In the world of private equity, Providence Equity Partners is a specialist. The firm, whose headquarters are in Providence, R.I., specializes in deals involving media, entertainment, information and communications companies. In 2007, Providence Equity opened its New Delhi office, headed by Biswajit (Bis) Subramanian, who had earlier been a managing director in the firm’s London office. By mid 2008, Providence Equity had invested more than US$1 billion in Idea Cellular, which, according to media reports, was among the largest private equity investments in India’s telecom sector. What is Providence Equity Partners’ strategy for India? How has it changed as a result of the global financial crisis? In an interview with India Knowledge at Wharton, Gaurav Sharma, who works with Subramanian on defining and executing Providence Equity Partners’ India strategy, discusses those questions and more.
An edited transcript of the interview appears below:
India Knowledge at Wharton: How has the private equity market evolved in India, in your opinion, over the last 10, and then maybe five years?
Gaurav Sharma: In terms of my experience in private equity in India, which is not over 10 years … Fundamentally, private equity in India is different than how you see private equity in the West, especially in the last decade or so, where in the West and especially in the U.S. it was more of a leveraged buyout model, where you have steady companies, steady cash flow, and you are looking to take companies private, buy them out, turn them around, and either exit through a strategic deal or through a listing again.
In India, given that the economy is in a different trajectory in terms of growth, the majority of private equity deals are growth-related deals. So you are not looking at buyouts. You are not looking at putting 90%, 80% debt and 20% equity deals to work. These are growth deals, given the nature of the businesses in India, more family-run businesses. These are promoter-led businesses. These are not buyout situations. These are situations where you come in and, hopefully, as a significant minority investor with appropriate rights on the board seat, etc. So you are basically providing growth capital.
The private equity model in India has been fairly successful. People have done well in the last four or five years, and obviously the bull market in India, the equity markets, did help. If you look at the number of funds in India who are investing, it is huge. Five hundred-plus is the number I hear. So what really happened in the last three or four years, there was a lot of hedge fund money. People looking for a quick flip, if you will, which was happening, so you have people looking at pre-IPO deals. People were investing and looking to exit within a one-year or even a six-month time horizon. So a lot of those deals were happening, which were labeled as private equity deals, but which is not a private equity deal in the true sense. At least that is not how we would look at private equity, where you are coming in, you are actually working with the management, helping to grow the business.
That is what happened in the bull run. People came in with that mindset that, “Hey, we are one of the big IPOs in the market.” There is a little big-bang IPO market, so they will run up and continue running up and then exit, which worked. People made money. But obviously since early 2008, when the market started going south, that model has gone away. Hedge funds are in any case globally under a lot of pressure. I think things have changed in that sense, going forward, to be more of a traditional growth capital model, where people are looking to come in and are not looking for a quick exit, because the quick-exit market does not exist right now.
It is going to be something where investors are going to come in and look to exit in the typical horizon, around four to five to six years, and in that time hoping that the company grows nicely as well. It is definitely going to be a more mature market. Promoters are quite savvy. They know about private equity now. It is not something that is new to them anymore. The bankers have also done a good job in covering private equity. All the major PE players are here now from the U.S. or Europe, and obviously the local funds are here, so in that sense it is still going to be a very competitive market. But overall, the deal flow has obviously slowed down.
India Knowledge at Wharton: So what made Providence enter India when it did, and how has the journey been so far?
Sharma: [Providence managing director Biswajit “Bis” Subramanian] and the folks [at Providence Equity] in London had been over the past several years looking at opportunities in India out of London. We are sector-focused. Providence focuses on media and communication and information services. Some of these sectors are going to be easier for us to get a handle on as to what is happening in India. So we do not have to look at 10 other sectors. As we were spending time in India we obviously appreciated and realized the potential of the growth in India and India’s economy. Based on that, we evaluated a couple of transactions. We ended up doing the one transaction that we did in 2006, which was Idea Cellular, before we even opened an office.
