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| Rahul Bhasin |
This interview first appeared in DNA Money edition on Saturday, January 15, 2010.
Rahul Bhasin, managing partner of Baring Private Equity Partners India and senior partner and global board member of Baring Private Equity Partners International, speaks about private investment business scenario in the aftermath of various scams/frauds, the role of government in policy making, creating business sectors with global leadership and challenges before the country. Excerpts from the interview:
How do you view the recent scams and their possible impact on the private investment sector? You think limited partners (LPs) in the funds will now keep a regular tab on how their money is getting utilised?
I think these scam have got nothing to do with private equity investment business whatsoever. The LPs expect PE firms to be professional and they do have particular standards of running private investment business. Given the way industry operates, they'd expect us to not fall victims of scams/frauds. It's a very baseline expectation since the scams which are being spoken about are diversion of funds in some passive accounts and I don't think it has any co-relation with our line of business.
What about the companies or managements being invested in? Is there a likelihood of funds getting mis-managed at that level?
No industry or individual is exempt from fraud or scam. Given the extent of diligence and the depth of engagement that happens, the probability of something like that happening in the PE industry is very low. Such incidents might be an issue for a novice entity which has little or no knowledge about inner workings of the private equity industry but it certainly is not applicable to seasoned players.
What is your analysis of the public / primary markets in the country? Where do you see it heading in 2011 given the volatility experienced in the recent past?
Market is a function of demand and supply. As far as supply is concerned, there is going to be a lot of primary issuance since there is a big pipeline. On one hand, we have government companies raising money and or government divesting shares, and on the other hand, there is issuance from companies trying to chase growth. A new category of companies approaching the equity markets of late is infrastructure and related asset owning companies that are raising funds. The flip side, however, is the supply of investment money, the primary portion of which has largely come historically from the insurance companies and the mutual fund industry.
If you look at the Indian market relative to a lot of the other markets, you'll notice a few peculiarities. One, our earnings multiples are higher than anyone else's. Two, we are running higher fiscal and current account deficits than anyone else. Topping it all is the high inflation which is a direct result of high fiscal deficits. So when you have this kind of a scenario, the only policy regime available with the government is to keep raising rates. When that happens it leads to devaluing of the equities or any other financial instrument for that matter. This is because the measuring yard itself is getting tougher and as a result the same set of cash flows will get discounted at a higher rate.
Given that we already have such expensive markets which are pricing in a lot of aggressive growth it is fairly unlikely that the foreigners will put incremental allocation of capital to India. My own view is that they all overweight India and while continuing to do so they will cut the relative overweight. For example, if they (foreigners) were initially 30% overweight they are likely to go 15% overweight. Thus, on a net basis this will either slow down money into India or defer it to a fair rate.
It's not a structural call I am making but more of a short-term impact of valuations being stretched. To my mind anything between six months and a year is short term. The market/index as a whole will not be able to see any new heights anytime soon. I think the market is ripe for a correction.
Having said that, individual companies and managements will still do well. One should also remember here that this is just a lull because underlying growth of the economy is still there. Tightening interest rates will slow it down but it will be from a short-term perspective without having any impact on the structural growth rate of the country.
Do you think companies can still look at the option of raising money through an IPO?
While there will be a lot of supply of paper, the demand from overseas will be challenged because of their worries on the currency side, inflation, interest rates and valuations. The retail shareholders have been largely absent because with majority of the IPOs in the last 3-4 years, they have systematically lost money. And that is because of rampant over-pricing of these IPOs.
Essentially every upside is captured in the pricing of the IPOs and as a consequence retail investors have lost money post the issue. As a result the general public has lost faith in IPOs. The only reasonably good and successful IPO in which people made money has been Coal India. So government companies might still get subscribed as a consequence but if you go back and look at companies like NTPC and a host of other government companies, people have not made money which has had a dampening impact.
My view is that irrespective of any sector or company, IPOs will do well as long as they are priced reasonably. The challenge arises when companies start chasing crazy pricing and as a result the IPOs do not get done. As long as the IPO pricing is leaving something on the table it will attract investors and will be successful.
Is there a role for the regulator to play in rationalising IPO prices? What about companies looking to go public, is there a need for introspection?
One of the most overdue reforms from Sebi has been disclosures from investment bankers akin to what it has for listed companies. They should make it mandatory for all investment bankers to report performance of all the IPOs they have done in the last few years. The minute such disclosure norms are put in place, investment bankers will then be cautious about pricing the issues right. My concern is the issue should be fairly priced and not under-priced or over-priced. I seriously do not understand why Sebi isn't insisting on IPO performance disclosures from investment bankers.
The second issue of course is that the government will have to control fiscal deficit if it wants to sustain long-term growth. Spending more money or for that matter printing money will not help and hence fiscal discipline is a must. The biggest issue with the fiscal deficit is that we do not even recognise what the true fiscal position is because we keep insisting on this cash system of accounting. Our budgets are all cash budgets and not accruals. All of corporate India has accrual accounting so why doesn't the government? This is leading to deficits being understated, which is a big area of concern.
A lot of entrepreneurs forget that IPOs are a big brand-building exercise for their respective organisations. The IPO does determine to a large extent how the brand will be perceived in the capital markets. This is very important for companies having a long-term perspective and I think they are not been well advised.
The fiscal so far has been very optimistic for the private investment sector. How do you see things panning out in the last quarter?
Markets are not cheap and people are paying a lot for growth. The pivot of this discussion is now whether all the growth will actually play out or not.
Do you see hiccups ahead?
Not really. But a lot depends on the policy makers and my major concern is the lack of bigger vision from the government's perspective, especially in terms of how to make our different industries more competitive and to work in tandem with them.
How would you like to see the government work towards for the benefit of the industry?
