Car­lyle Ex­pects In­dia to Of­fer Best PE Re­turns in the World

World’s 2nd largest PE firm says re­turns on in­cre­men­tal cap­i­tal will av­er­age 24.7% per year dur­ing 2016-2020

The Economic Times - - Special Feature -

In­du­lal PM & Ari­jit Bar­man

Mum­bai: Modi­nomics has just found one of its big­gest cheer leader in Car­lyle.

The world’s sec­ond largest pri­vate equity fund has ranked In­dia as the most at­trac­tive in­vest­ment des­ti­na­tion in the whole world, of­fer­ing the high­est ex­pected re­turns on in­cre­men­tal cap­i­tal over the next four years. Such views run con­trary to the pop­u­lar nar­ra­tive of In­dia be­ing largely a dif­fi­cult mar­ket to make money — ex­ac­er­bated by a lethal com­bi­na­tion of over reg­u­la­tion, de­mand­ing lo­cal pro­mot­ers, frothy val­u­a­tions, lim­ited exit op­tions, macro-eco­nomic head­winds and a volatile cur­rency.

In a first-of-its-kind note to its in­vestors, specif­i­cally on In­dia, Car­lyle’s di­rec­tor of re­search Ja­son Thomas has said af­ter In­dia for­mally as­sumed the man­tle of the world’s fastest grow­ing econ­omy in 2015 from China, it will con­tinue to out­pace the later by about1% this year and the gap be­tween the growth rates of two is likely to widen over time. “The most op­ti­mistic forecast for 2016 GDP growth in China (7%) matches the most pes­simistic forecast for In­dia,” Thomas wrote to Car­lyle’s lim­ited part­ners last month.

This will largely be on ac­count of In­dia of­fer­ing the world’s high­est re­turns on in­vest­ment. Quot­ing IMF data that said re­turns on in­cre­men­tal cap­i­tal in In­dia to av­er­age 24.7% per year be­tween 2016 and 2020, Thomas points out, “These re­turns are about 2 times the global av­er­age of 12.5% and 1.7x faster than the 15% re­turn forecast for Emerg­ing Mar­ket economies on the whole,” and adds, “With an in­vest­ment rate equal to roughly 30% of na­tional in­come, In­dian trend GDP growth is ex­pected to av­er­age 7.5% an­nu­ally through 2020.”

The pro­duc­tiv­ity of cap­i­tal is high, feels Thomas, thanks to a large sup­ply of low­cost labour, abun­dance of IT tal­ent and en­trepreneurs that con­trib­ute to rapid pro­duc­tiv­ity growth, favourable de­mo­graph­ics, im­proved qual­ity of pub­lic in­sti­tu­tions, and the small ex­ist­ing cap­i­tal stock. “High ex­pected re­turns on in­vest­ment are, of course, a key de­ter­mi­nant of the at­trac­tive­ness of var­i­ous mar­kets. There are many other fac­tors as well: risk, val­u­a­tions, the level of com­pe­ti­tion for ac­qui­si­tions, avail­abil­ity of fi­nanc­ing, exit mar­ket liq­uid­ity, etc,” he told ET in a sub­se­quent in­ter­ac­tion.

While elab­o­rat­ing on the co-re­la­tion be­tween GDP growth and re­turns on in­vest­ments, Thomas ar­gues that it de­pends on how the growth is gen­er­ated. If it comes from ex­ces­sive in­vest­ment and over­build­ing like it is in China, re­turns are gen­er­ally low be­cause ex­ces­sive in­vest­ment de­presses the re­turn on cap­i­tal. Con­versely, when GDP growth comes from high real re­turns on in­cre­men­tal cap­i­tal, fi­nan­cial re­turns tend to be high as well. “In­dia’s GDP growth comes pri­mar­ily from high re­turns on in­cre­men­tal cap­i­tal, as In­dia’s in­vest­ment share of GDP is about 30%, very close to peers and far be­low some Asian economies that ex­pe­ri­enced un­sus­tain­able growth. In­deed, most ev­i­dence sug­gests in­vest­ment rates in In­dia could in­crease sub­stan­tially with­out

MD & Di­rec­tor of Re­search, The

Car­lyle Group

As a firm, Car­lyle have been long on In­dia in re­cent times like some of its other PE peers like Black­stone and KKR. Ac­cord­ing to in­dus­try sources, it has in­vested the high­est amount last year in a sin­gle year since set­ting up its In­dia oper­a­tions in 2000. As of De­cem­ber 31, 2015, the group has in­vested ap­prox­i­mately $1.5 bil­lion of equity in more than 30 trans­ac­tions via its Asia growth and buy­out teams. Sources close to Car­lyle peg this year’s num­ber to be even higher. “The world is starved of growth, which makes economies like In­dia es­pe­cially at­trac­tive,” as­serts Thomas. Plans are also re­port­edly on to raise a new bil­lion dol­lar PE fund to in­vest in Asian growth com­pa­nies.

Over­all PE in­vest­ments in In­dia have also grown 81.2 % in the last cal­en­dar year


to $10.89 bil­lion com­pared to $6.07 a year ago, ac­cord­ing to data com­piled by Thom­son Reuters.

“2015 has been the best year ever for PE in terms of deal value and vol­ume of in­vest­ments. It was char­ac­terised by large ticket ac­tion in sec­tors like ecom­merce, fi­nan­cial ser­vices and pharmaceuticals. It also saw the high­est num­ber of ex­its recorded in a year with the value dou­bling as com­pared to the year be­fore. We ex­pect the mo­men­tum to con­tinue,” said Amit Khan­del­wal, Na­tional Di­rec­tor, Trans­ac­tion Ad­vi­sory Ser­vices at Ernst & Young.

While growth at this pace is surely im­pres­sive in the global av­er­age of just 3%, Thomas feels there’s no rea­son In­dia should set­tle for “just” 7.5%. “With ef­fec­tive wages one-tenth of the US level, a cap­i­tal stock one-third the size of China’s, and a large pool of un­der­em­ployed labour, In­dia could ab­sorb a sig­nif­i­cant in­crease in fixed in­vest­ment with no diminu­tion in re­turns, he said.

Putting po­lit­i­cal set­backs in re­cent state polls or re­forms like GST roll­out in per­spec­tives, Thomas is of the opin­ion that for­eign in­vestors in In­dia’s stock mar­ket seem to have over­es­ti­mated the speed at which struc­tural re­forms could be im­ple­mented. Yet, the pes­simism im­plied by re­cent out­flows seems out-of-step with un­der­ly­ing fun­da­men­tals.

Af­ter flock­ing to In­dia fol­low­ing Modi’s elec­tion, for­eign in­vestors have re­cently be­come more luke­warm on the coun­try’s prospects. Broad In­dian stock in­dexes rose by over 40% in the 12 months fol­low­ing the 2014 elec­tion vic­tory, but have since fallen by nearly18% from their 2015 highs.

“The re­form agenda pro­ceeds, al­beit at a slower pace than many ob­servers ini­tially con­tem­plated, and new mone­tary pol­icy tar­gets have re­duced the risk of a con­fi­dence-sap­ping rise in in­fla­tion that hits fi­nan­cial sav­ings and the cur­rency. In­dia’s hour on the global macroe­co­nomic stage has ar­rived. In­vestors should take no­tice,” Thomas said.

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