High Stakes

I set out to make a conglomeration of No. 1 companies. That’s easy to say, but difficult to do. I can’t think of anyone else who has done it.” That’s Masayoshi Son for you. He is the maverick founder of Japanese internet and telecom giant SoftBank, which has invested $40 billion from its $100 billion VisionFund in technology companies across the world, including India. Son’s vision is unidimensional — to invest in unicorn companies that are leaders in a certain segment in any part of the world. Not surprising that e-commerce major Flipkart, ride-hailing start-up Ola and digital payments player Paytm have all landed up in the venture fund’s portfolio. Last year, SoftBank pumped $1.4 billion into Paytm. While founder Vijay Shekhar Sharma solda small stake, a clutch of investors, including SAIF Partners, ended up making a killing. The Delhi-based venture capital fund, along with other investors, made a partial exit from One97 Communications, the holding company of Paytm, with over 26x return, post SoftBank’s infusion. Prior to this deal, Alibaba along with its payments arm, Ant Financial, in March 2017, gave Reliance Capital, Saama Capital and Sapphire Ventures an exit route when they bought shares worth $250 million. Saama, which had invested in One97 in 2011, made an astounding 75x, according to research firm Venture Intelligence. Not surprising that Mridul Arora, managing director, SAIF Partners, believes that it’s a new normal. “For a reasonable period we will continue to see strategic capital from the US and China. I don’t see availability of capital going away anytime soon,” says Arora, sitting out of the fund’s Bangalore office.

Indeed, 2017 was a good year for private equity investments with a record $23.8 billion spread across 591 deals, surpassing the previous high of around $17.1 billion seen in 2015 and 55% higher than the $15.4 billion seen in 2016. The gargantuan appetite of Softbank was evident as it accounted for three of the top five deals worth $7.5 billion, providing early-stage investors much-needed exits. The Japanese conglomerate has invested more than $4 billion into Paytm, Flipkart and hotel aggregator OYO in 2017, nearly tripling its investment in India in a year. “SoftBank is not just a passive investor looking for quick valuation gains. We look for disruptive business models targeting large addressable markets,” says a SoftBank India spokesperson. Having already deployed $6 billion in India, SoftBank’s target of investing $10 billion by 2025will be achieved well ahead of time. What’s amazing to note is the way Softbank has ramped up its investment bets in India, after it first entered in 2011 by investing $200 million in mobile advertising firm InMobi. In the past three years alone, it ended up deploying $6 billion.

After SoftBank began its 2017 shopping spree with Paytm in May, it shelled out a massive $2.6 billion for reportedly a 20% stake in Flipkart a few months later. About $1.4 billion went to Flipkart’s coffers and the rest went to existing shareholders who sold some of their stake. For Tiger Global, Flipkart’s largest shareholder, the partial exit came after eight years post its maiden investment in 2009 when Flipkart was valued at $42 million. Since 2009, it has ploughed in $1 billion in multiple rounds, each at a higher valuation. While the latest round of funding values the company at around $11 billion, which is still lesser than its 2015 valuation of $15 billion, it was a much-needed exit for Tiger Global which reportedly raked in $800 million from the sale. It still holds about 18-20% of the company. “We believe in investing in market leaders. Paytm is the leader in digital transactions in India and is slowly expanding into the financial services space. Flipkart is the country’s largest e-commerce company and is constantly adding various services and products to its offering. Given the current business and consumer environment, along with the government’s focus on bringing more citizens under the ambit of Digital India, both these companies are poised to grow exponentially,” adds the SoftBank spokesperson. In fact, last November, Son had mentioned: “Flipkart, India’s number one e-tailer has 60% in the domestic e-commerce market and is bigger than Amazon India. It is very difficult to see someone who is bigger than Amazon.”

