'Successful sustainable business when created will always have value and buyers'

This Q&A first appeared in DNA Money edition on Monday June 13, 2011

Warburg Pincus India Pvt Ltd went through a leadership transition in India recently. Niten Malhan, and Vishal Mahadevia, both managing directors, in a rare interview together, talked to Ashish K Tiwari and Satish John on the iconic private equity firm’s past and current India investments, and the strategy going ahead, etc. Edited excerpts:

Warburg Pincus was one of the earliest private equity players to enter India...
Niten Malhan: Among the larger private equity firms in the world, we were probably the first or among the first definitely to make a very significant Asia move. If you think about Warburg Pincus, its genesis and growth, it has always played in the entire spectrum with a big focus on growth investing. This doesn’t mean that we don’t do buyouts, it’s, in fact, a large part of our business globally and we are a meaningful player there.

You have a sizeable exposure to India…

Vishal Mahadevia: Since 1994, Warburg has invested over $2.5 billion. The firm has probably invested the same amount in China and India. We have been one of the first large global funds that moved into investing in Asia and India in particular, but probably even one of the fewer groups that has continuously been investing in India. We have seen the various challenging phases in the country thus far, and have continued to invest more and more, gained confidence and today India is a core part of the firm’s investment strategy, philosophy as a global firm.

Malhan: For any business, including the investments, in a new geography and a new kind of business environment, there is an institutional learning that you go through. And I think having been here now for over 15 years, as Vishal put it, we have gone through that learning curve and institutionally understanding the market — the positives, negatives, volatility etc.

It is thus a part of business now; both of us were not part of the 1994 start, but there must have been apprehensions about whether it will work and how. We have gone through that learning and completed the life cycle of investing, seeing investments mature, exiting, returning money to the limited partners (investors in the global fund). We have gone through the cycle quite a few times in India and the process continues thereby building confidence in the management and its overall business here in India.

Between 1994 and 2004, what kind of companies did you look for investments given that private equity was still very new?

Malhan: We are happy to participate in businesses relatively early in their lifecycle and provide capital and whatever help we can through their growth. For instance, there is this Alliance Tire Company which is a very unique mix of various types of investing.

We backed an entrepreneur — Yogesh Mahansaria and his father Ashok Mahansaria — who had come out of an existing business to start a new one in the same area, which is off-highway tyres. We funded and helped them acquire a business in Israel. We then funded them to set up capacity in India; the thesis was that we could use Indian manufacturing, combine it with an international brand and serve export markets etc.

Then we helped do an acquisition in the US to build this business. So we have participated with a high-quality distinctive entrepreneur, provided him with capital and a global footprint and leverage, and he is obviously running and driving the business.

We are quite happy and patient like in the case of Bharti Airtel, which is one of our most famous investments in India. It started with a $30 million investment. We grew over time to become an almost $300 million investment by way of expansion funding etc. So the model is identify high-quality entrepreneurs in scalable businesses and be a partner in their growth.

When you talk about off-highway tyres, does it mean for tractors, excavators?

Mahadevia: It comprises anything that is off-highway, including tractors, mining and construction equipment etc.

How big is this business now compared with when you took it over?

Mahadevia: It was zero when we took over because if you think about it, we were seeding an idea and the entrepreneur had nothing on the ground.

Malhan: The first three months was really spent in identifying opportunities. The debate was, should we do something that’s greenfield or go for acquisition. In the next few months the discussion revolved around potential targets across the globe. Then this Israeli company came up as an opportunity. We valued the business and eventually acquired it as part of a strategic business growth plan for Alliance.

Mahadevia: When the economy took a downturn, we felt more confident with Mahansarias and said let’s go out and find good strategic assets available in the downturn and grow the business. So we business faster and it’s a work in progress. But if you look back four years ago, there was nothing on the ground and today it probably will be one of the top five off-highway tyre producers in the world.

So when the Alliance entrepreneur came to you, he just had an idea and nothing else…

Mahadevia: He had an idea and an excellent track record.

