opportunities in india: transitions into an organized ......western europe 1.8 2 1.8 1.6 1.7 1.6 1.5...
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C Opportunities in India: Transitions into an Organized, Digital and Mobile Economy
This fall, we visited India, as guests of an Asian focused private equity fund of
funds manager our clients invest with. This is the second trip the manager has
taken us on; in 2015 we had an eye-opening visit to China with their team. This
year, the manager thought it would be a particularly interesting time to take
clients to India, given the country’s growing importance to investors as a leading
growth engine of the world economy. In 2016, India made headlines for being
the only major economy which grew over 7%; GDP growth for the year was 7.1%,
outpacing China’s 6.7% growth. Yet, 2017 growth has been slower than
expected, many say due to transitional challenges of reforms and issues in the
agricultural sector. The most recent statistics, however, show that growth has
picked up again. India is expected to continue to be the leading growth
economy of the world for the next few years, outperforming its long-time rival
in the region, China, and significantly outpacing the rest of the world (See Table
1)1.
During our trip, we met with several General Partners of private equity and
venture capital funds, key economic advisors to the government, and
management teams of portfolio companies in a variety of sectors. Throughout
these meetings, four themes were consistently touched upon as opportunities
for investors: 1) India’s transition into an “organized” economy; 2) the rise of M-
Commerce; 3) the move to a digital economy and 4) growing elite and affluent
consumer segment.
2016 2017 2018 2019 2020 2021 2022
India 7.1 6.7 7.4 7.8 7.9 8.1 8.2
China 6.7 6.8 6.5 6.3 6.2 6 5.8
United States 1.5 2.2 2.3 1.9 1.8 1.7 1.7
World 3.2 3.6 3.7 3.7 3.7 3.8 3.8
North America 1.5 2.2 2.2 1.9 1.8 1.8 1.8
South America -2.6 0.6 1.6 2.3 2.5 2.5 2.5
Western Europe 1.8 2 1.8 1.6 1.7 1.6 1.5
Eastern Europe 1.1 2.6 2.4 2.2 2.2 2.2 2.2
Asia and Pacific 5.3 5.5 5.4 5.5 5.4 5.5 5.4
Middle East 5.7 1.3 2.8 2.9 2.9 3 3
Africa 2.1 3.5 3.7 3.6 3.9 4.1 4.2
Source: International Monetary Fund
Table 1: Real GDP growth (Annual percent change)
The Thinking Man’s Approach
October 2017 | Series #54
Ignacio Pakciarz, CEO Ilina Dutt, Analyst
Summary
For more on how we are positioning our portfolios, please contact your investment advisor or email: [email protected]
December 2017 2
1. Transitioning to an “organized” economy
Despite strong economic growth, India’s economy remains highly “unorganized” – full of small scale
private enterprises which are not registered with the government. As unregistered entities these
enterprises1 avoid taxes and regulation. They operate without any oversight, and make doing
business for their compliant counterparts difficult. This contributes the India’s low position (100 out
of 190 countries ) in the World Bank’s Ease of Doing Business (and last year it ranked 130 out of
190).2 These unorganized companies pay workers below minimum wages, usually on a daily basis,
without any employment protection. About 90% of India’s work force is in the unorganized sector,
and only 1.5% of Indians pay personal income tax (as opposed to 58% of the population in the US or
60% in the United Kingdom).3
Perhaps the most crucial component to India’s growth story has been the country’s measures to
transition into a more “organized” economy. This will increase tax collection and thus government
revenues; the Goods & Services Tax Reform (GST) is expected to help boost GDP from 1-2% annually.
Formalizing the economy will also increase compliance, transparency, and productivity as
businesses will follow the rule of law; this will also encourage foreign entities to increase investment
and operations in India. Some of these reform measures are highlighted in Table 2 below, and should
help to secure and sustain a higher economic growth rate over the long term.