The Indian government can take a cue from South Korea and Taiwan which have developed the semi-conductor industry. They have created a global body of expat South Koreans and Taiwanese who are experts in their fields. They have brought in consultants, built infrastructure and attracted talent from across the globe. To shore up their initiatives they have built an educational system to train people in various aspects of the industry. They have facilitated people to set up clusters so that enough companies could be set up. Today, South Korea and Taiwan are significant players in these industries.
In the Indian scenario, power is going to be a big item of growth. However, the government is not taking enough steps to make us a global leader in the segment. There is a huge opportunity but we don’t see any discussions or affirmative actions in this aspect. It's been done already in the software, applications and 10 other aspects of software and it can replicated in power as well.
A few other sectors to be looked at are pharmaceutical and construction industries. We can become global leaders in these sectors in the next 20 years. But there is no discussion on the matter to make it happen. India is not only facing economic but also social and several other challenges now.
You think the various events in the country in the recent past will impact foreign investments?
Right now we are in that serendipity zone, because everybody believes that we are still performing well. However, these are all statistics which is making us feel good by explicitly saying that we have grown so much.
Could you elaborate?
For example, currently the size of our economy is $1.2 trillion. Assuming that we grow at 10% the overall growth would be $120 billion. But if we divide it by a population of 1.3 billion, the change in the per capita figure becomes very insignificant. Now take the US economy which is at $14 trillion growing conservatively at 2-2.5% and showing growth of $350 billion, adding more wealth this year despite of a troubled scenario. US added $350 billion on a population of 300 million and on the per-capita basis it added $1,000 while we have only touched the $80 mark. The gap has actually widened in this scenario. I think if we do not address this reality and keep looking at the statistical representation of an X% growth and self-congratulating ourselves, we can never grow significantly.
What are the other areas you think we are lagging significantly?
Another reality that has been missed is when countries get richer they urbanise and have a concrete plan for urbanisation in place. This implies that government needs to deliver public goods, services and facilities and make provisions for water, power, sewage management, urban transportation and so on. The standards need to be set to ensure the levels for delivering these public services. We need urban planning to implement this.
The reality is that in 1971 we had 61 million people living in the cities and the number currently is 250 million, expected to reach 600 million by 2030. The only planning when we talk about urbanisation is ‘for the government and by the government’ and they only plan for the bureaucrats / politicians and how they are going to live. They exclude common citizens from this process.
If the government does not plan for urbanisation, this will result in citizens breaking rules. When illegal work gets undertaken, bureaucrats / politicians play it safe by saying they should not bash this down because everybody breaks rules. The issue is, why have we not made the rules stringent enough in the first place for people not to break them? This is a very serious perception building up in the common Indian's mind that breaking rules will lead to prosperity. This is a grave issue and needs to be addressed at the earliest possible.
What is your take on the recent microfinance issue in Andhra Pradesh?
The microfinance institutions are facing flak because they were asking their money back. The bottomline is that if they don’t get their money back they will not lend. The issue highlighted here was that they were charging 25-26% per annum interest rate which is exorbitant. The MFIs didn’t force people to borrow. People borrowed because the only alternative was to seek funds from a local lender at 4% per month, which comes to around 50% per annum. This was a far better option than what was available to them.
The government has now said that for giving every loan you must pre-clear it. The recent move by the government has significantly raised the operating cost for MFIs, a policy unclear to many of us. While the government continues to preach that it is protecting the poor, in practice it is doing just the opposite.
How do you see the MFI situation panning out for the players and their limited partners?
I think they are in a horrible shape. They will go through a tough time and there is no doubt about it. The central government isn't taking note of it nor is it asking the state government for reasons behind their approach on addressing this issue. According to me, the global financial institutions including the IFCs of the world and the development agencies should be raising their concerns and seeking justification on the matter.
The government on its behalf should encourage more MFIs to come into this business, compete with each other and bring down the rates. Why is the government limiting access for financing to people, when they need it the most? For example, when a person has borrowed around Rs 7,500 and has no other means of raising money, he walks into a bank, the doorman will not even let him enter. Here I am not referring to foreign or private banks only because this is very much true in case of public sector banks as well. The person who is borrowing money might need it to eat his next meal or meet some emergency medical expenses and so on. By doing so, you are depriving the person of credit and access to credit, which is unfair.
What are your views on the Indian realty sector?
I firmly believe we need a Sebi equivalent to regulate the real estate industry. For example, a very small percentage of Indian population buy shares. However, look at the number of people investing or buying real estate. Housing comprises the single most important purchase people make in their lives and majority of people end up getting a raw deal when it comes to property transactions. The person has no recourse because he is fighting an unequal battle, as he does not have the same resources as the builder. That's why it becomes imperative for the government to protect him and a Sebi-like body will come very handy.
Last year we saw a bunch of PE veterans floating their own private investment firms and embarking on the fundraising journey. Not many have really managed to do so though. What is your take on this?
Just like any other business, there are different aspects that newly set up private equity firms need to bring to the table. LPs will invest only after considering things like economies of scale, value proposition and differentiation the entity offers. Just simply saying that the individual will set up a PE shop isn't enough. Those with strong value proposition for the investors, employees / talent and companies including investment bankers that are going to partner with will succeed else not.
As far as availability of capital is concerned, I think there is no shortage for the right product. I don't think prior fundraising experience really matters as such because this is a competitive business. I have a feeling that a lot of people took to starting a PE firm because it was so fashionable and there was a time when it was so easy to raise money as a result everybody thought it to be a piece of cake. I don't think we are in a bubble nor are we in a bust kind of a situation yet. So it’s a business as usual scenario at present. All the people setting up funds aren't equal and while some have done their homework work well others have not.