Even after that, Bis spent a lot of time in India talking to promoters, meeting bankers, meeting all the various parties, and making sure that opening an office made sense in terms of deal flow, in terms of putting capital to work. Once we made up our minds that it made sense, there will be opportunities. There is growth in market in terms of the system, in terms of the legal systems, in terms of the governances. It is obviously developing but it is good, it is fairly good. There are no major red flags. Given all those factors, we did think it is an important market to be in. As Providence Equity has grown over the last 20 years, and when we raised our US$12 billion fund, it was meant to be a global fund in India. Simultaneously we opened our office in Hong Kong, covering China and the rest of Asia, basically. We do realize that India is an important place in the global economy.
India Knowledge at Wharton: You referred to the fact that the market is very competitive, and you used the number of 500 players in this area. Given that degree of competition, what is your strategy to position yourself in a way that is unique?
Sharma: The competition by the nature of where we are in the new environment is going to slow down in the sense that hedge funds, people who are just putting in money expecting a quick flip, those are gone. And even in terms of investors today, everyone is extremely cautious. Some investors are not looking to invest money right now. Their funds are 90% exhausted and they are in the market raising new funds. So the competition has come down. Where we think we add value or we differentiate ourselves is that we are sector-focused. Globally we have a portfolio of companies which are obviously focused on telecoms, media and information services.
When we go out and talk to promoters, we try to convince them not to consider us as just financial partners, but to consider us as quasi-strategic partners, someone who you can bank on to help the company grow. We can bring our experiences to bear. You know Kabel in Germany, where we owned the largest cable company in Europe, Kabel Deutschland. So we can have them interact with the management of that company and see how that impacts the evolution of the cable industry in India, stuff like that. It is something which resonates well with the promoters as well, because they do appreciate that we are sector-focused and that we add more value than just pure dollars.
India Knowledge at Wharton: Historically, the size of private equity deals has been pretty small in India. When Providence did the Idea deal that was one of the biggest blockbuster deals of the time, and till today it stands clearly in terms of deal size among the top few deals. What gave Providence the confidence? And maybe if you can describe that process a little bit, going into partnership with the Idea company.
Sharma: At that time we were investing out of a US$4 billion fund, so investing almost 10% of the fund was definitely a big deal in terms of the size. What gave us the confidence is the growth of the telecom sector and the potential of the telecom sector in India. We saw that, and that has been borne out in the last two years. We can see penetration levels are close to 30% now. But also I think a key aspect of doing a deal in India is your partner, because you are not in the controlling seat, so you want to make sure you are partnering with the right person in the right ethical group. And I think in [Idea promoters] Birlas we have found a great group, a great partnership, and obviously we did the second deal through Idea as well, and that was again a result of our existing relationship with the Birlas. So I think the telecom sector and the right partner were drivers.
India Knowledge at Wharton: Can you describe the private equity investing process and, more specifically, the diligence process in India? How is it different from what would be done in the U.S. or the developed markets?
Sharma: I think the big difference, or one of the major differences, in the U.S. is what information you can get from a company. It is a little different than when you are looking at a privately held company, a family-run business in India. There is a lot more information which you can easily get from a U.S. company, which is, say, already listed. In India you need to work a little bit more at the management, making sure they are providing you the information. Some of the information they have never thought about in that manner. So they actually need to go out and gather that information. It is not something cookie-cutter that is available, so it is a lot more time-consuming.
Also, I think obviously in terms of corporate governance. That is something where we spend a lot of time. Post-Satyam, that is again one of the major areas of focus going forward for all parties concerned, and hopefully another Satyam does not emerge. Obviously, you can always argue that Enron also happened in the U.S. But again, because it is an emerging market, it is a developing economy, the onus is on India and corporate governance in India to make sure there are no red flags, and for investors to feel very comfortable investing in India. Because the emerging market risks are always going to be there. Currency risk is not going to go away. But you want to make sure that your partner in corporate governance is absolutely perfect.