1 International Monetary Fund. World Economic Outlook: Real GDP Growth. October 1, 2017. Accessed November 30, 2017. http://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/WEOWORLD/CHN/IND. 2 Business Today India. “Ease of Doing Business rankings: India makes highest-Ever jump to rank 100 out of 190 countries.” Business Today, Living Media India Limited, 1 Nov. 2017, www.businesstoday.in/current/economy-politics/ease-of-doing-business-rankings-india-rank-world-bank-100/story/262976.html. 3 Express News Service. “90% Indian workforce in unorganised sector deprived of welfare schemes, says, Justice T S Thakur.” The Indian Express, 12 Apr. 2015, indianexpress.com/article/cities/chandigarh/90-indian-workforce-in-unorganised-sector-deprived-of-welfare-schemes-says-justice-t-s-thakur/. 4 Economic Times, Morgan Stanley
Table 2: Major Indian Reform Measures
Reform Measures Update and Status
Goods & Services Tax (GST) Reform
-GST is the biggest tax reform since India’s independence in 1947. Once fully implemented it could help increase GDP growth by 1-2% per annum4 -GST in India is a comprehensive, multi-stage, destination-based tax that will be lived across the supply chain -GST will lead to an unified tax structure across the nation
Demonetization -The Government of India on November 8, 2016, announced the Demonetization of all INR 500 and INR 1000 banknotes -86% of the currency under circulation was rendered invalid
Digitization -Pro digital initiatives undertaken, such as e-KYC through a 12 digit unique identification number -Rural inclusion in the financial sector through launch of Unified Payment Interface and Bharat Interface for Money app
FDI regulations -in 2016, the government relaxed Foreign Direct Investment regulations in many key sectors, including insurance, defense and railway infrastructure
India banking reforms -New bankruptcy procedure will facilitate faster recovery of bad debts -21 new small bank and mobile banking licenses issues in the last 2 years
December 2017 3
Our fund of fund manager pointed out that while reforms will be a positive catalyst for growth across
the economy, they have identified two investment opportunities which will directly benefit: Mid-
Large Growth Equity and Buy-Out strategies.
The first companies to benefit from an organized economy will be well-established mid to large size
companies. They are poised to gain market share from the unorganized sector, as they have the
resources and the “culture of compliance” to seamless adjust to the initial complexities of adopting
reforms. They will also see some of their smaller competitors lose their pricing advantages, because
these firms will now be taxed under the GST Reforms.
We heard about these themes directly when we visited the Godrej Group, headquartered in Mumbai.
This conglomerate was founded 120 years ago and operates in consumer products, appliances, real
estate, industrial engineering, security and agricultural products. We met Nisa Godrej, Executive
Chairperson of the Godrej’s Consumer Products business (and fourth generation member of the
family). Nisa talked about the company’s frustrations in trying to operate in the most rural (and
often poorest) parts of India. The company’s consumer business started selling many of their
personal care goods, such as toothpaste and shampoo, in small disposable packets meant for daily
use (as this is all many of these rural workers, paid in daily wages, can afford). Even in a space like
consumer products where branded products should dominate, in rural markets, unorganized players
are almost as large as the organized players. Nisa told us that the business has had difficulty because
these unorganized players offer stockists higher margins.5 They can offer these higher margins, she
explained, because they don’t pay tax or compliance costs, they don’t compensate workers fairly,
and they don’t follow health and safety standards for the ingredients of their products. Godrej’s real
estate group faced similar dynamics in rural areas; in bids for projects, local unorganized players
who exploited workers and disregard standard safety procedures were winning bids.
As reforms become implemented, compliant and well-established companies, like Godrej, will be
beneficiaries. We met with a few mid-large growth equity managers who have already seen upticks
of profitability as reforms start to be implemented. Buy-out managers have also seen an increase
in deal flow as sector consolidation is on the rise. Companies are looking to merge and build their
market share. The buy-out managers we met have all expanded their internal operating team, and
the leading managers have brought in star professionals from multi-national corporations who can
help their portfolio companies scale operations.
