Success in PE ?1

Like they say deal-making is about managing 3 E's - Egos, Emotions and Expectations, this wonderful piece of article I came across in the blog The Private Equiteer throws light on what is needed in a mid-market PE fund. For once, I have very little to add except to shamelessly plagiarize the link and post it.

As said elsewhere in the post, the recipe for success is to be truly amiable and tenacious. PE deals take a lifetime to complete (in the context of finance where trading can make you as much in a month if not a year). Softer aspects like rationality, friendship, temperament and a X-factor (what does the team think of you ? Go or a no-go ?). I have been in situations where the sheer patience and ability to hang in there to the relationship has been a deciding factor for either side (assuming of course the price is in and around the fair zone - no one is a sucker). Sure, you may not consummate anything but the mindspace one occupies is sure to guarantee you a look-in in the future as well.



On the stuff about portfolio management, can't agree with the stuff any more. Remember you are only a general physician - so please do not get into cardiac or arthritic territory. Acknowledge your lack of expertise (self-deprecate and direct them to a specialist) and focus on generic issues which can be de-constructed easily (people, systems, process issues than technology or product or market dynamics). Remember no physician ever held onto a patient (and his trust) by monkeying around with his health !

~Varadha
(varadha.r1@gmail.com)

Dr. Jekyll Investor & Mr. Hyde Manager

One of the great many chasms that every single PE manager worth his salt has to go through is to figure out the delicate balance between the role of an investor and a manager without becoming disruptive.




How deep does one dive in ? How strong does the understanding of the organizational DNA have to be ? How strong should the technical/domain knowledge be ? For a relationship to blossom into one based on deep trust and commitment, the PE investor needs to move beyond the role of an investor who can bring in generic perspectives and become a trusted confidante; Being a trusted confidante automatically means ability to add value to the technicalities of the business/organization as also to the "mental orientation" of the promoter. May be the investment manager needs to ask himself if he can hold fort should the promoter vanish for 6 months which would mean answering the following questions for oneself:

• Do I understand the business in granular detail ? Sales structure, organization, productivity, sales cycles, supply chain, mark-ups, commercials, quality issues, customer expectations
  
• Do I understand the organizational DNA ? Is it driven by individuals or teams ? What are the motivation levels amongst lower rung employees ? How strong are the company's processes and systems when compared to its peers ?
• How is the market place evolving ? What are competitors doing that we are'nt ? What stage of the curve is the industry going through- early growth, heavy competition, consolidation or mature growth ? How well prepared are we for the next phase ?
  

An investor's role as a manager is like what someone said " it is not that you would, but you could". It is my firm belief that as one starts thinking about these, the value addition on business specifics tends to flow automatically strengthening the relationship that exists. Contrary to popular belief, I tend to believe that being an investor and a manager are not two different roles at different points of time. A good investor needs have a realistic managerial perspective and a strong manager needs to understand the way an investor sees things - you may be running the most salient business on earth, but if you cannot carry along your investors with you, it does not mean much.

~Varadha
(varadha.r1@gmail.com)

India's demographic dividend - a mirage ?!

Reading this wonderful article in the mint on the lack of challenges in a typical middle-class kids' life was quite an eye opener to the risk in India's much anticipated demographic dividend. It is certainly something most of us who spent our childhood in the pre-liberalization era can relate to - cycle as the only known mode of transport, one channel on TV, no computer, no video games, no internet, no mobiles, no apartments and no playing indoor games.

Kids of this age are getting increasingly isolated and cushioned at the same society from the realities of the society. My friend who runs a pre-school at Gurgaon was commenting about how a lot many kids in cities have never seen the outside except through the window of an air conditioned car. This might be great news for kids' TV channels, makers of video games and eatables but is not great news for the society (no, no "no sour grapes" syndrome here- coming from someone from the previous generation). I am now starting to find kids of house-maids and autorickshaw drivers to be much smarter on the street - for eg., buying vegetables, running errands, managing minor tussles on the street or for that matter even helping out their parents by earning a buck or two.



Every country at some point of time went through this stage of increasing luxury and isolation of children (Nordic countries and US in the 1970s) and it has remarkable repercussions like gun/drug/LSD culture, increasing suicides, violence. A spotless scrubbing of all grey/dark zones of life leads to an aimless drifting with most of them taking to "taboos" simply because those they are the only challenges for them to surmount.

Of course, it is just as likely that a few of these guys will turn out to be the Bill Gates-es and Michael Phelps-es, provided they have their value systems in place. Of course, that is contingent on parents and the time and effort they spend instilling basic values in place and giving kids a check of the societal realities. I am no doomsayer, but it is'nt going to be a rollercoaster as most of us imagine it to be.

~Varadha
(varadha.r1@gmail.com)

Right fund size ?!

This interesting article from KPMG that talks about the PE industry in India raises a pertinent question. What is the right fund size that marries the market opportunities with the economics of running a fund ? Seems like there is a difference between the perception of LPs and GPs (page 5). If 30% of the LPs want a small fund ($ 100-200 mn) 35% of the LPs want a fund that is in the region of ($ 200-500 mn) (vis-a-vis 20% and 35% for GP, it sure is an interesting combination.


