home about.  

Late to the party

Why Blackstone decided to look at Asia as late as 2005 has confounded most people in the private equity business. By this time, a host of players like Warburg Pincus, Actis, General Atlantic Partners, and the home-grown ICICI Ventures had established their presence here quite firmly. Indeed, some, like Warburg, had already been around for close to seven or eight years.

The only deal of significance Blackstone had concluded at the time of the Hutch sellout was a small $50 million investment in July 2006 in Pune-based Emcure Pharmaceuticals. This was the phase when companies of various shapes and sizes were in the throes of capital market mania and fund raising was almost a walk in the park. The robustness of such companies would become an issue only a couple of years later when the markets would come crashing down.

Strangely enough, rather than stick with pure PE deals, Blackstone decided to take the Pipe (private investment in public equity) route in a few cases at this stage and acquired stakes in companies like NCC (earlier known as Nagarjuna Construction) and, in early 2008, in Allcargo Global Logistics and Bangalore-based textile company, Gokaldas Exports. Of course, there were also investments in privately-held companies like MTAR Technologies, a Hyderabad-based precision engineering company.

A look at the performance of the Pipe deals shows the degree of Blackstone’s pain in India. All these investments were made around four years ago and are down 20-80% at current prices (see: Trailing behind). Logic would suggest that the folks at Blackstone India are a worried lot, though that is substantially underplayed. “Notional drops in share prices are insignificant as we are not looking at exits currently. Our focus is to build the competitive positioning of our existing portfolio companies by increasing market share,” says Akhil Gupta, chairman and managing director, Blackstone India. He points out that while about $2 billion has been deployed across 15 listed and unlisted companies, another $800 million of private equity is also at work in real estate. Not surprisingly, Gupta is taking a long-term view in terms of value realisation. The question is, if these investments aren’t looking viable after four years, how long will Blackstone have to wait to make money on any of these.  

Handshake gone awry

Executives at companies where Blackstone has investments admit the situation is grim. YD Murthy, executive vice-president (finance), NCC, points out that the real estate sector is going through a very difficult phase and that is taking a toll on his company. Certainly, the markets are making evident their displeasure with the sector. At present, NCC’s stock price is hovering around ₹45. Compare that with Blackstone’s acquisition at ₹202.5 per share. NCC is a key player in the construction and infrastructure space and brought in a consolidated topline of ₹6,252 crore for FY11, which was up less than 5% from the previous year.

“Yes, the working capital cycle has deteriorated. Debt collection has increased from 80 to 120 days. We are caught in a situation where debt levels and interest rates are moving upwards,” laments Murthy. While Ebitda (earnings before interest, taxes, depreciation and amortisation) margins currently hover around 9-10%, the silver lining for Murthy (and, perhaps, Blackstone) is the $1 trillion outlay on physical infrastructure proposed in the 12th Five-Year Plan.

Of course, in the current economic climate, construction isn’t the only sector that’s in the doldrums. The textiles industry isn’t doing well, either — and unfortunately for Blackstone, it has exposure here as well. When Blackstone bought over
Gokaldas Exports in mid-2007 at ₹275 per share, there was already a certain level of apprehension about the textiles sector. These concerns were not entirely unfounded and related to India’s ability to strike it big at the global level.

Today, the scrip quotes at ₹85 and Blackstone, after largely buying out the promoters followed by an open offer, holds a 68% stake in the company. Growth has been hard to come by and Gokaldas’ revenues have remained flat between FY08 and FY11; it was making losses even at an operating level in the last fiscal, having found it difficult to recover from the 2008 global slowdown.

