Interview with Jeff Schmidt and Rajesh Varma
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Jeffrey A. Schmidt:
We have been conducting a series of interviews with our international leadership team covering both our industry leaders and country managing partners. Today, we’re talking with Rajesh Varma, Regional Managing Director of Asia Pacific and CDI Global India. Rajesh is also a member of our management committee.
Rajesh Varma:
Thank you, Jeff, for inviting me for this program. I look forward to offering you insights, which are very peculiar to India and hope that will be of interest for all our colleagues.
Jeffrey A. Schmidt:
There's been a lot happening geopolitically in the world and some of that directly or indirectly affects India. What do you consider the major geopolitical forces impacting India right now, and particularly, their implications for middle market deal flow.
Rajesh Varma:
The biggest threat for India is energy. 85% of India's energy is imported. It’s largely from the middle east but late we have been picking up Russian crude as well. The private refineries have been picking up Russian crude. Essentially the cost of our energy is becoming very prohibitive. It is impacting everything. And what we call is imported inflation, we are now facing an insulation retail inflation of about 7%, which I started pinching people in the lower segment of society. Even more alarming is that gas supply, which actually feeds the industry in a very large way, now the government and private agencies are not able to pick up gas as they could earlier because everything is getting diverted to Europe because Europe is willing to pay a higher price.
Rajesh Varma:
That is a challenge. The cost of energy has gone up so obviously it's going to impact the cost of production. If it's impacting the cost of production, it'll have an impact on the IBIDA. And though we have not seen the full impact of it in Q1 in India which is April to June. What our results have seen on the newspapers over the last two weeks. it has not yet fully begin to impact, but in Q2, I think we'll see the full burden of the cost price impacting all the balance sheets and profit loss account. So it'll naturally have an impact in terms of the company's ability to earn and generate transfer cash flows.
Rajesh Varma:
There has been an impact, but not significant as yet, but I would imagine that Q2 will see the full brunt of this impact in the PNLs of most companies. There is a significant impact because of the energy prices. And this is also leading to an inflation retail inflation of 7%, and that is clearly pinching the lower segments of the society. This is another aspect which is evident, but the good part is that India has got significant food stocks. So from the point of you of availability of food, there's plenty of it for everyone. India is also supporting countries like Sri Lanka and Afghanistan, which large amounts of green. So food, food is not an issue, but energy certainly is.
Jeffrey A. Schmidt:
Certainly, with 85% of India’s energy imported, there's no quick fix. But do you think this situation will encourage the Indian government to provide incentives to invest in alternative energy sources such as renewables, wind, solar, and maybe tidal power?
Rajesh Varma:
Some of the largest investments in renewables, mainly solar, is happening in India. There's a company called the Adani green energy which has invested about 5 billion us dollars so far, and they have a target and they kept us at a budget of 25 billion to be invested for green energy. And likewise, the other large Indian company called Reliance industries also investing significantly in green energy. There is a lot happening in wind and solar. You cannot wish away oil for the moment. Knock, can you wish away coal? And they will continue to play a significant role for the, at least the next 25, 30 years.
Jeffrey A. Schmidt:
There's a trend to shift production away from China. Do you see that trend in India as well? Are there new investments, either through acquisition or Greenfield investments, in plant construction to move production from China to India?
Rajesh Varma:
Yes, indeed. There is a lot of activity on that front because most of the European companies have decided to go for a China plus strategy. And while they have tried out Indonesia, they feel that India is a better, but India has its own challenges in terms of infrastructure. It doesn't have infrastructure, anything compared to what China has. So interestingly the budget for the year 2022, which was released in February of this year, the government has decided to allocate a significant portion of capital for multimodal logistics. No India. Interestingly, the cost of logistics is certain to be percent of GDP. And you can compare that with USA, which is considered to be 8% of GDP. There is a considerable root for improvement there. The government has realized that unless they bring, uh, the cost of logistics to 10% of GDP, they can now be the capital for manufacturing and computer China.
Rajesh Varma:
So they have ear-marked a significant portion for multimodal logistics, both by water, sea, road and rail and air. Very interestingly, they have made a separate ministry for that to make sure that everything is integrated. And the roads are improved. Railways are connected to the ports and airports. This multimodal integration is currently happening as we speak and it's expected in about three years, all the investments will be in place. Perhaps by that time, the cost of logistics will come down and India become a more attractive place to manufacture.
Jeffrey A. Schmidt:
If we turn to middle market deal making, please comment on which industries you see as being the most active currently, and perhaps in the future (intermediate term) with respect to inbound M&A investment. Also, do you think Indian companies will want to expand outside of India so they become buyers or investors in various parts of the world?