India Knowledge at Wharton: What kind of red flags in the corporate governance side do you look for before considering the private equity?
Sharma: I will make sure that a big part of the diligence is always the partner. You want to make sure that you have done your diligence, you have done your background checks, you have talked to multiple people who have had experiences with the partner. There are a lot of intangibles going there. You want to make sure there are no red flags. It is a clean slate, that the partner is a good ethical partner, someone who you can trust and someone who is open to ideas, someone who is not just like a bull who is just going to do what he or she just believes in and is not going to be open to ideas, to change. So that is very important.
In terms of corporate governance, you want to make sure that the books are clean, the accounting is clean. I think that is what I meant that now the scrutiny will be even more. Obviously, we will always tend to hire a big firm to do the diligence for us in terms of the accounting diligence, the tax diligence. We will want to make sure that there are no discrepancies in terms of the billings, etc. There are no cash deals going on etc., so I want to make sure that all that is clean.
India Knowledge at Wharton: But at Satyam there was, in fact, a big firm …
Sharma: I know. It is just that …
India Knowledge at Wharton: It is foolproof …
Sharma: It is just the comfort. Yes, exactly. That is why I said the scrutiny will be even higher now. You want to make sure that … In Satyam you could argue that at least that is what you read, that the bank provided the fixed deposit statements, etc. So I do not know what went wrong out there. So that is a different level of fudging and hopefully that is an exception and not the rule. So that is an area we focus on more so than you would expect when you are buying the listed company in the U.S.
India Knowledge at Wharton: And the telecom sector in India, have you had any disappointments about the way the sector has evolved, especially with relation to 3G? Where do you see the opportunities?
Sharma: When we made our investment, we probably did not expect the market to have eight, nine, ten, eleven operators. So the way things have evolved in terms of the number of operators with the new licenses etc., that is something we probably did not foresee. Because globally we have not looked at the market. I have seen the market where there are nine, ten operators. Probably four, five, six makes sense. That is enough competitive tension when you have five or six operators in the market versus eight or ten, which is more disruptive than I would think, but obviously the government in the past did not think that way. So that was definitely a surprise. But on the positive, the growth in terms of penetration, in terms of subscribers has definitely been a great plus.
And in terms of upside, I think 3G in India is still going to be more voice. India is ready for technology like Japan or Korea in terms of how they are using 3G. I think the 3G spectrum will, given the dearth of spectrum, the availability of spectrum, still be used more just for voice. But in terms of opportunity, VAS right now is 9% to 10% of revenue, and if I can expand the buyout there, sure, why not then? We are actually surprised when we hear that in the north, the high R-proof or the low R-proof customer, like the taxi driver, spends Rs.200 on his bill and Rs.100 of that is VAS — just ring tones, downloads — and that is surprising. I do not care about the ring tone or what is in my phone. I mean, I actually do not want anything. But those guys change that every month and they are willing to pay Rs.30 a month or whatever.
The rural story in terms of telecom not only being just a means of communication … For the rural guys, and the semi-urban and the urban, at the lower R-proof level again, it is also a means of business. People have been able to increase their business or make their business more efficient, like a plumber, right? He probably made five calls a day. He was standing near a small paan shop. People used to call him at that paan shop, but now he has a cell phone, so he gets that additional two calls a day on his cell phone, which is enough to recover the cost. And for the farmer who used to have to travel distances to figure out where he can sell his crop for the best price, he can make that call. If the same guy has to visit his daughter 400 kilometers away, he had to make that one trip a month. Now he can call her every second day.
So I think those things were all theoretical five years ago, but they are actually happening. They are actually helping, and that is what is driving the telecom story in India. So there are a lot of positives.
India Knowledge at Wharton: A lot of PE firms in India are now focusing toward private/public market deals, as well as distressed deals. And the land between hedge funds and private equity is blending toward a central point. Do you see that trend continuing into the future? And how are LPs in particular reacting to PE firms’ going and doing public-market or distressed deals?