2. The Rise of M-Commerce
Smart phone use has exploded in India. Now about a quarter of the Indian population (321 million
people) are mobile phone internet users. This has coincided with explosive growth in “M-commerce”
or mobile commerce, defined as buying or selling goods or services with the use of internet/cellular
data via a wireless handheld device6. This year retail m-commerce sales are on track to be about
5 “EquityMaster: Consumer Products” Equitymaster.com, 10 July 2009, www.equitymaster.com/research-it/sector-info/consprds/index-jul09.asp. 6 “11 key differences between E-Commerce and M-Commerce.” M commerce blog - SimiCart, 27 Nov. 2017, www.simicart.com/blog/differences-between-e-commerce-and-m-commerce/
December 2017 4
$17 billion (USD), up from $6 billion in 2015. By 2020, they are expected to be about $38 billion (see
Graphic 1).7
Every early-stage venture capital (VC) manager we visited touted m-commerce as a wave of the
future for Indian technology based companies.
We met the founder of a food delivery app,
which allows consumers to order a variety
of cuisines from their mobile phones.
What’s differentiates about this company
from its competitors is that it owns and
operates its different food brands. It’s
not just a delivery service; the company
has four different food brands, in Italian
cuisine, Indian cuisine, “healthy” cuisine
and “tea and snacks” cuisine. None of these
brands have storefronts; instead all the food
is made and delivered from central kitchens.
These brands only sell to customers via the
mobile delivery app, Owning all stages of the process allows the company to keep 100% of the
margins. The company reports serving 15,000 customers per day orders and has now expanded to
16 cities since its launch in late 2014. In the last year, they have reported 20% growth per month in
sales and are launching new food brands and expanding locations for their central kitchens.
Another VC manager we visited made an investment in an e-wallet start-up, which has now become
the leader of mobile payments in India. The company has had a partial exit, and is reportedly
currently trading at a multiple on invested capital of 65 times. This e-wallet start-up was founded
by former employees of eBay, PayPal and Oracle in Silicon Valley. We saw this trend at many of the
VC managers and portfolio companies we visited – some of the Indian diaspora of Silicon Valley
who worked for star technology companies have brought their knowledge and experience back to
India. VCs in India clearly benefit from this experienced talent pool, and on our trip we met early
employees from Google, Facebook, Uber, as well as seasoned investors from leading Silicon Valley
VC firms such as Sequoia and Andreessen Horowitz.
3. Moving to a Digital Economy
As part of the reform efforts, the Indian government has created several game changing “pro-
digital” policies, primarily for identity, banking and mobile services. This includes the Aadhaar
program, an initiative issuing all Indians a unique identity number based on biometric and
demographic data. It’s been estimated that about 80% of the population have been issued Aadhar
7 “Mobile phone internet users in India 2022 | Statistic.” Statista, Aug. 2017, www.statista.com/statistics/558610/number-of-mobile-internet-user-in-india/.
0
5
10
15
20
25
30
35
40
2015 2016 Est. 2017 Est. 2018 Est. 2019 Est. 2020
Re
ven
ue
in b
illio
n U
SD
Graphic 1: Retail M-Commerce Sales in India from
Source: Statista
December 2017 5
cards.8 Another initiative is the Bharat Interface for Money (BHIM), a mobile app launched by the
government at the end of 2016. The app can be used on all mobile devices, and supports all major
Indian banks, and allows the user to transfer money instantly between two bank accounts of any
two parties.
These types of digitization efforts will help reduce transaction and on-boarding costs for businesses,
as well as add accountability for customers. Many of the venture managers we met see this as
paving the way for additional opportunities in fintech and marketplace. It also opens up the rural
consumer segment as technology increasingly penetrates in the rural areas.
Suryoday is a company benefiting from these digitization advancements. The company started as
a micro finance organization, but in January 2017, Suryoday launched as a small finance bank. We
met with the CEO, Mr. Baskar Babu in his office in Mumbai. He explained to us that with Aadhar, his
bank could now lend to rural village people who he previously couldn’t do business with because
they had no means of identification.