Apart from making new bold bets, SoftBank also backed up some of its existing portfolio companies, Ola and OYO. For Ola, Softbank joined hands with China’s Tencent to invest $1 billion in October 2017. SoftBank first invested in Ola back in 2014, leading a $210 million investment round into the company. Couple of rounds later, SoftBank reportedly owns more than a 30% stake in Ola. It also partnered with Sunil Munjal’s Hero Enterprises to infuse another $250 million into OYO. The last time SoftBank went on an investment spree like this was in 2014 when it invested nearly $2 billion within a year across companies such Snapdeal, Ola, Housing.com, Grofers and OYO. By the end of 2015, SoftBank was up there with Tiger Global as one of the most influential investors in the Indian start-up space. But the title did come with a costly price tag. In a market where valuations were already out of whack, SoftBank’s aggressive bidding pushed the price tag even higher — fetching some entrepreneurs much more money than what they could handle. For instance, Housing and Grofers got $100-million cheques, which was more capital than what they could manage at that point. In a bid to gain scale, both companies threw money to gain market share and floundered. While Grofers was able to cut costs, scale down operations and got back on a more profitable track, things imploded at Housing and it had be merged with rival PropTiger in an all-stock deal. Things also went horribly wrong for the Delhi-based e-commerce major Snapdeal. Until its recent deals, Snapdeal was SoftBank’s biggest bet in India, having pumped in nearly $900 million. It made its first investment by leading a $627-million round in 2014 and followed it with another $500 million in 2015. SoftBank did push very hard for a merger with Flipkart but the deal fell through. With Snapdeal fighting for survival, SoftBank is likely to write-off its estimated $900 million. While a write-off of this magnitude would be the death knell for most VC funds, SoftBank doesn’t blink an eye when it cuts the cord with portfolio companies that don’t measure up to its expectations. And that has been the case with its investments in India as well. With $60 billion at its disposal, it looks like SoftBank isn’t going to slow down any time soon. Having learnt from their previous mistakes, Softbank is likely to wait for companies to perform and dominate the market before splurging more money on them.

The Chinese invasion
The cross-border attention doesn’t stop with SoftBank, the Chinese too have infiltrated the camp. Two of the world’s largest and most successful internet companies, Alibaba and Tencent, see India as their next strategic market as growth tapers back home. And what’s more, both of them aren’t running out of capital anytime soon. Tencent, the most valuable social media company with a market cap of over $500 billion, generates a free cash flow of $14 billion and has cash of over $60 billion — that equals VisionFund’s spare kitty. While Tencent has been hugely successful in China, it hasn’t been able to replicate its success worldwide. Flush with funds, Tencent has been an active investor across the globe picking up stakes in Snapchat and Tesla. So far in India, Tencent has invested around $1.3 billion across Flipkart, Ola, ed-tech start-up BYJU’S and healthcare technology start-up Practo. While it started with initial investments in Practo and messenger app Hike in 2015-16, the big bets started in 2017.

In April 2017, Tencent led the $1.4 billion round in Flipkart alongside eBay and Microsoft, coughing up nearly 50% of the amount. In October, it joined hands with SoftBank to invest over a billion in Ola. “India’s transportation market is developing and highly fragmented. We believe Ola is well positioned to further strengthen its market share with its large driver base, localised and diverse product offering. Flipkart is a leader in e-commerce in India, with strong operational expertise and a deep understanding of user behaviour. The strategic partnership with Flipkart enables us to participate in exciting opportunities in the e-commerce and payments space,” says James Mitchell, chief strategy officer, Tencent Holdings.

Its arch rival and e-commerce counterpart, Alibaba, is building its own ecosystem across e-commerce, logistics and payments in India. It entered India with a $575-million bet on One97 Communications in 2015. Since then the Chinese e-commerce major and its subsidiaries have invested nearly $2 billion across half a dozen companies. After picking up a stake in the logistics group XpressBees, it recently led a $300 million round in online grocery store BigBasket, while Ant Financial, its payments arm, invested $200 million in food-ordering app, Zomato. Alibaba is looking to integrate BigBasket and XpressBees into Paytm Mall to create a larger ecosystem. Paytm Mall is in the process of integrating BigBasket on its platform. It is also working with XpressBees to develop logistics solutions. Alibaba already helps Chinese companies sell in Russia and Brazil and American companies sell in China. The overarching ambition remains to build a logistics network where products can reach a buyer anywhere in the world within 72 hours. While it is still early days, the strategic investments in India is a start in creating its own ecosystem here. By doing so, Alibaba also hopes to take on Amazon as both battle it out for supremacy in emerging markets. Amazon, which like Alibaba is looking to set up a global network of sellers, will be pumping in $5 billion to scale up its presence in India.

While tech giants are putting their weight behind India, hoping, that it would emerge as the next big internet economy, things don’t catch fire here so easily. The past couple of years have been proof that Indian e-commerce will not grow at a blistering pace like the Chinese and American markets, which had better infrastructure, smartphone and income levels to begin with. Besides, Chinese internet companies also had the additional lever of scaling up in a protected market. In comparison, India has a poor infrastructure, income and smartphone penetration levels are also much lower.

