PE changes the face of corporate India

India’s corporate sector is in such flux that bankers and investors are constantly on alert for signs of distress. At the faintest whiff of misfortune or hint of corporate collapse, these predators get ready to pounce.

Thanks to a new insolvency tribunal and bankruptcy code, creditors have more clout and a greater chance of recovering their loans, while private equity and distressed debt investors see more opportunities to pick up the pieces.

This important change in the corporate landscape becomes apparent when Asiamoney visits an investment banker in Mumbai in late January. The interview is interrupted by rapid updates from a junior banker on the state of Zee Entertainment Enterprise’s share price, which falls 20%, then 30%, until the interviewee, a seasoned operator, can bear it no longer.

“I’ve got to see this,” he says, disappearing down the hall. A few minutes later he’s back, shaking his head and tutting. “Zee – wow,” he says. “I didn’t see that coming.”

Mumbai-listed Zee’s shares ended that day down 37%. In the end though, it was a storm in a teacup. A report by online newspaper The Wire had linked Zee’s owners, Essel Group, with an infrastructure company under investigation for irregular deposits. When Essel was cleared, Zee’s stock bounced back. By early March, it was up more than 50% from its January low.

But Zee is not an isolated case. The reaction of both junior banker and boss to the sharp fall in market value of a single firm underscores the nerves coursing through corporate India. 

Where local media once led with tales of incredible India, now front pages are splattered with cases of restructurings, insolvencies and financial malfeasance.

Many former high-flyers have turned out to be debt-ridden and are fighting for their lives.

In January 2019, consumer goods firm Videocon Industries was hauled in front of the National Company Law Tribunal (NCLT) to face insolvency proceedings. It owes a consortium of lenders, including State Bank of India (SBI) and ICICI Bank, an estimated $3 billion.

Videocon is also being investigated alongside Chanda Kochhar, former chief executive of ICICI Bank, on separate charges of money laundering: India’s second-largest private lender by assets sacked its chief executive in February.

In March, Jet Airways grounded a fifth of its fleet as it sought to hammer out a rescue plan with creditors. India’s largest private carrier had defaulted on $255 million in loan obligations a few months earlier in December, but as of March, it owed $1.65 billion to 26 entities including SBI, the Dubai branch of ICICI Bank, and the Hong Kong branch of Punjab National Bank.

Then there is Anil Ambani, once the world’s sixth-richest man. He faces bankruptcy, having seen the fortunes of his flagship telecoms business, RCom, collapse, and could perhaps even face a stint in prison. In February, India’s Supreme Court ordered the tycoon to pay Sweden’s Ericsson, a key equipment supplier, $68 million within four weeks or face a three-month jail term.

This new environment presents India’s banks with a dilemma. On the one hand, all are owed large sums of money by the country’s big firms. Corporate indebtedness has been rising for years: back in 2012, Credit Suisse published an influential report, titled ‘House of debt’, which noted that 20% of all bank loans over the previous five years were disbursed to just 10 industrial groups, including Videocon and Anil Ambani’s holding group.

“In the past,” notes a veteran Mumbai investment banker, “when a company needed to delay repayment on a loan, its owner would ring up a political mate in New Delhi, who would call the firm’s creditors and tell them to back off. That’s how the system worked, and it allowed these bloated firms to continue to kick the can down the road. All the companies that did that for years are now struggling.”

That cosy old way of doing business began to change in 2016. Over the course of two months, the government handed final approval to the NCLT, which oversees the winding up of insolvent companies, and passed the Insolvency and Bankruptcy Code (IBC), a bankruptcy law that underpins the tribunal’s decision-making.

Both have real teeth, as formerly untouchable corporate titans have found. Suddenly, notes Amrish Baliga, head of financing at Deutsche Bank India, there was a “genuine political will to go after defaulting borrowers – something that was previously unthinkable”.

This more assertive approach had several root causes. One was prime minister Narendra Modi, who swept to power in 2014 promising to shake up India’s sclerotic corporates and make it easier for smaller, innovative firms to get credit.

Another was a belated recognition of the torrid state of public-sector banks (PSBs). Non-performing loans peaked at 14.6% in March 2018, but India’s 25 PSBs reported a combined loss of $1.7 billion in the three months to the end of December 2018. In the same period, their private-sector peers made a combined profit of the same magnitude.

New Delhi knew the old model was broken. State-run banks had to be taught not to lend on the basis of friendship, but rather to companies that were able and willing to meet their obligations.

“The government has begun imposing a serious level of discipline on [PSBs’] lending practices,” notes Deutsche’s Baliga. For their part, private-sector banks, while better run, struggled for years to get some clients to repay their loans, or to tackle teetering debt. Winding up an errant company could take up to 15 years. With the tribunal and new bankruptcy law, they got the help they needed.

The NCLT has a simple intent: to deal quickly with failing firms, removing them permanently from the clutches of owners. It has 13 offices, including two in New Delhi, where judges are tasked with winding up insolvent firms or corporate divisions, and processing and re-selling non-performing assets (NPAs). The tribunal recovered $12 billion in 2018, and expects to claw back another $28 billion this year.