Doing business with rural customers has
been made easier thanks to mobile
payment options which allow customers
to pay from their phones, so they can
avoid traveling each month to make
payments. Suryoday’s strategy is to
target rural women, and give loans to
groups of four or more of them. The social
pressure to pay the loans helps ensure
solvency and after successfully paying a
group loan, the women can apply for
single loans.
We met with a woman who had taken out both group and single loans. She used the single loan to
buy better equipment for her small snack shop, which she said helped her increase sales by 5 times
per day. Once this loan is repaid, she will take another one to open a second small snack shop in
her village. Pictures of the Suryoday branch we went to are found above.
4. Growing Elite and Affluent Consumers
Growing consumption in India has been a theme managers have been talking about for the last few
years. Many of the early stage venture managers we met were investing in start-ups catering to the
elite and affluence segments of the market, which in the next several years and expected to double
in size from 8% of the population (2016) to 16% of the population (in 2026), see Graphic 2.
8 “UIDAI claims that 1.05 billion Aadhar cards have been issued so far, 20 crore Indians still to enroll.” Tech2, 29 Sept. 2016,
www.firstpost.com/tech/news-analysis/uidai-claims-that-105-billion-aadhar-cards-have-been-issued-so-far-20-crore-indians-still-to-enroll-3689571.html.
Suryoday Financial Literacy Center in
Mumbai
December 2017 6
Many of these managers had experience working in start-ups in the US which were catering to
equivalent segments of the market and are trying to bring similar products and services to India.
We met with Droom, a company founded by an entrepreneur who had previously lived in Silicon
Valley and had worked with many different e-commerce businesses. Droom is an online marketplace
for buying and selling new and used cars, scooters, and bikes, and remains the only player in this
space. Droom is now the fourth largest e-commerce company in India (in terms of gross
merchandise volume).9 The quick growth of Droom and demand for this type of service
demonstrates the power of the growing affluent/elite consumer in India. Incidentally, the founder
told us that in response to customer demand, Droom now offers a “Vintage” category which sells
high-end collectible Mercedes, Jaguars and other luxury cars. They site also just launched a private
plane category.
One of the venture managers we met brought in Furlenco, whose business model is based upon
these changing income dynamics. One of the consequences of growing affluent and elite consumers
has been young working professionals leaving their family home and renting their own apartments.
Furlenco saw an opportunity to rent modern designed, moderately priced, and good quality
furniture to Indian millennials for their “starter” apartments. Users pay Furlenco a monthly fee to
rent furniture, appliances and accessories by piece (from beds to microwaves to table lamps) and
also by pre-set packages by room (a complete queen size bedroom or a living room, for example).
Furlenco has grown its operation to six cities in India, and expects to be profitable in early 2018.
After Furlenco’s presentation, the venture manager who brought them in told us that they are
increasingly seeing start-ups catering to the affluent Indian millennial.
9 “About Droom.” Droom: First Mobile Marketplace to Buy & Sell New & Used Automobiles, droom.in/about.
December 2017 7
5. Conclusion
A key tenet of our investment philosophy is identifying the right themes that will shape the markets
we invest in. In complex markets where we have less familiarity, such as India, we look to find
managers that are focusing on long term fundamentals as opposed to the markets “flavor of the
day” – and seek to pick management teams with strong track records and alignment of interest.
The four themes highlighted in this piece coincide with investment opportunities in mid-large
growth equity, buyout and early-stage venture segments of the Indian private equity landscape.
Our strategy for investment in India remains unchanged; the majority of our exposure comes from
our Asia dedicated fund of fund manager. The team has the resources, relationships, access and the
“boots on the ground” to evaluate the opportunities in India and greater Asia. The manager
combines this local Asian presence with a Western approach (they are headquartered in San
Francisco and the founding partners are Harvard MBAs) and an American governance style of
transparency that fits BigSur.
December 2017 8
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