 At the height of the market frenzy in 2015, analysts were predicting the Indian e-commerce market to touch $100 billion by 2020, growing at an average of 50%. The market size was then around $13 billion. Soon the funding tap turned dry as the hedge funds developed cold feet, forcing e-commerce firms to cut costs, reduce discounts and go slow on their expansion. As a result, the market grew a tepid 16% to $14.5 billion in 2016. While it recovered in 2017 to clock a growth rate of 28%, it is nowhere close to the projected figure. Just to put things in perspective, Alibaba clocked sales of $25 billion on Singles Day in November 2017. So, any India-China comparison should be taken with a pinch of salt. Achieving that scale and profitability in a highly competitive market will be a huge challenge for homegrown consumer tech companies.

The year of IPOs
Even as a new breed of investors are breathing life into consumer internet companies, a buoyant public market meant that PE investors betting on traditional businesses finally got to have their exits as well. Investors raked in over $5.3 billion through the public market, $4.2 billion via secondary sales and $3.3 billion through strategic sales. “These are investors who have stayed invested for five-seven years and needed some liquidity. So, it’s only natural that a significant chunk of the IPOs were opportunistic ones that gave investors an exit option,” says Arun Natarajan, founder, Venture Intelligence.

In 2017, nearly 20-odd PE-backed IPOs hit the market, helping investors rake in $1.17 billion — almost 4x the amount seen in 2015. When AU Small Finance Bank and Eris Lifesciences listed in June, Christmas came early for ChrysCapital. The homegrown PE firm made a return of 6.78x and 6.91x, respectively. It had come on board with AU in 2013, acquiring 10% stake for Rs.120 crore, whereas it had picked up 16% stake in Eris in 2011 for about Rs.160 crore. Over the past five years, the firm cashed out with $2.5 billion from 25-odd exits. Last year alone, ChrysCapital realised $700 million from eight full exits and three partial exits. Recently, ChrysCapital also exited its controlling stake in LiquidHub, a digital customer engagement firm based in the US through a strategic sale to Capgemini, making 4x return on its investment in four years at 40% IRR. The bullish equity market also helped a handful of funds such as Warburg Pincus, Kedaara Capital and KKR to generate impressive return that stood at 13x at the top end of the return band in 2017. While KKR managed 4.27x on its investment in Dalmia Bharat (first investment in 2010), Warburg Pincus made an impressive 9.16x in AU Finance (2012) and 4.54x in Capital First (2012).

For a market where exits were considered a challenge, the development is good news. It makes it easier for general partners (GPs) to sell the India story to limited partners (LPs). Kunal Shroff, managing partner, ChrysCapital, agrees. “One of the key concerns for global investors were the lack of exits and realisations — so clearly an improving and sustained exit momentum will bode very well for the PE industry. Exits will demonstrate that Indian PE is not just a one-way street, and will also help free up allocations for future commitments by these LPs,” says Shroff.

Reformative measures such as GST, IBC and RERA have sent positive signals to the global investor community, signalling the government’s intention to improve governance, transparency, investor protection and ease of doing business. And it did help as India’s ranking in the ease of doing business index improved from 130 to 100 and Moody’s upgraded India’s rating from Baa3 to Baa2. KKR, which invests in India through its regional fund, the Asia Fund III, believes it is the right time for PE investors as the reforms have only bolstered their confidence in the country. “India’s macroeconomy has largely been stable, even during times of global slowdown. Investors are betting on India with a strong belief that this macroeconomic stability will continue in the coming years. Sentiment within the LP community is also hugely positive as reflected in the funds raised by PE funds, including us,” says Sanjay Nayar, CEO, KKR India.

KKR managed the largest exit of 2017 when French Company Altran Technologies acquired Aricent (earlier Flextronics) for $2 billion. Aricent was KKR’s first bet in India, when in 2006, along with Sequoia, it invested $765 million. Since the deal, it had pumped in more money into the company. “There is an increasing sense of confidence of a pickup in capital market, and interest from strategic investors. We see a clear path to realising return in India and sending money back to investors,” adds Nayar. The firm has invested close to $5.7 billion, including structured debt in Indian companies across industries such as telecom, technology, manufacturing, entertainment and financial services. 