“Textiles is a low-return sector, which has not created wealth for as long as one can see. This is not just an Indian phenomenon. It is one that applies globally as well,” points out well-known investment banker and former head of Carlyle India’s buyout team, Rajeev Gupta. For his part, Blackstone’s Gupta steadfastly maintains that Gokaldas is a strong investment, though he is candid about what has gone wrong. “In the recent past, it [the company] has, unfortunately, suffered as the whole garment industry faced a perfect storm resulting from the global financial crisis. This saw weakening of demand, price squeeze compounded by an unprecedented increase in labour costs and reduction in subsidies,” he says. 

A close look at Blackstone’s Pipe deals reveals that they were all done when the market was at its peak. In fact, when the Sensex dropped quite dramatically below 9000 after the 2008 global meltdown, there must have been several attractive opportunities, but Blackstone seems to have missed the bus. Often, this has provoked a view from rival private equity players that Blackstone does not have the right mindset required for India. The head of a private equity fund who does not wish to be identified believes that has a lot to do with “Akhil’s upbringing in companies like Reliance Industries where there is an obsession with topline”.

As it happens, the topline focus has worked very well for RIL but, as the PE head points out, the approach “doesn’t always deliver shareholder returns”. Gupta, who was Mukesh Ambani’s classmate at Stanford University, doesn’t agree with that thinking. “We invest in companies that can be leaders in their industry, where Blackstone can add significant value and earn targeted return for our investors. These companies are in high growth industries and typically entrepreneur-driven organisations,” he justifies. 

This entrepreneur thrust is visible in an investment like Allcargo, a player in the integrated logistics business offering services across multimodal transport operations, container freight station operations and project & engineering solutions. The company went public in 2006 at an offer price of ₹675 per share. In early 2008, when tremors in the Indian stock market had just started, Blackstone bought in at a pre-split price of ₹934 a share. In a press statement after the deal, Gupta said the Indian logistics sector would experience significant growth in the coming years. “India is seeing buoyant economic growth, improvement in infrastructure and a rationalisation of the country’s tax structure. And Allcargo is an ideal platform for Blackstone to be in this highly attractive sector,” he added.

At present, the stock trades at around ₹130, giving it a pre-split price of ₹650. But S Suryanarayanan, group CFO, Allcargo Global Logistics, is upbeat. “In the last five years, all our verticals have grown impressively and the ability to offer integrated container movement is our strength,” he says. The fund infusion from Blackstone has largely gone into capex requirements, which includes the acquisition of land.

In at least three instances -— Allcargo, NCC and Monnet Ispat & Energy — Blackstone’s investments have come at the growth stage, which perhaps made its task tougher. “Being primarily a growth capital market, many funds in India look to invest in mid-size businesses, which lack systems and processes. This makes it difficult to assess the robustness of businesses during the diligence stage,” points out Jayanta Banerjee, managing partner, ASK Pravi Capital Advisors. 

If there is consternation about Blackstone’s poor strike rate, there is also unanimity among PE players about how tough the Indian market is. A quick look at the top deals (over $50 million) of the past few years shows only a few sparkling performances (see: How big PE deals have fared). According to Banerjee, business owners in India are keen on maximising valuation when they raise capital. “Many a time, they are ready to sacrifice growth if they do not get the desired valuation,” he explains. Indeed, most PE firms have had more success in Pipe deals than pure play private equity. 

More often than not, a couple of great investments take care of a bunch of just about mediocre deals. A case in point is Warburg Pincus’ $300 million investment in Bharti that eventually raked in $1.8 billion. Then there’s ChrysCapital’s investment in Spectramind, where it made a 5X return, or its almost unbelievable 12X return in Shriram Transport. Interestingly enough, it acquired a 2.6% stake in the Blackstone-invested NCC in May last year for around ₹99 a share and some more a couple of months later for ₹54. 

What’s worrying is that there has been no such remarkable return on any of Blackstone’s Pipe deals. Considering it’s invested nearly $500 million in India in Pipe deals alone, that’s hard to comprehend. The PE firm also invested $50 million for a reported 12% stake in Jagran Media Network, the holding company for the listed entity, Jagran Prakashan. This group’s flagship brand, Dainik Jagran, publishes over 35 editions across 11 states. Apart from this, Jagran Prakashan has a presence in outdoor advertising, internet and mobile value-added services.