I guess the question that LPs are asking themselves really is that in PPP terms a $ 200 mn fund in India would be the equivalent of a $ 1 bn fund in US (which pre-2007 was fairly common place), a significant size even the world's largest economy, especially if you are focussed on "classical private equity" (unpolished, unlisted companies). That means a $ 100 mn deal size assuming a portfolio of 8-10 companies (which means company revenues of anywhere from $ 50 -250 mn and PAT of $ 20-30 mn) - not pushover numbers in any case.


Dissecting the onion another way, the micro fund category (sub $ 100 mn) seems grossly under represented, given the fact that this is the sweetest spot in terms of risk-reward (get into companies with minimal concept risk but significant execution risk). However, it seems that the jury thinks it is unviable given the bandwith issues involved in managing the portfolio (I think this is an area that will get changed along the lines of the Silicon Valley model - where you could have a roster of operating partners that devote a part of their time to grooming companies thereby reducing the burden on the fund management team).

Given the current circumstances, I would think the ideal size for an economy like India (which is far more broad based, driven primarily by entrepreneurs, not the Government and hence has a larger range of opportunities) ought to be in the region of $ 200-300 mn.- if one were to marry the overheads of fund management with the opportunities available in the market). Of course, this will also depend on the style of investing (preference of size of stake, operational involvement).

Thoughts, any one ?

~Varadha

Why some PE funds do better than others

For once, I do not have to write a cent from my own thinking in a post. The Mckinsey Quarterly article (though dated but clearly in with the theme of these times) sheds light on why fundamental outperformance is the only sustainable source of value creation (very very cliched, but terribly true).

Assuming there are no free lunches, there is so much to the arbitrage a PE fund can seek at the time of entry. A proprietary relationship built on trust and commitment can get you a discount but is not going to entirely contribute to an arbitrage opportunity. Of course, the smarter, seasoned ones can spot smart "buys" or smart "sells" in special situations (how many times a century are you going to have Goldman or a GE with a bowl in front of your house giving you a 10% preferred ?! or dump everything before a bubble ?) but for the majority of homo sapiens, the arbitrage opportunities are not worth too much salt.

Of course, pushing for outperformance means the obvious nitty-gritties - kicking tyres all the time to understand ground realities, understand organizational levers, spending quality time with top management and focussing on continuous improvisation.

But as a Private Equiteer, the piece de resistance is the fact that you can go to sleep every night assured in the fact your investment has appreciated (and is appreciating) even if a gale force hits the markets. That's priceless !


~Varadha
(varadha.r1@gmail.com)

Entrepreneur and the art of identifying "Tipping Point'

Last week, I chanced upon Graham's essay on "what start-ups are really like". A lot of it holds true even in early growth companies (including investors are clueless !). The one thing that stuck me is every single business I have seen seems to go through that one single "Tipping point' or 'Inflexion Point' from which it emerges much stronger or much weaker (hence, takes on a different trajectory post that).


I am not necessarily talking about topline or bottomline (often they could be misnomers for the amount of confidence and dynamism you see in the Management team). It is just that one single event/incident/spark that changes the entrepreneur's outlook towards the meaning of his business and life. It ironically always comes from outside and from the most unexpected quarters - like a peer outside telling you what a great business this is or one of your suppliers telling you that you are his "fastest growing customer". Case in point being A.R. Rahman's music - if the Slumdog Millionaire recognition had not happened, he probably would have coasted along as yet another great Indian music director, only to be relegated to oblivion by the succeeding generation.


It seems it is one such small spark that turbocharges the small motor that is the human mind and makes it spin faster, harder and bigger. To quote from Malcolm Gladwell's The Tipping Point, it seems like one needs a connector (who are social trend setters) to make one realize his own potential (Johari Window, anyone ?).

As for my tipping point, I do not think I am there as yet...!


~Varadha (varadha.r1@gmail.com)

Private Equity : Absolute Vs Relative return

Coming on back of this great article I read on investing across Geographies, I am tempted to ask ourselves the question - is Private Equity an absolute or a relative return asset class ?

Most people investing in India over the last five years would tell you that private markets have had a much higher volatility and have underperformed the public markets overall (extremely illogical, no reason why size and liquidity premium should be negative). As things stand, if I were allocating assets I would be hard pressed to answer as to why I should choose Private Markets in India over public markets or better still, why I should choose India at all ?

Going by the flights/hotel test (Indian hotels are overpriced and yet overbooked and similar is the case with flights), it seems like India is seeing a bubble, at least for the time being. So are you better off betting on a star-fund manager in India (for the uptick provided by his alpha) or are you better off investing into the beta of a new market. Tough call, is'nt ?



Even in this era of globally mobile capital and minimal information asymmetries, the first movers stand to make an inordinately high return. With internet, new age media and mobile, the window of opportunities are becoming smaller and tighter which also means the rewards for the birds that spot the window are that much higher.

However, as an institutional investor are you looking to maximize returns in the medium term (3- 5 years) or in the long term (15-20 years). It seems like a lot of people are willing to stick their neck out for the long term and back fund managers that deliver superior alpha than piggyback on the next market beta wave. I guess the underlying logic must be sustenance of outperformance in the long run than a flash of brilliance in the medium term.

~Varadha (varadha.r1@gmail.com)