Rajesh Varma:
I think we'll have to look at it not only from an M and A perspective, but also from a private equity perspective. In terms of the middle market, we have seen a significant number of startups, which I've been able to raise capital, and most of them are in FinTech and in the it TMT segments and where we have also seen that, many of them have turned in unicorns in a very short period of time. In fact, the number of unicorns from our last, what I last recollect is about 44 in number. And that is third in the world after China, after USA and China. So there's a lot of capital raising in private equity, and that is also triggering M and A because once the company start are well funded to achieve growth, they take the inorganic route.
Rajesh Varma:
There is a lot of activity happening there. So that is one aspect of it. The second aspect of the middle market is that most of the M and A activity are domestic. So we don't see too much of cross border in India. I would say about 70% of all the transactions, which you read in the newspapers, or even you follow from any database are mistaken in nature. It's only about 30%, which are cross border in cross border. Also roughly 15%, 14 to 15% would be inbound. And the balance, 15 to 16% will be outbound. And so, this is a trend. The assembly segment, per se, inbound and outbound cross border is not a very happening thing. It is primarily domestic transactions, which are happening, but there is a huge potential which can be picked up, as you know, in the last two, three years, there's been no international travel.
Rajesh Varma:
We have all seen horrific scenes of COVID impacting and creating destruction. So we probably will see a change to this. The statistics I gave you is for the year 2020 and 2021, both of which work COVID infected years. So we may see some difference happening. We may see some moments happening from 2022 onwards because now COVID is practically not impacting India as much. There are hardly any cases nobody's wearing a mask, and even then there's hardly an infection.
Jeffrey A. Schmidt:
In advising international investors, either from North America or Europe, interested in making growth or diversification acquisitions in India, what are the keys for doing deals successfully?
Rajesh Varma:
Some insight in terms of how our Indian businessmen thinks so far is they have not been very worried about compliances. They are more focused on business and not very concerned on either accounting practices or on compliances. This is changing because their Indian companies act 2013 have just come and has not only made compliance as a very important part of the overall governance structure. But also they have made the Institute of Charter Accountants, which governs the auditing has become very much more stringent. They're taking action against auditors who have not been complying with accounting standards in the course of the audit. So, there is a change happening. In fact, it is quite visible over the last two years, especially, it took some five, seven years to percolate downwards.
Rajesh Varma:
Now we are seeing changes happening and even the small businessmen are very well aware of what they need to do. And I would expect about three to four years’ time, anybody coming into India would see the books are substantially clean and compliance are substantially in order. So things are going to change. It is going to take some time because there's a cultural view aspect to it. And there is also the government, which is bearing down on both the businessmen and on the auditors to make sure there is compliance. So that is going to change for the present for the present. Anybody coming in from north America and from Europe will have to keep a watch out in terms of maybe they will have to do the due diligence, whatever numbers they had decided in terms of the evaluation and the multiple. You had to bear in mind that it could change downwards because of issues that may come up in accounting or in compliances. So these are two aspects, which they need to keep in mind. And secondly, for indemnities, they may need to make sure that there is assumption cushion available for them in case of some surprises coming up in the near future.
Jeffrey A. Schmidt:
Many international companies tend to use the large M&A advisors such as Big Four accounting firms, the international law firms, and large investment banks. Is that smart? Or should an investor from Europe or North America develop relationships with local Indian firms to be able to do deals effectively in the country?
Rajesh Varma:
I think big four is not the way to go because they are one, prohibitively expensive and invariably the seller has to bear the cost and second, the compliances, which they need in terms of client onboarding are very honors and time consuming. I would recommend, while there are some very good Indian firms, we should go for affiliate firms of the tier two international firms like B grand, tho RM next year, baker, tele, et cetera. So they can go with the affiliate firms of the tier two international firms. I think that would be the way to go because in terms of the quality of work they do in India, it's quite stringent. They are subject to peer review by the global headquarters of the respective network. In terms of quality and cost, it'll be very effective. And in terms of the final delivery, it is going be the same, if not it'll be the same as what they can expect from a big four. So I would strongly recommend to go from entire two network of a global organization, the BS grant partners of the world. And that should suffice
Jeffrey A. Schmidt:
In terms of the competitive landscape, how do we position CDI Global India relative to the other M&A advisory firms, either the domestic firms or the international banks?
