Mid-market businesses drive India's broad-based growth

Kanchan Jain

Much has been said and written about the great Indian infrastructure opportunity. Whether it is the government, the bureaucratic machinery, investors, lenders, intermediaries – every player has played its part in propagating the thought and attracting much needed capital for this sector. Any large emerging market investor with allocation to the Indian sub-continent has had an investment in this sector. However, the same investors who were gung ho about the great Indian story are today perhaps sorry for taking that investment call. Many of these investors have discovered that the ending hasn’t been quite as happy.

Who can question the great potential of the Indian Infrastructure story? One could argue that the potential is huge simply because it doesn’t exist. But let’s be fair – it does. However, the vast country that India is, it could be so much more. The last decade or two has seen tremendous growth in some segments of infrastructure. Telecom has experienced huge success, and through mobile telephony, the remote corners of the country have been connected. Moreover, there have been improvements in surface transportation with addition of express highways and development of metro/monorail facilities in various large cities. However, the fact to ponder upon is that in 1980, India had a greater investment and infrastructure base than China, but as of today, China is far ahead in terms of availability, quality, and quantity of physical infrastructure. So much development is still to come and hence the story is very much intact. Financial investments in Indian infrastructure should pay off – at least in the long term. But that pay-off comes with strings – all the very factors that make the opportunity a 'potential’ and not a ‘reality’, still. The risk attached with this pay-off comes from all the systemic inefficiencies, the lack of bureaucratic will and the political claim to the value even before it can get created, not to mention lack of longer term funds and inflationary pressures, which are so typical of a developing economy. And so the returns required to justify these risks necessitate investments in early stage projects.

As somebody who has worked nearly equally in India – the caged tiger, Asia – the uncaged tiger of the 90s and the developed world, my perspective altered dramatically as I completed five years of my second stint in India. And it reminded me of a conversation I had with one of my CEOs many years back. I had just left India, with two years of work experience from a premier financial institution and education from a reputed business school, not to mention the great Indian survival skills! And I landed at a leading investment bank based out of Hong Kong, headed by a dynamic CEO. And there were others from our motherland - hard-working, intelligent and with an insatiable hunger for ‘burning the midnight oil’ – all firmly on the path to becoming one of the many expatriate Indians who seem to do so well abroad. And as he saw and interacted with more of us, he remarked – If all of you Indians can be so good, what’s wrong with the ‘country’? The typical answer was – all of the above. It could also have been – nothing! But you wouldn’t say that until you had seen and truly experienced The Indian Edge – the Indian Mid-Market. And you can truly understand and appreciate it only once you have seen other corporate segments and the Indian MME, up close.

The sapling of Indian private entrepreneurship has survived and flourished, through a long and hard Winter Solstice imposed by the Indian political inaction and corruption. We are talking of the typical Indian entrepreneur who started about 10 years ago, if not more. It is now the second generation family business, with management structures that present a curious mix of educated & traditional, second generation professionals and first generation patriarchs, who know their ecosystems inside out. They know how to manage these and they know how to make them work! These enterprises are in all sectors – the traditional and the new. Metals, agri, food, chemicals, pharma, auto ancillaries and the entire gamut that makes the very backbone of a strong domestic manufacturing culture and that has now got strengthened thanks to the information explosion & access to technology. More importantly, they are now armed with a mindset that wants to grow – with or without external help and are no longer hesitant to dream and ‘execute’ big. Same is the story with services – healthcare, travel, education, engineering, you name it –and they are there. Anybody who has grown up in India and knows the fabric of this Indian entrepreneur, understands what it means to have created a business that is anywhere from Rs 250 cr to Rs 1000 cr in revenues, is profitable and can grow even in the most hostile environments. One such business is a healthcare unit, based in Rajasthan started by the first generation doctor nearly 20 years ago but now represents a large modern multi-specialty hospital aiming to target medical education, medical tourism and anything related. The second generation has entered, armed with both technical and management skills, and coupled with the experience of the elder generation, makes a formidable team. A certain chemicals company in Gujarat has impressive growth, financials and sound operational parameters that will allow it to grow further over the next decade. Or the real estate business in Chennai, where the owner / CEO knows his local market like the back of his hand and perhaps more importantly, knows that markets in Chennai can be very different from markets in Pune. He is content to work in his market, may venture out to Bangalore at some stage but not just yet. This business & promoter is completely tuned in to the local community, has a significant land holding, which has been accumulated slowly over a period of time and not out of leveraging unrealized cash flows. There is the example of a certain forging unit in Baddi in Himachal Pradesh, which has just acquired a cash rich business in Central India to complete its product suite and plans to extend its geographic reach beyond the country’s boundaries. This segment is the True Indian MME. It is the powerhouse of Indian broad based growth. It has moved on even as infrastructure has lagged behind. Industries have evolved even as reforms have stalled. And businesses have flourished even as capital access has been restricted. We are talking of a segment that is easily 2000+ companies with at least a half of them, profitable and with a good track record.

Curiously, while this represents a sizeable chunk of the Indian corporate sector, it still represents a significantly smaller portion of the organized capital deployment. While large Indian corporates can raise equity and debt from public markets, bank consortiums and capital markets, the MME still resorts to traditional bank financing for much of its debt capital and other non-mainstream sources for its growth capital. These companies don’t quite make it to the PE radar since most PE capital is benchmarked to USD ticket sizes. For the amount of due diligence that goes in a PE deal, the time spent in understanding the promoter and the business, it makes sense for the PE investor to look at deals that are at least USD 50m in size, if not more. In INR terms, a business that is worth INR 300cr for a minority stake is already a well evolved, large business with sufficient access to capital. Arguably therefore, PE investee companies represent only a top slice of the true mid-market. Ask any PE investor, and most would complain about too much money chasing too few deals, making the promoter’s view of their valuations untenable. At that cut-off, the pyramid is too narrow and leaves a whole lot of deserving MME out. The Indian private banks, though perfectly poised to access and understand this risk, are limited by regulation to offer structured solutions and fund valid, productive but restricted end uses. Foreign MNC banks too have stayed at the higher end of the ‘mid-market’ spectrum, for wanting to benchmark credit ratings to levels their international counterparts in credit risk can understand and deal with. The true mid-market structured business is today, still, no man’s land.

This risk segment comes with its idiosyncrasies. There is the widespread allegation of lack of transparency in reported numbers, rampant inter-company transfers and blurred lines between promoter and company funds. But what also sets this business apart from rest of the more professional and larger corporate India, is the promoter’s significant skin in the game. What sets out also is the promoter’s hands-on approach in managing a modest, yet growing business. For a long term player with a local, committed and on-ground presence, this risk is decipherable and manageable. The growth of credit bureaus in the last few years & the higher proportion of educated first/second generation entrepreneurs have also structurally improved the behavior of the typical MME borrower. The larger Indian private houses have played their part beautifully in fuelling the ambition of the MME players and availability of organized means of financing will certainly play its part in making this segment more accountable and open to better governance. For players with teams that can understand the local culture & interactions, that have access to the local intelligence (formal and informal), and have experience in managing this risk, there is a huge opportunity waiting to be tapped.

The author is Chief Executive Officer and Principal Managing Partner, Religare Credit Advisors LLP

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