As reinforced by the recent Knowledge@Wharton article on Warburg Pincus, most private equity investors in India have focused on later-stage investments in mature industries. Over 80% of the $3-odd billion invested in India over the last 3 years are in late-stage companies. 90% of investments have been in fairly mature industries, such as construction, financial services, hotels, manufacturing, pharma, healthcare, IT/BPO and energy.
At first glance, this seems quite simple and low-risk. We know there is strong demand. The products and services are standard. There is no technology risk or long product development cycle. All that is needed is for the company to execute to plan. That’s where is gets complicated. Execution isn’t as simple as it looks on paper (or powerpoint). In fact, the only thing that differentiates between companies in India is strong execution.
Let’s take the Bharti example. At the time Warburg invested, Bharti was one of a dozen emerging telcos, that each had a circle or two. Without the benefit of hindsight, all these companies looked more or less alike. All of them had access to the same network equipment, billing software, vendors, consultants, you-name-it. They all hired from the same pool of ex-FMCG managers to handle sales, distribution and marketing. While not all of them raised $ 600 million, access to capital wasn’t an issue either as everyone was affiliated to one business group or another. Today, Bharti’s a clear market leader, while several of the others don’t even exist anymore. Bharti has done the same things all telcos did – roll-out network, get the best price/service from vendors, market services, take care of bad debts, handle customer complaints etc. Only, they’ve done each of these just a little bit better and more consistently. It’s been plain, old-fashioned execution and managerial ability. The same story repeats itself as you look at companies such as HDFC Bank, Infosys or Bharat Forge.
As an investor in India, the single most important parameter to assess is the company’s execution ability. This ties in directly to the emphasis on later stage investments, as the only way to ascertain this is to actually see it in action. The main question is how long must one wait to figure out if this is a company that can execute its way to becoming a market leader?
To answer this question, let me take a specific sector – retail – as an illustration. I break up any retailer’s evolution into two phases – a trial & error phase, followed by an expansion phase. The first phase is where one figures out the right business model specific to the Indian context. This is an iterative process that can take several years. FoodWorld was the first organized retailer in India, starting in my hometown – Madras. They toiled many years with the supermarket format, before finally figuring out that this format doesn’t work and have now shifted focus to a big-box hypermarket format. The coffee chain Barista has gone through three owners and as many CEOs, in trying to figure out its positioning and pricing. Many others are grappling with choices to be made on store formats, size, own-vs-franchise etc. Once the right model is established, it’s a question of scaling up by rolling out a proven model across cities, regions and more stores. The most optimal approach is to stay small and preferably stick to one city/region in the first phase. This limits the amount of capital being expended on the ‘error’ part of trial & error. Besides getting the model right, this phase also demonstrates the ability of the core team to pull this off.
For an investor, the best risk-reward is to invest after the first phase, in a proven business model and team that can then expand significantly with access to capital. In predominantly execution-driven businesses (as opposed to those based on IP or innovation), I’d rather not invest early. This execution thing is way harder than it looks!
Here’s some food for thought. Warburg made about 6 times their investment in Bharti over approximately six years. If you or I had bought Bharti stock in 2002, we’d have made over 10 times our money in 3 years. Better late than early?