In a Facebook Live conversation as part of the programme Deals Hub, Siddharth Shah, partner with law firm Khaitan & Co., decodes the stressed assets investing landscape, what foreign investors should be cognizant of and how they need to work with promoters in restructuring of some of these assets. Excerpts:
There is so much buzz around investing in stressed assets with significant pools of capital being established by Indian financial institutions in partnership with global stressed assets specialists, but it is not really translating into actual deals. Could you perhaps give us a sense of where we go from here?
From a practitioner’s perspective, stressed assets investing is coming of age in India and many of these platforms have been set up in anticipation of the future opportunities being thrown up. The 12 cases that have been referred to NCLT (National Company Law Tribunal) under IBC (Insolvency and Bankruptcy Code) in a way have set the tone for the changing landscape in the Indian distressed assets space. While things look calm, most of these platforms are busy on the deal-making side and my sense is that some of them could be closer to a deal in terms of the way things are moving for these test cases. On the supply side too, banks are being forced to bring these assets out for effective resolution and many of them may find it an attractive opportunity to clean the balance sheet at the current valuations. I would not be surprised if at least one sizeable deal be announced in the near term.
Are banks willing to take haircuts? Is that still a question of negotiation?
I believe that stage in some sense has passed. With the RBI essentially pushing the banks and forcing them out of inaction and to go down the path of IBC, banks are slowly recognising that staying away from this decision is no longer an option. The urgency from the RBI has triggered a moderation and expectation from banks’, bridging the false perception of a valuation gap. While banks on one hand see IBC as the holy grail, they also recognise the risk of salvage value under the IBC if the borrower goes down the liquidation path. In some instances, resolution outside of IBC has gained some momentum as banks are willing to be realistic in their valuation expectations. The way IBC is unfolding in India, it has triggered some favourable outcomes for secured lenders, namely, the enforcement actions are becoming much more effective, banks are actually being able to recover and compel promoters (defaulters) to settle and restructure more realistically rather than being pushed down to IBC route.
If you were to give me an opportunity set for the distressed assets investors looking to invest in India, what would that be?
I will first try to talk about the landscape as it may not be fair to generalize them. There are a set of opportunities that would emerge out of the whole distressed space in India and depending on their appetite, players will take on the pockets of opportunities. Firstly, there are the classic distressed private equity players who would want to use the opportunity to buy controlling stakes in the distressed businesses at a deep discount under the resolution plan formulated pursuant to IBC. Secondly, there are specialist players who are looking into these current 12 cases and many more in the Indian context where they would look at the opportunity to step in and restructure businesses to create value. Thirdly, there are players who are purely focussed on the debt side of it, from where mezzanine and high yield products can be derived to fund restructured debt. Fourth, could be interim finance providers who would look to capitalise on the opportunity to fund companies under a resolution process through a high yield senior debt. The other area where you will see activity would be traditional private equity players. As part of restructuring, a lot of assets will get carved out, which will attract a lot of classic PE players. For e.g. there is an opportunity for the REPE (Real estate private equity) players for the huge amount of real estate that is expected to come out through the resolution process. The initiation of IBC has removed the inertia which existed in the system and the degree of confidence amongst the investors has changed significantly. This, in its own way, is a game changer of sorts and is being watched with very keen interest and expectations by every stakeholder including service providers, resolution professionals, strategic investors as well as investors.
Which sectors do you think will be the first ones to get into IBC process?
Infrastructure and steel have been a large component of distressed assets. Personally, I think the way things have turned around for steel globally, the outlook for the sector have changed. Steel appears to be the first one off the block which is showing promise for distressed investors and there are interesting assets within the current 12 cases which actually would attract some of the larger strategic or financial sponsors.
What are the things financial sponsors should be cognizant of? Most of these foreign investors are looking at what I call bragging rights, (investing in companies that they can brag about), and not factoring that they need to work with the promoters..?
There is bound to be a learning curve for most financial sponsors of such platforms. Distress investing unlike many other markets is not a court-driven or liquidation-driven exercise. For e.g. in the Indian construct, I don’t think hostile takeovers are expected to be a reality anytime soon. The market complexities, the inter-dependence of the company and the promoters and their connect with the financials (promoter guarantees, etc.) make it very clear that one cannot take over a running business, say steel manufacturing or infrastructure projects with the expectation of easily finding a replacement to run them. These are areas where investors would, at least initially, be looking at opportunity to create a value for themselves by acting as white knight for the promoters and helping them restructuring debts and businesses to create mutual value.
What is the mind-set of promoters at present?
I think the way Indian businesses and promoter mindsets are concerned, it is very difficult for the promoters to part away their businesses which they see as family crown jewels and which they have built over the ages or generations. Even within the given 12 cases, some of these are actually into healthy cash flow generating businesses which may have landed in defaults arising out of cash flow mismatch. This is where many investors are seeing them as an opportunity to play the white knight for the promoter, use the opportunity to restructure debt to ease out the mismatch and bring in the requisite equity and debt capital to bridge the gap. In a global construct, it’s called a ‘pre-pack’ deals wherein a promoter works effectively with the investor on pre-agreed terms and present that as a restructuring package which is permissible under several other bankruptcy proceedings in other jurisdictions. Unfortunately, today’s provisions of IBC do not appear to accept a pre-pack arrangement once the proceedings are initiated, so one has to go through a resolution process effectively controlled by the lenders through the IRP. But I think this is where promoters may start looking at such pre-packs in anticipation of IBC proceedings and work with players where they can see opportunity to salvage and even create value. The fact is that the fear of IBC is looming large for many promoters to restructure using other mechanisms.