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The Year that Was: The Blackstone Hypothesis

The world's largest private equity firm took two contrarian bets in India nearly two years ago. Making them work will be quite a challenge

Published: May 25, 2010 09:27:11 AM IST
Updated: Feb 27, 2014 01:53:34 PM IST
The Year that Was: The Blackstone Hypothesis
Image: Dinesh Krishnan
MAN IN THE HOT SEAT: Akhil Gupta's fate would rest firmly on the success of his two bets

Rajendra Hinduja is busy crafting an epoch of transformation at his garment exporting firm in Bangalore.

A 1,000 kilometres away at Malad in Mumbai, Susir Kumar and his senior managers are drawing up the strategy to win the largest contract yet for their business process outsourcing (BPO) firm focussing on banking and financial services sectors.

Hinduja and Susir Kumar represent two diverse industries, but their companies have several things in common. Both are labour-intensive businesses depending on outsourcing orders from the West. And in the world of investment, they are both out of fashion.

Hinduja’s Gokaldas Exports and Kumar’s Intelenet have another thing in common: Both were bought by the world’s largest private equity (PE) firm some 20 months ago. Blackstone Partners owns the companies, letting their previous owners still run them, on the basis of one assumption: It can unlock hidden value in these companies that will disprove the conventional wisdom about them. And make 200 percent profit in five years.

There was one man behind Blackstone’s acquisition of Gokaldas and Intelenet, much against the consensus of the market: Akhil Gupta, managing director of Blackstone India.

Gupta and his team believe they can make both Gokaldas and Intelenet more efficient and profitable. This will be achieved in three steps. One, Blackstone will leverage its professional management expertise to improve operations. Two, they will help the companies scale up globally. The third approach is the key. Blackstone will get the companies it has invested in globally to outsource their needs to Gokaldas and Intelenet, keeping the business with the family as it were.

With Blackstone’s nudging, Hinduja got experts from the US and Japan to help them adopt lean manufacturing in Euro Clothing, one of Gokaldas’ 47 factories. Since Blackstone acquired the firm, Intelenet has been in acquisition mode. It paid $75 million for a Mauritius-based BPO firm that ran two businesses with centres in the US and India.

Even as internal changes were taking hold at Gokaldas and Intelenet, the external atmosphere started to deteriorate. Blackstone investments in India have been battered by the economic meltdown. Gokaldas has lost 71 percent of its value. At Intelenet, the investment has lost two-thirds of its value.

Of the seven investments Gupta has made, his fate would rest most firmly on what he achieves at Gokaldas and Intelenet. One, both have brought management control and that means Blackstone must ensure entrepreneurial energy keeps flowing through the companies. Two, both investments account for half the total money that Blackstone has invested.

The only way out for Gupta is to improve the core profits of the two firms. Blackstone’s appointment of an industry expert at Gokaldas shows it anticipated this need. Blackstone invested in Gokaldas at Rs. 250 a share, at nearly 10 times earnings. Even if the same pricing multiple were to hold in 2012, the earnings per share (EPS) would have to increase to Rs. 81 for Gupta to get his three-fold returns.
Not everyone agrees that companies would start outsourcing services just because their PE investor has also put money in the services companies. Each company will decide what is best for it and may choose not to take part in the network effect. Despite all the challenges, Gupta insists Blackstone will achieve its goal, even if not in exactly five years.

Industry peers and Blackstone’s investors are impatient to see results.

- This article was earlier published in Forbes India magazine dated June 19, 2009
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WHY DID WE DO THE STORY
Three years ago, private equity giant Blackstone started operations in India. It had Akhil Gupta, former chief operating officer at Reliance Communications at the wheel. When Gupta first invested in Nagarjuna Construction, it looked like Blackstone would behave like any other PE firm. Then came the surprises. It invested in Gokaldas Exports. Given that the textile industry had been written off as lacking growth potential and suffering from labour problems and rising costs, even veterans in the industry were not making any investment. But here was a PE firm, which expects an internal rate of return at 33 percent for its investments, putting money in Gokaldas. Next up was Intelenet, a call centre company. Blackstone put money in it when investing in BPO had already become passé. Obviously, Gupta was going against the grain.

Our enquiries showed that Blackstone’s idea was to take on challenging investments in sectors that investors typically stayed off, polish the rough edges and create value when the tide turned. We called this the Blackstone Hypothesis.

WHERE DOES THE STORY STAND

Shortly after Gupta made his investment calls, the global markets bore the brunt of credit excesses. As the financial sector and consumer businesses took a hit, Gupta’s call seemed horribly wrong. A year after he bought the stocks, at the time of our story, Gupta’s investment managers were staring at sharply lower valuations. But they put up a brave face. They worked to bring down costs and looked to boost sales at the same time. A year later, Intelenet’s revenue grew 10 percent. It acquired a company along the way, despite a tough year for BPO outfits. Gokaldas Exports saw its net profits more than double, even as its customers - global garment brands – shrunk their retail networks. The stock price of Gokaldas is up 80 percent from its lows last year. As global economies stabilise, there is now a ray of hope for Blackstone and Gupta to make money on the investments. Will they achieve their target to double their money in four years? That’s still a tall order.

 

(This story appears in the 04 June, 2010 issue of Forbes India. To visit our Archives, click here.)

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