Why do you even need to raise funds from other sources? We will give you the funds needed for investing in troubled assets in India." This response from the manager of a global distressed fund stumped the executive of a big Indian corporate, who was on a tour of the US to explore business tie-ups. The manager, with decades of experience in turning around junk assets, suggested that the Indian corporate partner help in managing the assets on the ground. "We both can share the returns," he said, matter-of-factly. The Indian partner in question is a domestic conglomerate with diversified business interests. There's more. In another meeting in the US, a global investor indicated to this executive that he could put in large money in their India-focused distressed fund but demanded flexibility to co-invest along with the fund when they are convinced of a good deal. "So he wants to double his stake in certain distressed assets deals," says this seasoned corporate representative who is now stitching a strategy for the group's maiden foray into distressed assets.
Cut to Mumbai. There is a palpable sense of excitement at the office of a large global distressed fund with operations in India but it's tempered with caution. The Indian-origin partner of this fund often has to rein in the enthusiasm of his partners in New York. "They are gung-ho on the distressed assets market post the new bankruptcy code. They want to cut deals fast, but I have to keep reminding them about the risks every time." His worries are about the likely challenges to new bankruptcy code. "Anything can go wrong," says this middle-aged Indian who had seen the jubilation post the introduction of the SARFAESI Act in 2002 and also the disappointment when one of the defaulters, Mardia Chemicals, challenged the very validity of the new Act in the Supreme Court. The apex court subsequently stayed the process for almost three years. "Everything is possible in India," he says with a smile, adding that he wants to see the bankruptcy code pass the litmus test - successfully untangle the first lot of big assets like Essar Steel, Bhushan Steel, Jaypee Infratech, etc., in a time-bound mechanism.
Indeed, investors who have tasted blood in distressed assets globally are now descending on the Indian market place after watching from the sidelines for almost a decade. In February this year, Dallas-based Lone Star partnered with IL&FS to jointly explore the distressed assets opportunity in India. Oak Tree Capital , the world's largest special situations and distressed fund, has hired a JP Morgan senior executive to study the potential in India. J.C. Flowers has Ambit Financial Services as a joint venture (JV) partner. Apollo Global Management is already ready with a billion-dollar fund via a joint venture with ICICI Group to explore the special situation market in India. Two large Canadian funds - Brookfield and CDPQ - already have operations in India. Hong Kong-based SSG Capital too is active in the Indian market.
The origin of the market for near-junk assets actually dates back to some four decades ago when the US bankruptcy code was enacted. Initially, the junk bond market was developed by offering a high coupon rate for troubled assets. Subsequently, specialised buyout funds emerged in the US. They made windfall gains by turning around distressed companies and later diversified globally. In the late '90s, they lapped up companies in East Asian countries hit by the currency crisis. The world also saw vulture funds (basically hedge funds) in the limelight for buying sovereign distressed debt of African and Latin American countries at a deep discount. Clearly, the action of global funds is now shifting to India.
Last year, Jim Carter, CEO of $75-billion global alternative asset firm TPG, flew down to India with a 65-member entourage of high profile investors. Carter and investors had some close-door meetings with government functionaries to understand policy dynamics. Around the same time, James Christopher Flowers of J.C. Flowers landed in the country for a tie-up with Ambit - a financial player with interests in investment banking and institutional broking. "One thing that's very important is the change in the bankruptcy rules. Then the attitude from the RBI towards banks to clean up their bad assets," said Flowers, who has made a fortune in the junk assets market. The action has already started with the unveiling of the new bankruptcy code late last year. The adjudicating authority, the National Company Law Tribunal (NCLT), is hearing hundreds of cases. The size of the stressed assets, to the tune of `14 lakh crore, is large enough for global fund houses. (See The Opportunity in India)
Indeed, global funds had exposure to the India distressed assets market in the last decade. The market was not actually ready because of regulatory reasons. At that time, global funds like Clearwater Partners, Asia Debt Management (ADM), Wilbur Ross and Eight Capital made investments in stressed small- and mid-sized companies. The SARFAESI Act 2002, which gave power to take over the assets of the defaulting company, was an encouraging step but got bogged down in procedural delays. The decade also saw the setting up of asset reconstruction companies (ARCs), but they ended up focusing on recovery rather than restructuring. Also, a corporate debt restructuring (CDR) mechanism was introduced to deal with overleveraged corporate. But that, too, was criticised for evergreening loans. That kept global funds away from India. The secondary debt or bond market wasn't there at all. That (bond market) is true even today. It was also impossible for a global fund to buy out an Indian company without the consent of the existing promoters. There was also a supply issue because of banks happily evergreening the loans. Then, the ARCs were following a "recovery" model or doing financial engineering like recasting or rescheduling debt. There was no turnaround.
The global funds present in India did only equity transactions. Wilbur Ross, one of the early investors, invested $86 million in the ailing airline Spice jet when oil prices were at $150 a barrel. It exited making $127 million when the turnaround happened through falling oil prices and a new management under Sanjay Aggarwal. Private equity players like KKR and Blackstone, focused on growth capital and did some management buyouts in India. But these were pure equity deals with the consent of promoters. "Distressed situations are buyout situations. The ideal way of resolving the distress is to buy out the company and not infuse equity," says M.K. Sinha, Managing Partner & CEO of IDFC Alternatives. The buyout situation requires huge funds, operational expertise and also strategising the future product play in the industry.
