Watching a perfect storm

The time for distressed investing in India has arrived, but investors on the whole are hesitating to take advantage of it.

Macroeconomic events in India have triggered a wave of distressed debt opportunities.

First, GDP growth is slowing. The annual GDP growth forecast was lowered to 6.9 percent this year, according to the International Monetary Fund, compared to 7.1 percent in 2011. At the same time, the cost of doing business is more expensive: inflation is projected to reach 8.2 percent this year. Also challenging are India’s public markets, which were down 37 percent year-on-year in 2011, according to Thomson Reuters.

As a result, cash flow at many domestic companies is tight, pressuring those firms with debt payments due.

Many Indian entrepreneurs are exposed, explains Joshua Kahn, director at fund of funds Hamilton Lane. Companies previously took on local bank debt for expansion rather than selling equity in their businesses to avoid diluting their ownership stake.

“[Many entrepreneurs] have exhausted the ability of their lending relationships to continue to give them debt,” Kahn says.

With the shift in the macroeconomic environment, “they’re often finding themselves in a position of being overlevered”, he says.

David Makarechian, who leads the India practice at law firm O’Melveny & Myers, adds that the inability of entrepreneurs to refinance foreign currency convertible bonds (FCCB) is producing opportunities.

Refinancing is impossible in India without specific approval from the Reserve Bank of India (RBI) and the Securities and Exchange Board of India. Approval is difficult to get, he says.

Close to 60 companies in India are currently facing the due dates on FCCB loans, according to a report from ratings agency Fitch.

The confluence of all these factors suggests the time is right, says Vikram Chachra, founder of distressed investor Eight Capital. “We’ve got a bad government, we’ve got inflationary issues in the country and we’ve got slowing growth. So it’s what I call a perfect storm and you need a perfect storm to create a nice, big heap of distressed assets.”

However, some LPs aren’t convinced. Distressed deals in India pose new challenges for LPs that are unfamiliar with the nuances of distressed regulation. “When people put money into growth equity, they know the FDI route very well, what the laws are governing FDI in India and how the whole thing will play out. When it comes to doing credit or distressed, they really don’t understand the legal system,” explains Chachra.

Overwhelmingly, sources say that LPs are concerned with certainty of outcome and predictability of the courts. Indian courts can show few examples of successful efforts to enforce debt or security, making it difficult to evaluate restructuring strategies or options, Makarechian says.

While several pan-regional distressed funds are being raised for Asia (see chart), fundraising for distressed in India will be tough, sources say.

Investors are closely watching an India-focused distressed fund being raised by AION, the joint venture between Apollo Global Management and ICICI Venture, the private equity arm of ICICI Bank. AION is expected to make a $350 million first close in the coming weeks on its $750 million fund, which previously reduced its target from $1 billion, says an industry source close to the matter.

Pan-regional distressed funds may decide to allocate to India depending on the extent to which AION can invest its fund, says Niklas Amundsson, managing director of MVision in Asia.

“[AION has] essentially been given the task to educate LPs around the world about the asset class [in India],”
 Amundsson says. “If they’re successful, others will follow.”