Sharma: I would not be able to comment on other PE funds, but in general we have shied away from doing any public deals, or PIPEs,as they are called in India. Unless there is a special angle in terms of control available or a special relationship, we will not tend to look at public deals, PIPEs. But I know in India that that was the case. That is another difference in terms of how we … It is like buying into a public deal at the premium, whereas in the U.S. if you are buying into a public company you would be at a discount, so people would be willing, and that is a lot of deals. Again, that was the function of a bull-run market. You are buying at a premium. You are paying 20% to the market, and then you are hoping that the market is going to run up and you will make your 40% IRR. So I think that is increasingly tough, especially in this environment when you have to mark to markets every quarter. I just do not see us doing that, and I do not know how other PE guys are thinking about it in terms of doing public deals.
India Knowledge at Wharton: Do you see the ICICI Ventures and the ChrysCapitals of the world as direct competition, or is it maybe limited as far as Providence is concerned to the KKRs and the Blackstones of the world?
Sharma: No, I think everyone, the local firms and ChrysCapital, ICICI, they are all active. They are investing in the smaller ticket sizes, because we in India, to invest in smaller … I mean, we have not made an investment of smaller ticket size, but we would be willing to. So I think the competition would be everyone. I do not see why ICICI would not invest in a particular sector or a particular kind of deal that we would like to invest in.
India Knowledge at Wharton: This deal size concept, US$25 million to US$50 million is kind of the sweet spot that you keep hearing time and again for a lot of private equity guys. Do you think that is going to change and drift toward more of the US$100 million, US$200 million and maybe someday buyouts and leveraged buyouts also in India at some point?
Sharma: I think the US$25 million to US$50 million is more a function of where the deals were in the past. But we have always maintained in India that we would do US$50 million-plus deals. The smallest ticket size would be US$50 million at least, but for some of the bigger funds doing a US$25 million deal probably does not make a lot of sense, compared with the fund size. If you have a US$10 million-plus fund, a US$25 million deal does not really move the needle for that fund. And you obviously have to spend almost the same if not the same amount of effort doing a US$25 million or US$250 million deal.
We are still maintaining our same in terms of deal size. Nothing has changed. You know US$100 million, US$150 million would be great, and I think the one thing which I would say would change is, we would not in this environment do a megadeal. So US$200 million to US$300 million may be a deal max.
India Knowledge at Wharton: Obviously, the global crisis affected the Indian PE market to quite a large extent. A lot of people are sitting on the sideline just watching investor valuations and public-market valuations readjusting. When do you see this coming back to an active field?
Sharma: We have almost half our funds, US$6 million, around that number, uninvested. So we are open to do business. The bar is higher, the return expectation is going to be higher, the risk is higher in this environment. Obviously the bar is higher in terms of the return expectation. So for the right deal we are open to do business, but in terms of where valuations are in India even today … I think the public markets have come down and adjusted quickly, and public markets always adjust fairly rapidly. But private-market valuations are yet to mirror that decrease, that quantum jump.
Once that happens, plus if there is more visibility in terms of how the economy is going to evolve, I can see more deals happening. You are right, people are on the sideline right now, because it is a very uncertain environment, and globally it is a very uncertain environment. Not too many people want to put money to work right now. Again, we are open to doing business. It just depends on the right opportunity, the right kind of returns, the right kind of risk profile, so valuation would be a key driver. We continue to talk to people. We are having discussions right now with multiple parties, making sure that we are there when there is a deal to be done.
India Knowledge at Wharton: What do you think are some of the biggest benefits and drawbacks of being a sector-focused fund in India?
Sharma: We talked about the benefits of being a sector-focused fund. Partners have thought about that for 20-plus years that we have been in business. We have expanded to the extent that it made sense in terms of where we were maybe 10 years ago, in terms of focusing on media and telecom. There are industries we evaluate to see they fit in with the kind of profile we are looking for in companies. We are open to evaluating those, and that is how we have ended up investing in some of the sectors like information services or education.