Malhan: He’d run a business like that very successfully prior to our association.

And that was?

Malhan: It was a family business — Balkrishna Tyres — and they had moved out of that entity as part of the family re-organisation. The Poddars continue to own Balkrishna Industries, while the Mahansarias moved out a couple of years prior to that. And they were keen to start this business. This in some ways is an example of the flexible approach to investing that we take where we don’t get bucketed and look for high-quality entrepreneurs and interesting business opportunities.

Patu Keswani of Lemon Tree Hotels would be another similar example of an entrepreneur you’ve backed…
Malhan: Yeah, when we had invested in Lemon Tree, it was operational with just 90 rooms. Today it’s about 1,400 and we hope that over the next 2-3 years it will be 2,700 to 3,000, making it a sizeable player in India. The fundamental point is, we are willing to back an entrepreneur relatively early and be a partner in the
journey.

Not that we don’t invest when businesses are mature. We’d invested in Gujarat Ambuja Cements which was already a large company. When we invested in HDFC it was already an established entity and we saw an opportunity to partner with them. Kotak Bank is another example.

What are the sectors that look interesting these days?

Malhan: There are certain things that have been true 10 years ago and will remain the same in the next 10 years as well. These are themes that are consumption-driven — consumer goods and financial services — to name a few. Things that have emerged today and were probably not so apparent 10 years ago are the broad infrastructure-type themes, which, in the mid-90s, was not as visible.

Mahadevia: Consumption and infrastructure have been the sectors we are investing in and we continue to look at it. There are a few other areas that we have got into recently like power and ports (Gangavaram port), which fall in the infra category but wasn’t available in the mid-90s. When investments in ports opened, we met an entrepreneur who we thought was visionary, was building a project that was transformational. When we’d invested it was just a beach and today it’s India’s deepest and the most efficient port in terms of handling bulk cargo. So we are happy to come at a very early stage and see it grow.

Malhan: Healthcare is another area we have been investing and like to do more because we see it as a very promising sector. In fact, one of the challenges in India is that if you start looking at sectors, you end up basically defining everything.

When you exited Bharti, people felt that you exited too early. But now in hindsight, that seems fine…

Malhan: Our CEO often says a hindsight fund can have infinite returns but that’s not the way we look at businesses. Yes Bharti turned out to be a fantastic investment for us and we are very happy about it. Yes, we could have timed it better, but we don’t spend too much time thinking about those things. We are not into timing things.

If you knew that three days later something would be better you’d obviously wait for it. But based on your best judgment at the time if you did well … I have spent about 10 years in the firm and have never been in a discussion where people have sat and agonised about, ok, if we had done that, what would have happened. That’s not the culture of the firm.

Mahadevia: Just to add to that, the philosophy is that if we do a good job partnering and helping build a sustainable business it will always grow in value after we exit. So any time we look at it, our hope is that the value of the business will be greater from the point which we exited otherwise we have not helped build a great business.

Would you take a relook at the telecom sector now?

Malhan: We haven’t spent any proactive time on it but there is no reason why we wouldn’t. It’s not about whether a sector is good or bad. If we feel there are interesting opportunities that can be catalysed by finding an interesting entrepreneur and if that turns out to be in telecom, so be it.

Which are the sub-segments in telecom where you still see an opportunity?

Mahadevia: Telecom has huge, continued potential in India. Now the point is whether to invest in the carrier, the mobile value-added service provider or a handset manufacturer. Looking at that value chain there are very different themes within telecom. So when entrepreneurs come to us and when we meet interesting people they may have very different themes. I think terming telecom in its entirety as not interesting would be wrong because there is an entire ecosystem around it.

Warburg recently added real estate to its investment portfolio by backing, again, Patu Keswani. What prompted the move given the current state of realty?

Malhan: Yes, it is pretty much our first investment in realty. There are some conversations but we haven’t yet started anything concrete. Our view on real estate is that in the long run there will be a lot of activity and value creation. We have built a very significant real estate portfolio in China in the last 4-5 years. We would love to do that in India as well. If you are taking a 5-7 year view, I think it’s a very attractive sector.