KKR also became the first foreign investor to get an approval to set up an asset reconstruction company. With India sitting on a bad loan pile of over $150 billion, PE investors see a huge opportunity in stressed assets. Pawan Singh, managing director, Bain Capital, notes how the insolvency and bankruptcy process could be a game changer. “It is a significant opportunity for specific companies to attract foreign capital to enable a resolution. There is a lot of interest from global investors, including ourselves. Our joint venture, IndiaRF, with the Piramal group is actively looking at these opportunities. You didn’t see much of that capital flow last year, but you will see it in 2018. I’m optimistic about a good amount of foreign investment and capital flowing into these situations,” predicts Singh. Bain Capital made the single-largest investment in financial services in 2017 when it picked upnearly 5% stake for a billion dollars in Axis Bank. After technology, financial services has caught the fancy of investors with the sector attracting $4.40 billion across 61 deals in 2017.

Long-term view
Pension funds, which have been investing through private equity firms as LPs, are also looking to increase their direct investments in India or co-invest with their GPs. “We’re seeing some LPs looking to increase their direct and co-invest exposure to India. From our perspective, it is a big positive because it allows local funds like ours to “punch above our weight” — we get invited to larger deals due to our sector specialisation and it helps to have willing and able LPs keen to co-invest alongside you. In fact, we’ve offered close to $500 million in co-investing opportunities to our LPs over the past two years,” says Shroff.

As return from developed markets is hard to come by, pension funds are actively increasing their exposure to emerging markets. From instance, Caisse de depot et placement du Quebec (CDPQ), Canada’s second-largest pension fund which manages assets worth $286 billion, has increased its exposure from a little under 7% in 2010 to around 10% currently. It is looking to increase it further to 12-13% over the next four years. The fund, which invests across real estate, infrastructure, PE, listed equities and fixed income, has committed around $4.5 billion, of which $3 billion has already been deployed (50% in private equity investments).

Apart from forming a partnership with the Piramal Group for real estate investments, it has also invested close to $300 million in Edelweiss ARC. Anita George, managing director (south Asia), CDPQ, believes that since they don’t have a timeline to exit unlike the GPs, direct investments could work well for them. “As a long-term investor without timelines, we have that flexibility. That makes it much easier for us to plan even if there is a downturn,” explains George. In other words, it allows CDPQ to make larger bets on companies or sectors that they are bullish on.

CDPQ’s counterpart, Canada Pension Plan Investment Board (CPPIB), the largest pension fund in Canada, has invested $1.5 billion in the past one year and has allocated more than $1 billion for investments in Indian public markets. In March 2017, it picked up 3.3% stake in Bharti Infratel along with KKR for $955 million and is believed to be working on a $4 billion deal with KKR to buy out Bharti Infratel. Apart from looking for more opportunities in real estate and infrastructure, CPPIB wants to bet on India’s growing consumption story and invest in financial services, education, healthcare and retail. That’s a welcome change from the past. According to Peeyush Dalmia of McKinsey India. “If you look at the skew in 2008-09 vis-a-vis to where the money was going in last year, there is a dramatic shift towards new sectors.”

CDPQ’s threshold is a minimum of $100 million and it prefers to do large-ticket sizes when it comes to direct investments. Given that there are limited universe of companies that can absorb that kind of capital, it tends to push up valuations at times. “We like to invest significant ticket sizes, and that universe of available opportunity is much lower, even in China. There will be much more competition for this limited pool. But we have a comparative advantage thanks to our long-term approach and, in many cases, companies may have got a higher valuation from a strategic partner or aggressive PE, but they have opted for us because they also see the value of having a partner whose interests are totally aligned with theirs,” says George.

On the other hand, with investors understanding the Indian market better and promoters increasingly becoming more comfortable working with private equity investors, strategic buyouts, promoter funding and  structured debt deals are only set to increase in the next couple of years.

Thanks to better visibility on exits and return generated over the past one year, investments are likely to continue its good run in 2018. “Assuming that the public market continues to perform well, it should be another good year for exits. If the IBC process works as intended, it could contribute significantly to new investments during the year. We are bullish on India but it is a high valuation environment so you have to stay disciplined in terms of where you invest and what opportunities you pursue,” says Bain’s Singh.

Here’s where things could get a bit tricky. According a study by McKinsey India, like many emerging markets, India too is prone to momentum investing, with few contrarians to be found. More than 70% of private investments in the past ten years were made when the index traded above its ten-year median price-to-earnings multiple of 17.4x, states the study. In fact, according to McKinsey, 880 exits over 16 years in Indian private equity, at an aggregate level, have shown that returns drop as holding periods increase. While this time around the PE investments have yet again coincided with a market peak, the profile of investors is vastly different from what was seen in the past. Going by what Son had to say at a leadership summit, big money is not concerned about market downturns. As Son said at the event: “It’s a long journey. There will be good times, and there will be bad times, but SoftBank is always there.”