The holding company’s stake in the listed entity stands at over 55%. From the time the investment was made, the stock has fallen by over 20%. According to RK Agarwal, CFO, Jagran Prakashan, his company has a debt of just ₹80 crore. “We have a lot of liquidity and are not really in need of funds. Blackstone said they were not interested in a transaction if it was anything less than $50 million. The funds that have come in will form our war chest,” he says.

Blackstone’s soft corner for the media space first surfaced when it agreed to invest $275 million in the Hyderabad-based Ushodaya Enterprises, which owns Eenadu. The deal was eventually called off after it got embroiled in regional political tussles and failed to get the go-ahead from the FIPB. “It’s not hard to explain why Blackstone managed to get it wrong on all its Pipe deals. It is a combination of not buying at the right valuation and investing in sectors that have historically been volatile,” says the earlier unnamed PE head.

Power Back-up

Of Blackstone’s corporate PE investments in India, 40% has gone into the power sector. Is that not a case of too many eggs in one basket, given the ambiguity that abounds the sector? Gupta is unruffled. “Yes, there are uncertainties in the power sector, though the investments we have made are not as much impacted. This is simply because our plants’ primary fuel source is either a captive coal mine or linkage coal that is backed up by captive means,” he says. Blackstone’s investments in the power sector include projects like Monnet Power, Moser Baer Projects and Visa Power. The worry is that Blackstone appears to have overpaid at an early stage in most of its power investments.

Ratul Puri, director, Moser Baer Projects, readily accepts that the sector is fraught with challenges. “This relates to the availability of coal and long-term funding,” he says. His company has plans for thermal, hydro and solar power projects. Though Blackstone has invested $300 million in his company, Puri declined to comment on breakeven targets and agreements signed.

Executives at Monnet are a little more forthcoming. Here, the $60-million investment in the power project in 2010 was followed last year by the open market purchase of shares in Monnet Ispat & Energy, the company that holds an 87.5% stake in the power business. Monnet Ispat is a steel producer with manufacturing facilities in Raipur and Raigarh in Chhattisgarh. Sandeep Jajodia, executive vice-chairman and managing director of the company, says its 1,050 MW thermal power plant in Angul, Orissa, is backed with a pit head coal mine. “This not only ensures availability of coal but cuts down on logistic costs, making us one of the lowest-cost generation units across the world,” he claims.

Monnet Power’s plant has an outlay of ₹5,000 crore. Blackstone has picked up a 12.5% stake in the company. “The money from Blackstone will be used to take care of the equity requirement for the first phase of 1,050 MW,” says Jajodia, who adds that the funds are in place, apart from contracts that will allow him to sell power at an average tariff at ₹2.80 per unit.

What the new entrants in the power sector are banking on is a high valuation exit. That may be rather difficult, given the cloud of uncertainty around the sector. What does not come as a surprise, though, is the intention of promoters to list their companies at some point. Jajodia, for instance, speaks of financial closure having been achieved for his first phase. “While there is no urgent requirement of funds for the current power projects, Monnet Power would explore the option of approaching the markets while setting up the remaining 1,320 MW power plants.” Moser Baer Project’s Puri is more definite and says he will list the company in the next five years. “Sizeable operational portfolio and  market conditions would determine the timing of the listing,” he says.

For a while now, worries around the power sector have remained and seldom without reason. The prime one being that Coal India will be able to cater to only 50% of the requirement of power projects. This issue gets even more complex since 60% of thermal capacity under execution by independent power producers is based on domestic coal. With the rest coming from imports, costs could seriously spiral out of control. An Icra report on the power sector predicts that higher coal prices for many thermal projects could adversely impact returns and undermine debt servicing capability of the project promoters. “This will be more so for those that do not have a “pass-through” of fuel costs in their power purchase agreements,” it states. 