New Funds, New Strategies
Global-distressed fund managers are not in a hurry to take the plunge. "The opportunity is not massive straight away, but it will become one in the next 5-10 years," echo many global fund mangers who spoke on the condition of anonymity. Today, the business has become much more cash-focused. For example, an ARC today has to put upfront 50 per cent cash to buy assets. So you need deep pockets to play in the market. Similarly, banks also expect a faster turnaround. And this is possible with participation from a strategic player. The likes of J.C. Flowers and Lone Star have the ability to write fat cheques. They have expertise in certain specific sectors and can bring specialists from across the world to manage assets.
Many say that traditional private equity players in India - such as KKR, Blackstone - have the advantage of being in the country for a long time. There are a handful of private equity players in India with special situation funds and they appear better placed to exploit the distressed opportunity. Special situation cases are contrarian bets and not distressed situations. AION, a JV with ICICI Group and Apollo Management, has a special situation billion-dollar fund at its disposal. Currently, AION is the only fund with a broad mandate to play in the market.
In terms of the structures, traditional PE players are looking at the NBFC and ARC models to play in the market. KKR is keen to be active in the stressed assets market and has already an ARC license.
Many of the global funds are testing the waters by tying up with local partners. US-based J.C. Flowers has joined hands with Ambit. The duo will have a fund and an ARC to play in the market. "We will focus on the mid-market. We will look at a ticket size of $15 million to $30 million. We are not looking at the first 12 insolvency cases," says Rahul Gupta, Co-group CEO, Ambit. The Ambit-Flowers JV will look to raise a fund of anywhere between $150 million and $250 million overseas, so will have equity capital and debt working together. Toronto-based Brookfield, which has made some successful investments in India, has a joint venture with the largest bank in India, State Bank of India. It's a good combination to cut deals though nothing much has happened. "There are funds that are not interested in the turnaround of a company but instead focus on some good assets. Brookfield is an asset owner. It owns lot of area in the commercial space," says a PE player. Brookfield is active in buying parts of the assets. The Canadian fund has made successful investments in real estate by buying properties of Unitech and Hiranandani Group.
Many funds with financial partners in India may or may not need a strategic partner to turnaround operations. They bring in the new management to restructure the operations. In India, IndusInd Bank and RBL Bank are two great stories of new managements turning around the operations in six to eight years.
Big Local Players With Foreign Tie-ups
Many analysts suggest that it is difficult to run a company in India without the support of promoters as they are usually a part of the management. This is unlike global trends where professional managements run the operations. "Indian promoters multitask and are crisis managers. They manage many issues like regulations, labour laws, government and legal issues," says Nirmal Gangwal, MD & Founder of Brescon Corporate Advisory. Global funds may have the capital but not the expertise in managing a local business. "India is a slightly different animal. To play this (distressed assets), you need to be little more local," says Amit Agarwal, Executive Vice President - Stressed Assets, Edelweiss Capital. Edelweiss, with CDPQ as a partner, is ready with a billion-dollar fund to invest in the Indian distressed market. "Practically, we will have $2 billion to invest in India," says Nitin Jain, Head (Global Assets & Wealth Management), Edelweiss Capital. The Canadian partner CDPQ has extended additional capital in a separate account for investing in distressed assets. CDPQ has also taken a 20 per cent stake in Edelweiss ARC. Among the local players, IDFC Alternative is exploring the possibility of buying stressed thermal power plants. In addition, ICICI Venture and Tata Power have launched a platform to look at power assets together. "Lot of the thermal power plans are in distressed situation and we do have the ability to pick it up," says Sinha.
Similarly, Ajay Piramal and Bain has a tie-up to look at deals together. Aditya Birla Group is also exploring the possibility of a combination of a fund and an ARC. Kumar Mangalam Birla, Chairman of Aditya Birla Group, recently talked about jumping into the stressed assets space. "We are talking about turning around assets not just through financial restructuring but also in terms of operations," says Birla.
"We think there is an opportunity to actually get involved in the operations of a company," says a strategic player with huge manufacturing capacity in India and abroad. Currently, Tatas, JSW, Aditya Birla and Shapoorji Pallonji are showing interest in buying distressed assets. Hemant Kanoria, Chairman of SREI Group, knows a thing or two about distressed assets. "There is the opportunity to provide priority debt while bankruptcy proceedings are going on. Second, when the restructuring is done with sustainable debt, there will be an opportunity to provide secured debt. We can also fund the new promoters who come in," says Kanoria. In the past, the group has made successful exits in distressed loans, especially Kingfisher where it bought the loan from ICICI Bank that was backed by shares of United Spirits. The group understands the infrastructure sector where it has experience of three decades.
There is no dearth of funds. There are global pension funds, sovereign funds, insurance companies and asset managers that are seeking higher returns. But the challenge is generating returns. "There is time value for these funds. Unlike our banks that used to evergreen the loans," says Gangwal. There is another issue. In terms of productivity and cost efficiency, Indian companies are not globally competitive. "Whatever worked abroad will not work in India," says a PE player.
The global funds would certainly take time to take a plunge. They want to see how the first few deals are structured under the IBC. "It's a well conceived code we also have to watch out for any execution flaws or legal challenges in future," says Sinha of IDFC.
There could also be challenges from existing promoters if thrown out. They may try to bid a higher price than other bidders and disrupt the process by challenging it in higher courts. Some fear fight between partners over running the operations and strategies after the deal is struck at the IBC. There is also a possibility of sudden changes in government policies impacting returns. "There should be sanctity of contracts. This is a must for the long-term infrastructure project. There should also be no retrospective changes. There should be clarity in policies," says. Sinha.
There is lot at stake. If the experience is good for global fund managers, India will see a huge flow of global money into distressed assets. "This will have a positive impact on the Indian banking system, FDI inflows and currency value," says a global manager.