Why foreign investors find stressed Indian firms attractive

As the Covid-19 slump deepens, a bunch of global investors is looking to snap up stressed Indian companies at a bargain.

Earlier this month, Singapore-based DBS Group Holdings stepped in to bail out Lakshmi Vilas Bank, which was struggling with a massive bad loan problem. As per reports, another major global investor, New York-based Apollo Global Management, was also eyeing the small private bank.

Similarly, several global investors are in the fray to take over the fraud-hit non-banking financial services firm Dewan Housing Finance, which has been grappling with insolvency since November last year. Last month, the US-based bargain hunter Oaktree Capital proposed to buy out the NBFC for Rs 28,000 crore ($3.73 billion). Oaktree Capital is reportedly also keen on investing in beleaguered telecom firm Vodafone Idea.

This trend had started picking up even before Covid-19 as India’s economic growth had started declining. In March, for instance, Hong Kong’s SSG Capital acquired the defaulting Altico Capital.

So what is it that makes stressed assets in India, especially in the financial sector, so attractive to foreign investors?

Takers for DHFL and Lakshmi Vilas Bank

Experts say there’s a lot of merit in buying even distressed Indian companies, especially in the financial space. Players like DHFL and LVB may be grappling with the crisis over the last few years but one cannot discount their strong physical presence and experience of operating in the country. This market depth can help global players make faster inroads into India.

For example, as of September 30, Lakshmi Vilas has 563 branches, while DBS Group Holdings’ banking entity in India has just 27 outlets. The merger could provide DBS Bank India a “meaningful physical presence” in the country, said Deepali Seth Chhabria, a banking analyst at S&P Global Ratings. The acquisition will complement DBS Bank India’s digital strategy and also help it penetrate deeper into the southern parts of India.

“Such franchise development requires long gestation periods and opportunity to acquire such assets at valuations significantly lower than historic average levels coupled with huge haircuts on the underlying liabilities would be the key attraction for global investors,” said Karthik Srinivasan, group head-financial sector ratings at ICRA.

Similarly, DHFL has more than 250 branches across India, which can work as a strong asset for any investor.

What is further helping foreign entities’ cause is that Indian banks, barring a few large private ones, are not in a state to rescue smaller and mid-sized financial entities. Even the government, which is grappling with the slump caused by the pandemic, does not have the fiscal elbowroom to pump money to carry out the rescue act.

India’s growth story still intact

Besides cheap valuations, what is driving global investors towards Indian stressed assets is the faith in India’s long-term growth story – despite the sharp economic contraction this year.

“From its robust and young population to the strong fundamentals, the country is poised to recover strongly post-Covid,” said Elaine Teo, spokesperson for global hedge fund JJ Richman. Teo added that India is one of the major markets for them, too.

With this long term perspective in mind, experts believe that global investors will also be hunting for opportunities in other areas such as retail, telecom, manufacturing, and infrastructure. “Entities with high leverage (debt) saw increased cash flow pressures because of Covid-induced lockdowns, which further added to their stress. Such entities across sectors will remain potential investment targets,” said Srinivasan of ICRA.

In fact, recently even global investment firms such as Morgan Stanley and Goldman Sachs – once extremely pessimistic – have turned bullish on India, predicting a sharp rebound in economic activity from next year.

Challenges of investing in India

But favourable valuations and economic revival do not translate into a smooth road for global investors. “For India, some of the challenges for many foreign investors have been corporate governance concerns and its rather complex tax framework,” said Teo of JJ Richman.

Teo is right. Several Indian companies in various sectors – from pharma to lending – have been marred by poor corporate governance over the last few years. Carmaker Toyota recently complained about India’s high tax rate, only to later retract its statement. India’s telecom sector is facing a mountain of dues, which have been levied upon it retrospectively.

So, even as the opportunities in India are enticing, they come with a big baggage of challenges.

This article first appeared on Quartz.