Q4-2015

Welcome to the quarterly newsletter of SeaLink Capital Partners (SCP). 
 
There are close to 12,000 mid-market businesses (between USD 25-125 million in revenues) in India, which represent the growth engines of the economy – filling crucial need gaps in various industries and geographies and providing local employment.  With agility, local knowledge and innovation, several of them have been able to compete successfully against multinationals in select regions.
 
As these businesses aspire to scale and reach the next level, there is a growing need for ‘smart capital’ from involved investors who will go beyond writing a check to actively serving as mentors, advisors and thought partners.  However, supply of private equity capital in the mid-market segment in India has not kept up with demand and almost half of the companies seeking funding do not get access to it.  Significantly fewer are receiving ‘smart capital’.
 
Our discussions over the years with entrepreneurs and Limited Partners alike have often focused on the attributes that tend to make or break an investment decision.  In environments where investors and high quality entrepreneurs may both have choices, those discussions have focused on identifying the key criteria behind partner selection for both parties.
 
We’ve chosen to shine a spotlight on the criteria and attributes that drive an investment decision and influence its ultimate success in this issue of our newsletter.  If you have any additional insights or comments on it, do let us know.  

The fundamentals in India remain strong

Recent volatility in worldwide markets following the devaluation of the Chinese Yuan and uncertainty on a rate increase in the US also impacted India. However, it is important to separate out the temporary effects of global volatility from the underlying fundamentals of the economy.

Over the last eighteen months, several economic indicators in India have improved significantly, either due to government or central bank actions, or aided by global factors.  Fundamentals behind the Indian economy (fiscal deficit, current account deficit, foreign exchange reserves, growth in industrial production) are stronger than they have been in years, thereby spurring long-term confidence and optimism among investors. 

Retail inflation (measured by Consumer Price Index) has declined from 8.8% in January 2014 to 3.7% in August 2015 and is well below the central bank target.  The steady decline in inflation has enabled the central bank to make four rate cuts totaling 125 basis points in the last ten months.  With the lending rate at the lowest it has been in four years (6.75%), there is significant stimulus for further growth. 

In order to create sustainable growth, the federal government and the central bank remain focused on economic reforms.  A strong dose of recapitalization in public sector banks, approvals for 11 new payment bank licenses and 10 small finance bank licenses are recent moves to expedite banking reforms and enhance financial inclusion.

As per the International Monetary Fund, the world economy is expected to grow at 3.3% in 2015, with advance economies (e.g., US, UK) growing at an average of 2.1% and emerging markets growing by 4.2%.  With an expected GDP growth of 7.5% in 2015 and similar projections for 2016, India is the fastest growing major economy in the world.

With an expectation of continued focus on reforms, the case for optimism in India remains strong.  A manifestation of the optimism is visible in India surpassing China and the US to become the world’s number one destination for foreign direct investment during the first six months of 2015.  India has also jumped 16 places in World Economic Forum’s 2015 global competitiveness ranking, a reflection of businesses’ favorable outlook towards the country.  And the optimism extends to domestic consumers.  As per a recent study by Pew Research, 74% of Indians believe that the economic situation will improve further over the next 12 months. 

What influences an investment?

Warren Buffett has a famous 20-slot rule for investors.  When evaluating prospective investments, Buffett recommends asking the question – “If I had a punch card with only 20 slots for my entire career, and every investment represented one slot, would I punch my card on this investment?”  

The 20-slot rule forces investors to think carefully, to do their diligence, to poke holes in their own analyses, and make a very conscious and deliberate choice on whether or not to invest in a company.  If you’re punching your card on this deal, you have one less slot for the future.  Each punch counts.   

So what makes an investor punch their card on a prospective investment?  Are there some non-negotiable attributes when looking at investments?  Conversely, are there certain factors that will cause an investor to put the card in their pocket and walk away? 

Click here to read more 

Making the most of the punches

One of the intended outcomes of Buffett’s 20-slot rule is that by being very selective about investment decisions, investors also have more ability to focus on the punches that they’ve made.  Investing is not a spectator sport where one waits by the sidelines to see how a portfolio company performs and occasionally cheers on the management team.  Punching the card represents a complete and active commitment from the investor.  And in our experience, the best investments go far beyond the financial commitment. 

Punching the card is a critical decision, but it represents only the beginning of the journey.  The ultimate success of the investment is crucially dependent on the quality of the partnership and the onus for making that happen lies equally with the investor and the portfolio company.  Open communication, transparency and positive intent form the foundation of the partnership.  Given that typical private equity investment periods can last a few years, establishing a collaborative and partnership-based approach from the very start is critical. 

An active, engaged and collaborative partnership can reap significant mutual benefit.  For instance, an involved investor can add considerable value by providing the portfolio company with best practices in a variety of fields including sales and marketing, financial controls and accounting, supply chain management and organizational and leadership development.  While the company management remains the primary owners of the initiatives, the investor can supplement their efforts in those areas, enhance the overall strategic focus and also strengthen overall corporate governance, all of which can help the business (and the investment) reach the next stage.

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