Companies or assets wind up in arbitration for any number of reasons. The most common is because they are forced into it by financial or other creditors keen to recoup as much capital as possible. But others choose, for financial reasons, to jump before they are pushed.

“When you have companies or divisions that are in trouble, the threat of arbitration and $1 settlements is forcing them to the table,” says Manisha Girotra, chief executive officer of boutique investment bank Moelis India.

In the main, the new laws have been effective, more often than not leading to decisions that benefit creditors.

“The IBC has made it easier to resolve distressed corporate debt, while the fear of the process has also pushed some borrowers to find resolutions faster,” says KVS Manian, president of corporate, institutional and investment banking at Kotak Mahindra Bank.

The process isn’t perfect. Rules mandate that all insolvency proceedings must be completed within 270 days, but the tribunal is under-resourced and vulnerable to delaying tactics. When Essar Steel entered bankruptcy court in August 2017, it was saddled with debts of $12.3 billion, owed to a cornucopia of creditors, mostly Indian banks. But after rival ArcelorMittal bid $6.3 billion for the assets, the firm’s former owners, the Mumbai-based Ruia family, tried to buy it out of bankruptcy, offering $8.1 billion. Creditors including Canara Bank, Punjab National Bank, ICICI Bank and SBI nixed the offer. Finally in March 2019, after 584 days of legal delays and procedural obfuscation, the tribunal approved the sale to Mittal.

There is profit to be found here for local and foreign lenders, if they are savvy and willing to set aside enough time and resources to understand the process.

“There are three clear opportunities for us here,” says Kotak Mahindrak’s Manian. “We can advise the buyer or seller of a distressed asset for the resolution package or for an M&A transaction. Then there is the financing opportunity, in the sense that if the asset changes hands, the new person may want to restructure or refinance the loans. We can, apart from refinancing ourselves, also be arrangers of a new consortium to refinance the loans.”

Deutsche was a notably fast starter in distressed-debt financing. The German lender is a pioneer in the space, specializing in financing last-mile project completion through priority financing, one-time settlements for existing balance sheets and potential acquirers keen to acquire stressed assets.

Baliga, the bank’s head of India financing, predicts there will “definitely be a lot more distressed-asset sales” in future. “More companies and assets are being taken to the NCLT, and this opens up a sizeable opportunity for banks such as ours.”

Kotak Mahindra was also hot off the blocks. In February 2019, its alternative investments arm, Kotak Investment Advisors, announced the creation of an eight-year, $600 million distressed-assets investment fund, in union with the Abu Dhabi Investment Authority. The new Kotak Special Situations Fund will invest in domestic non-performing assets and in firms that are financially stressed but not actively failing.

“We are pretty excited at the distressed-asset purchase opportunity in India,” says Dipak Gupta, joint managing director at Kotak Mahindra. “We have been an active player in buying distressed assets from other banks for close to 20 years and are probably the first and only bank that buys, rather than sells, distressed assets. There is value in buying stressed assets if it is acquired at the right price.” 

Commercial and investments banks, as well as private equity firms, are also studying the profit to be made as India’s PSBs clear out the worst of their bad-debt backlog.

In November 2018, Mumbai-based Dena Bank put 84 non-performing assets worth $500 million up for sale, inviting bids on an all-cash basis, or via a mix of cash and security receipts. Six months earlier, Dena was told by the Reserve Bank of India to halt all lending, due to falling asset quality. In January 2019, it was told it would be forcibly merged with Vijaya Bank and Bank of Baroda, with effect from April 1, creating India’s third-largest lender by assets after SBI and HDFC Bank.

That should mark just the beginning of a much-needed industry clear out.

New Delhi continues to mull the benefits of mass mergers; in March, former finance minister Palaniappan Chidambaram weighed in, saying India should have no more than eight PSBs. And mergers in theory mean more NPA sales, and more profit for nimble-footed lenders.

And there’s more. While the eye is naturally drawn to the tribunal, and to the sight of corporate titans being dragged through the mill, another seismic shift is under way.

In the early 1990s, the central government moved to liberalise key industries. A stronger economy emerged, but so did a new class of corporation run by so-called “promoters”, typically the billionaire controlling shareholders of these sprawling conglomerates. The bigger ones didn’t stop growing.

Reliance Industries (RIL), controlled by India’s richest man – Mukesh Ambani, the brother of Anil – explores for oil, refines petroleum and owns a nationwide chain of supermarkets. Its telecoms division, Jio, launched in 2016, is now the third-largest mobile network operator by subscribers.

RIL is in good shape, but many of India’s biggest firms are not. Even those not facing insolvency proceedings are burdened by debt. In the past, most banks would simply, on request, have rolled over loans or opened new lines of credit. But public-sector banks have the state breathing down their neck, while private lenders are more discerning about whom they lend to, and why. In the past, non-bank finance companies filled the void, but they too are faltering, undone by a liquidity crunch and a rolling crisis at IL&FS, an infrastructure finance firm that defaulted on several loan obligations in late 2018.

A dearth of credit and the threat of the bankruptcy court are forcing promoters to take stock of assets and to ask if pursuing size for the sake of it is a sign of strength or frailty. Many say the era of the ever-expanding Indian corporate is over and that businesses will become more streamlined.