There’s also the issue of timely completion of infrastructure projects. “The inability to complete projects on time results in investors not being able to see returns that were projected at the time of investment,” agrees Banerjee. Rajeev Gupta thinks the fault lies more with the government on decisions like preserving the monopoly structure in coal mining and rail freight. “Now, the government has proposed a land acquisition regulation that will halt the progress of land-intensive industrial projects such as power generation. Given the government’s unwillingness to reform, new power generation projects in India have risks that are beyond the appetite of any rational investor,” he explains. 

From Blackstone’s Gupta’s point of view, what has attracted him to his investee companies is their ability to manage costs. “As such, with any commodity, we believe that the lowest-cost producers will be the eventual winners in the power sector and we have backed some of them. Overall, we see huge potential and attractive growth opportunities in the sector, which is why we have committed close to $800 million over the last year and a half,” he says.

Will the tide turn

That may sound like a lot, but even the most cursory glance at Blackstone’s global PE portfolio will give an indication of how small India actually is to this giant. In less than a quarter of a century, Blackstone’s PE business has invested in 160 transactions with a total value of $300 billion. In mid-2007, it acquired Hilton Hotels for $26 billion, which included $6 billion in debt. Other multi-billion dollar buyouts include US cable and satellite TV network The Weather Channel for $3.6 billion and the California-based Apria Healthcare Group, a home healthcare services provider, for $1.6 billion.

In emerging markets, Blackstone, in September 2010, acquired a 40% stake in Brazilian PE group Pátria Investimentos. As for China, Blackstone has invested $1.65 billion across three businesses — healthcare, agricultural produce and specialty chemicals and in a media interaction in late 2010, Blackstone’s chairman Stephen Schwarzman spoke of investing another $3 billion over the next five years in India.

Blackstone has moved quite quickly in the recent past in the real estate space as well, investing over $350 million in 2011. In September 2011, Blackstone also sold its India-focused mutual fund that managed $1.22 billion and its $60 million Asia Tigers Fund to Aberdeen Asset Management. The big news has been a potential buyout of Reliance Communications’ tower business. While the potential size of the deal could not be ascertained, media reports have said both Carlyle and Blackstone are at an advanced stage of negotiation.

The one feather in Blackstone’s India cap has been Intelenet, a Mumbai-based outsourcing company, where Blackstone held a 67% stake. This was sold to UK-based support services player Serco in June last year, for $634 million. In 2007, Blackstone bought Intelenet for around $200 million. The other 33% in Intelenet was held by its employees, HDFC and Barclays Bank. “It is the only exit we have made so far and it is clearly one of the most successful exits by a private equity major in India with around a 3X return on investment,” says Gupta.

It has not been the easiest of times for PE firms in India. The choppy markets have been merciless, with large players like Carlyle’s investments in India Infoline and Edelweiss or Sequoia’s investment in Ess Dee Aluminium being down by at least 20%. On the last working day of 2011, Arka Capital — a PE firm co-founded by Rajesh Khanna, ex-Warburg Pincus’ managing director — decided to shelve plans to raise $400 million citing a tough business environment. This was barely eight months after it announced plans of setting up the fund. The challenges of the market aside, Rajeev Gupta points out that another issue is that most PE partners in India tend to have a background in financial services, not industrial operations. “Since PE value-add is low, PE investments have not generated high returns in India,” he states.

For Blackstone, the next phase in India will be about making the right investments and getting rid of its underperformer tag. Anyone in the PE space will readily say that anything less than a 20% return in dollar terms is just not worth it. 

Query Blackstone’s Gupta on how he defines ‘good return’ and pat comes his answer. “It means exiting a business when we have realised the value of our initial investment and have helped the business scale up to the next level as a solid and high performing company.” He must be hoping that each of his investments manages to do exactly that.