The reason we got talking to Patu is that we know there is a need for housing, especially mid-market — something very similar to his hotel product. And if someone can deliver that with a manufacturing sort of a mindset — like for instance, when you buy a car you get treated in a certain way as a customer. I don’t think you get treated the same way when you buy a house. Most of us feel pretty sad about the whole experience, especially when we buy a property in Mumbai. We’d like to do more in that sector like we have in China.

Could you take us through your investment in ACB India? That’s also one of your very unique investments…

Malhan: Yes it is, and it certainly doesn’t fit into a particular stage of investment. The core of ACB’s business is coal beneficiation or coal washing, which is removing ash and impurities and making the coal more transportable. And over time they have now built a business where they use some of the byproducts to fuel power. ACB is also now getting into mainstream power. When we had made the investment, some of it was to be used to set up the first power plant of scale based on coal rejects.

That plant should be commissioned sometime this year and ACB plans to proceed further in this business. The investment is now five years old and the management has filed to go public and we’ll see how it goes.

Warburg also recently invested in the NDR Group. Can you explain the logic?
Mahadevia: The NDR Group is in the logistics space. When you take a macro look, as the economy grows, logistics will continue to be a more and more important part of both the customer’s and the supplier’s value chain. Logistics costs in India are extremely high partly because of infrastructure bottlenecks and partly because there is no real strong organised sector.

There is an opportunity for smart entrepreneurs to invest in strategic infrastructure assets and build a supply chain management capability to reduce costs for customers. So as we spent time meetings different entrepreneurs we met Continental Warehousing, which is a part of the NDR Group, and we were very impressed with the management team and the entrepreneur and thought this is somebody who has the opportunity to really grow in this space and take it forward and we could provide them with growth capital.

Some of the individuals you have backed like Analjit Singh, Narottam Sekhsaria, Ajay Piramal and Uday Kotak have also got into the private equity business. They competing with you now…

Malhan: Different people are developing those businesses differently. All of them have created very sizeable and successful businesses and are now diversifying into other things. We have never thought of them as competitors. In any case, if you think about most entrepreneurs in India, once they have created wealth they do want to diversify.

There is this talk about investment firms focusing more on proprietary deals as against those coming from investment bankers thereby avoiding overvalued transactions…

Malhan: It’s a wishful thinking. Sure there are transactions occasionally which happen that way. The reality for any market, including ours, is that for any entrepreneur when we are talking of a sizeable investment, he does want the comfort of some price discovery. There are situations where this doesn’t apply, especially in the early-stage investments.

Mahadevia: And in many of these cases, the entrepreneur is looking for a partner and longer-term, patient capital. A lot of our time is spent meeting and talking to entrepreneurs who don’t need any capital today. There is no immediate transaction but we are building relationships. And ultimately, when you have established the relationship and comfort level, that’s when it leads to a situation where you are the preferred capital provider.

Malhan: We invested in Patu a year after first contact. We invested in Gujarat Ambuja over a year-and-half after first talks. With Uday Kotak, it was an existing relationship. Alliance - Yogesh Mahansaria … we had actually started talking to him while he was with Balkrishna Tyres … we were looking at Balkrishna at that point in time.

Has there been any company you thought could have been a very good investment but you didn’t do the deal and now it has flowered to a particular scale?

Malhan: Look, there are always successful investments that people make in the market, about which we would ask, why didn’t we make them?

Mahadevia: It goes back to the hindsight theory. I don’t think we ever fool ourselves that we’d get everything right. We hope to give ourselves more chances to do things right than wrong.

Of the overall portfolio so far, have most of Warburg’s investments been very positive?

Mahadevia: Net-net, I’d think we will be happy to say we are more positive than negative.

Which are potentially the more defining, Bharti-type deals?