“We are seeing a realignment of corporate ownership,” says Pramod Kumar, head of banking at Barclays India. “Big companies owned over multiple generations may remain, but the number of sectors they operate in, and their size, is being whittled down. They are becoming more focused. It is a sign of corporate India maturing.”

Ramesh Srinivasan, managing director and chief executive of Kotak Investment Banking, adds: “If you go back a decade, there was an emotional attachment to keeping your business intact.”

Ramesh Srinivasan, CEO of Kotak Investment Banking

But those ties are loosening, as cash-hungry corporates scrabble to sell redundant, marginal or failing assets.

The process has two key beneficiaries. The first is investment banks’ advisory teams. After a few lean years, mergers-and-acquisitions took off in 2018. The total value of announced M&A deals in 2018 was $118.3 billion, according to data from Dealogic, up 70% from 2017. Foreign investment banks dominate the 2018 league table, led by Goldman Sachs, JPMorgan and Barclays. A total of 73 M&A deals were completed, versus 60 in 2017.

The second is private equity, until recently a minor player in domestic corporate and financial life. When Sanjiv Kaul joined ChrysCapital in 2004 from pharmaceutical company Ranbaxy, the total value of all private equity-led deals ever completed in India came to just $1 billion. But over the last two to three years, says Kaul, who is the firm’s Mumbai-based partner specializing in healthcare and consumer goods, “private equity investments in India have been averaging around $18 to $20 billion a year.”

In fact, according to data from EY, total private equity and venture capital deal-making hit $35.1 billion in 2018, up 35% over the previous year. 

For buyout firms, from global operators like KKR and TPG Capital, to local or regional players such as ChrysCapital and Everstone, the picture doesn’t get much better. They look around India and, for any number of reasons, see opportunity. Take capital: India’s big companies need it, and private equity has it. In January 2019, ChrysCapital closed its eighth fund, having raised $850 million in under four months.

“You are now seeing more situations where a company overextended itself with overly aggressive loans from banks, and finds itself in a position where it can’t repay,” says Kaul. “So they are forced to find someone to step in and take control of a business, perhaps add capital or take a haircut.”

The key point here is the issue of control. In the past, most promoters fought tooth and nail to avoid selling or ceding control of assets. Credit was more plentiful, and there was personal and corporate pride at stake.

Now, though, there is “motivation for families to sell businesses, either their whole business or parts of it, to private equity, for multiple reasons,” says Manian at Kotak Mahindra. “It can be because of generational change, where the next generation is not interested in the business, or there is no clear succession plan – something that is certainly happening. In some other cases, families see that to grow the business to the next level, they need significant capital, know-how and access to markets and technology, and they know that a PE firm can bring that in.”

Buyout firms also know and like India, and are comfortable there.

Private equity’s big break came in 1999, when Warburg Pincus invested $60 million in Bharti Airtel, a newly formed telecoms firm. It upped its stake twice over the next two years, before exiting in 2005, pocketing a profit of $1.9 billion.

The industry has waxed and waned in line with economic and financial cycles. Over the last five years, notes one Mumbai-based M&A banker, “India has demonstrated some very good exits”.

According to EY data, private equity exits in India hit $26 billion in 2018; that’s a record, and double the level of the previous year.

A key recent deal from a buyout point of view was Walmart’s $16 billion acquisition of Flipkart in August 2018. It proved a bonanza for New York-based Tiger Global, which pocketed $3 billion in profit from the sale, having made its first investment of $9 million in the e-commerce platform back in 2009. SoftBank’s Vision Fund invested $2.5 billion in Flipkart in 2017. It exited the investment 12 months later and $1.5 billion richer.

It is no coincidence that the growth in private equity tracks the decline in fortunes of corporate India. The assets that PE firms really want are often available to buy, at reasonable prices, from companies eager to focus on core assets. A case in point is KKR’s acquisition of a 60% stake in Ramky Enviro Engineers (REEL), finalized in February 2019. The US buyout group invested $530 million in the Hyderabad-based waste management firm, which also has offices in China, Vietnam and Thailand.

The capital commitment aside, the deal was a win for all parties. KKR got a desirable asset with vast potential in a country struggling to tackle rising human, agricultural and industrial waste. REEL got a global investor that will help to scale up its business at home and abroad. And REEL’s former owner, the Ramky Group, received a much-needed injection of capital to shore up its infrastructure and real estate divisions.

Srinivasan of Kotak Investment Banking expects more private equity capital to flow into deals involving capital goods firms and manufacturers in future.

“Those kinds of sectors offer a good five-year exit,” he says.

This is a tipping point for India’s corporates, and there is no going back. Some of the country’s biggest business leaders will cling on to their best assets – perhaps all of them. But many others, deep in hock to banks and other creditors, and desperate to avoid India’s powerful new bankruptcy court, will turn to private equity in search of capital and a reliable partner willing to turn an ailing asset around.

“Increasingly,” notes Kotak Mahindra’s Manian, “private equity players [will be] the new owners of big business in India”.