I do not think there is any disadvantage. I mean, we do not want to do real estate. So I do not think there is any disadvantage when we are talking to [technology, media and telecommunications] companies in our space as to, “Hey, you do not do real estate, so I would not want to partner up with you.” I do not think there is a disadvantage as such.
India Knowledge at Wharton: But if you were not focusing on one particular sector, what do you think would be the best investment opportunities broadly, maybe in terms of just sectors, for India in the next three years?
Sharma: Based on the discussions I have with my other PE friends in India, it seems power is a very attractive sector even now There is lot of interest in that sector in terms of the visibility of cash flows as long as you can get the plant up and running. The demand is always going to be there, so I think that is still a very attractive sector. Sectors in infrastructure will continue to be attractive. Power is one big one. Education, again, is part of our sector. But again, there are some things we are very bullish on. No one has cracked the code in India as to how you get a big K-12 company, for example, up and running, because there are restrictions in terms of not-for-profit, for-profit, etc. So education is a big sector. Health care, sectors which are obvious in terms of the demand, is going to be there. So I think health care, power, education, these should all be interesting sectors.
India Knowledge at Wharton: In terms of the regulatory environment — and we have sectoral caps such as media, minority squeeze-out issues in terms of buyouts — is there any active lobbying by PE funds or venture capital funds in India to deal with those issues?
Sharma: I do not know how active they are, but I know there are a couple of forums which do give feedback to the government. I would not categorize them as extremely active. But those are things like the squeeze-out, which I think media caps are therein. I cannot think of any country which does not have caps. Even in the U.S., there are caps on foreign ownership in terms of controlling the media. I do not see them going away in any case. To the extent that could increase in terms of what is allowed … But you know some sectors, like telecom, are fairly open. I think India in the last three or four years probably had been a bit slow in terms of liberalization. But hopefully, post-May 16, we will see a stable government and the reform process continue. But that is still up in the air right now.
India Knowledge at Wharton: Again speaking on the regulatory front, a lot of people when Satyam happened called it India’s Enron. Carrying that same analogy further, do you expect there to be an equivalent version of Sarbanes-Oxley for India?
Sharma: It is hard to say. I do not think I am in position to comment on that. I would not know the answer to that. I think the Indian filing, the disclosure systems … People could work on that and take now into account what Sarbanes could not achieve in the U.S., in terms of there are obviously drawbacks to everything. I think over-regulation versus under-regulation, that is always a debate. So I am sure there is room for improvement in India, but I do not know how active the equivalent of the SEC is in India.
India Knowledge at Wharton: What lessons would you have for our audience, or advice in terms of private equity investing in India, what to watch out for?
Sharma: I do not think there is an overarching theme other than “the right partner is the key to a good deal.” Yes, the obvious ones as in the right valuation, the lower the valuation the better. That goes without saying, but I think the partnership is key, the exit mechanism. You want to make sure that the exit mechanism works for you in every sense, so that if Plan A fails there is a Plan B, there is a Plan C. Because ultimately all PE investors need to exit, and if you do not control the company, you are not sure if your partner wants to sell, because in most of these situations, the promoters hope to run the company over to the next generation. So you want to make sure that you have the right structure where you can exit, where you can get your premium as well. You do not have to exit under some kind of pressure where you are not getting that premium. You are actually exiting at a forced discount. So that is a key as well, plus strong corporate governance. That is always going to be critical.
India Knowledge at Wharton: What are the plans in terms of Providence’s ramp-up in India? Head counts, or in different sectors if at all heading toward it?
Sharma: No change in strategy as of now. The head count … we feel we are appropriately staffed, especially that things are slow nowadays. If things do pick up we would reevaluate that down the road, but right now we do not see ourselves expanding. Given that deal flow is slow, we will see as things pan out and the second half is more active than the first half. We will see.