Malhan: It’s hard to say when things are still in process. After we bought into Bharti, there was a time when the value of our investment was below cost. So it’s kind of hard to say what will be a success and by how much. That’s part of the risk and the fun of equity investment. While Bharti was a defining deal, we have had pretty reasonable success with a bunch of other investments.

HDFC, Gujarat Ambuja, Sintex Industries, Kotak and Max are very successful investments. There are others in the making that we hope will be very good and there are others where it is less clear at this point.

You have discovered quite a few high-quality entrepreneurs in the last 10-15 years in India. Could you tell us who among them — or generally in India — could be emerging as business leaders in the coming years?

Malhan: I am sure India will throw up a lot of leaders. I don’t know who they are. I hope some of them are in our current portfolio. It is very hard to say five years from today which of them will emerge as business leaders because it is linked to many other things. Some of these companies that are young today will become large and very different enterprises and the people at the helm of those companies will be very different in stature five or seven years from now.

Just to pick a name, five years from now, if Lemon Tree becomes, as it aspires to, one of the largest hotel groups in India, Patu will have a very different stature than now. If Diligent Power becomes a large power company with several billion dollars of investments five years hence, Girish Agarwaal will have a completely different stature from today. I think it’s a function of how these companies grow. We would hope that some of these leaders are from companies we have backed.

Mahadevia: If you look at our investments and portfolio, the entrepreneurs / management teams we’ve backed have all got proven track records. When we invest in them, the aspiration is all of them will continue to grow and become business leaders. How large their companies become and how visible they are within the Indian business context will differ from one to another. Even if you look at some of the companies we have invested in five years ago, all of them were at a very different scale from today.

On the exit part, is there a Warburg strategy?

Malhan: When we make an investment we tend to be less fixated on what the exit option will be. Our belief is that a successful sustainable business when created will always have value and buyers. What that form of exit is that comes up 5-7 years later is very hard to predict. Whether capital market or strategic is a function of what the entrepreneur wants to do, what you as an investment firm want to do.

Mahadevia: And with all our exits, we worked very closely with the entrepreneur to understand what is right for him, the business and the company. Certain businesses better tap the capital market, while others are better staying private and just have a financial investor. There are multitude ways and exit decisions are always taken in conjunction with the entrepreneur and the company.

So which is the exit option that has been the most prominent one for Warburg in the last 15 years in India?
Malhan: It’s been the capital market. My sense is that the capital market will continue to be the predominant form of exit for us. Unless both (entrepreneur and the investment firm) decide to sell the company — and there may be some of that too.

Mahadevia: We have made a few exits to financial investors but I don’t think we have ever done a strategic exit.

With ACB India you are looking at a partial exit. What is the push factor behind such an approach?

Malhan: It’s a function of how long you have been in an investment, what was the thesis behind it, have you seen it play out, etc. There are several instances across the world where we have not exited in an IPO, because we think there is still some way to go before our thesis plays out fully. Then there are others where we would say if you hold a significant share in a company you can’t exit in one go in any case.

For example, let’s say if you own 20-30% of a company, you’ll have to do a phased exit to avoid disruption. So you exit a third of it in the IPO, then I have to wait for a year to do the next tranche because you want to stabilise your exit as well. So you tend to keep some of those factors in mind. In the case of ACB, we have been around five years now holding over 20% stake. It seems appropriate that we start to find some path to liquidity.

So we will do a part now and over time as the company hopefully keeps doing well we will exit more in the market. In fact, our Bharti exit was also in tranches because at a 20% position you are not going to be able to exit quickly without disrupting.

Mahadevia: If you think about growth investing, Warburg Pincus globally has taken 125 different companies public over the last 10 years across 11 stock exchanges around the globe.

Warburg did five deals last year. Will you maintain the tempo in this fiscal as well?

Mahadevia: We hope so. It’s not a market-share game and we hope to find more than five good opportunities. We are only limited by the number of opportunities available and we continue to look for them. In the coming 3-5 years, we will continue to expand the team and commit and be more aggressive about investing in India. So over the next five years I’d hope at least for this pace, if not more.