Rajesh Varma:
So whether it's a big four or the international banks or competition in our line like Lincoln, et cetera, invariably they don't involve cross border teams. So they try to do the transaction using the resources which are available with their Indian operations. So what we bring to a table and what we sell differently is that we are a global organization and we work together in harmony with other global offices, and that is something which is actually helping us win deals as well. So, as you know, Jeff, we commence operations only in August, 2020 because when we started, we are in the midst of the COVID lockdown. And there was no pedigree for the franchisee, which is currently holding CJ global, but we could win purely on the basis of showing that we are an international organization. We work as a single office and that has helped us win all the mandates we have once so far. From that point of view, I would say CDI global is different. All of the organizations tend to work locally while we trying to bring in our international partners, at least for the point of pitching for the job. Once we win then we work with multiple countries and see how it was.
Jeffrey A. Schmidt:
You mentioned about 30% of middle market deals in India are cross border transactions. Roughly half were inbound and half outbound transactions. Are there certain regions or certain industry sectors particularly important for identifying potential acquisition opportunities?
Rajesh Varma:
Yes about 45% of the outgoing from what I have read is towards Asia, about 15% is, and after that 15% is to the middle east. So a large component of that is in this continent. And the rest are primarily directed towards Europe. There's not much for north America from what I read. So it's primarily Asia, middle east and Europe, Asia having the largest component, then middle east and then European continent.
Jeffrey A. Schmidt:
In Asia, are certain countries more important than others reading cross border deals? For example, is Japan particularly important for India, or would it be Southeast Asia, maybe Indonesia?
Rajesh Varma:
Yes, this the Southeast Asia, it is Southeast Asia, largely the Asian countries and Indonesia where bulk transactions have been reported. But again, so your clear in mind that this is a COVID during the COVID period. I don't have data prior to COVID what I saw was data during the COVID years. And it seemed to indicate that 45% of the transaction move to Asia, 15% middle east, and the bulk of the balance to the continent European continent.
Jeffrey A. Schmidt:
With respect to the private equity firms, you indicated earlier they were providing funding for startups and growth capital for early-stage companies. What are the restrictions currently on private equity investment in India? Are there restrictions in terms of how much equity a PE firm can own in an Indian company? Do PEs tend to be focused on certain industries with respect to the investments they're making?
Rajesh Varma:
So the restrictions in terms of how the equity they can hold is largely in the banking segment. In the banking and financial services, rather I would say banking service, banking, banking sector, they can't hold more than 10% equity. So that is one restriction they have, in the rest of the segments, there is no such restriction. You'll find that most of them have a significant minority and some like Blackstone, KKR, et cetera, they have a significant majority. It depends on the segment sector, but primarily most of the money seems to be going into FinTech, into information technology, into e-commerce and into the education sector.
Jeffrey A. Schmidt:
In what sense in the education sector, online?
Rajesh Varma:
Yes, it's online, primarily online. We have a company called
Jeffrey A. Schmidt:
They're providing content, right? Or are they providing the infrastructure to deliver online education programs?
Rajesh Varma:
So everything, so they're providing the content they're providing the infrastructure. Many of them are not going into hybrid. They have started acquiring companies which are offering physical classes. So they're offering both the options online and physical. There's a lot of things happening over there. There will be some consolidation further happening in that space. You'll find many of the smaller players who don't have the funding backup, they will all die down or get acquired.
Jeffrey A. Schmidt:
You've covered lot of interesting topics that will be interesting for our members and the people that follow CDI. Are there any other comments or observations you would make in closing about the opportunities in India, particularly for cross border M&A?
Rajesh Varma:
Now that the COVID restrictions have gone and the fear of COVID also has disappeared, I think we now see a lot of activity in industrial manufacturing and the chemical sector, in fact we also have been focusing on INFR information technology because, you know that's much easier to do a transaction given the restrictions we had during COVID. But now we expect a lot of activity in industrial manufacturing and in chemical sector, in industrial manufacturing, we see a lot of potential in the electronics sector, and in capital equipment. So we will be perhaps aggressively targeting these segments or sub sectors and, and see how we can convert into transactions. One important aspect which I think will be very interesting for our colleagues to our note in India.
Rajesh Varma:
We are seeing a lot of the first generation and second generation businessmen and business women looking to potentially sell their companies because they don't either. They feel that the third generation doesn't have the capability of running it successfully, or the third generation are not interested in doing the business. So we are having a lot of such cases coming up, and this is a very unique phenomena across sectors. We hope to see a lot more transactions coming out in this space. Most of the businessmen and businesswoman would prefer cross border transaction because a domestic transaction would not Fe the valuations, which they will expect. I think there's a lot of potential there. We will work very closely with CDI colleagues and see how we can announce potential transactions in this space.
