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| Perry : Asia cannot price in bubble | |
“I try to stay focussed in the Asian space,” says Robert Petty, managing partner of Clearwater Capital Partners, echoing the sentiments of his company. Indeed, Asia will continue to be the cynosure of the investment initiatives of Clearwater in the coming years. Korea and India remain Clearwater’s largest exposures to date, a fact that can be attributed to their large economies and relatively efficient regulatory systems, which have opened up considerably in recent years. “But most importantly,” Petty points out, “these economies have real cultures of entrepreneurship and capitalism. The small and medium enterprises in these economies are empowered – both by law and the markets – to grow their businesses.”
Clearwater directs its investments towards this segment of small and medium enterprises across the Asian region. It seeks to support small and medium companies that find themselves in distress or ‘special situations’ characterized by non-performing loans, portfolios or pools, difficulties of an operational turnaround or financial stress.
The Asian market targeted by Clearwater comprises eight different economies representing a third of the world’s GDP. A company may find itself in a ‘special situation’ due to sector-driven or economy-driven developments or reasons specific to the company – a cyclical downturn or even a questionable business decision. These are situations that can typically arise anywhere, but particularly abound in economies, which are growing at a rapid pace between 7% and 10% a year Hence, the arena of small and medium companies in Asia represents a wealth of opportunity for Clearwater.
Robert Petty is a member of Clearwater’s investment committee and oversees the functioning of the firm, in particular its portfolio allocation. He is also involved in the larger private equity transactions in the company. Prior to founding Clearwater, Petty was managing director at Amroc Investments LLC from 1998 to 2001. From 1996 to 1998, he was an executive director and head of syndication and high yield trading for Asian high yield credits at Peregrine Fixed Income Limited, before which he was with Lehman Brothers for 12 years. Petty acknowledges that he continually draws on his experience in Asia in his current role at Clearwater. “The years of being closely associated with the growth periods and declines in Asia have given me the insight that when things are down, they are not so bad and when things are up, they may not be as good as they seem,” he says.
His partner, Amit Gupta, is intimately involved with the analytical and investment team of Clearwater – a team that functions both on a geographical and industry-specific basis. Petty’s other partner, Bruno Beuque, brings an asset management perspective to the firm and has been instrumental in building Clearwater’s substantial finance and operations team, which is based both in New York and Singapore.
To illustrate the nature of their participation in companies, Petty cites the case of Diamond Power – one of the largest makers of high density transmission cables in India. Diamond Cables, as it was then known, was encountering difficulties with its creditors who refused to provide the financing to enable them to tide over their working capital requirement. In 2006 and 2007, Clearwater provided the requisite term capital – both debt and equity – for what they felt was a fundamentally sound venture. Following this new money injection and the financial restructuring that accompanied it, the company was able to overcome the negative cash cycle of working capital constraints and increase production, capacity utilization and profitability. The company has seen its stock price go up more than three times since.
Clearwater is involved in the whole range of special situations from non-performing loans accounting for between 20% and 35% of their business to the high-yield trading business that is between 25% and 40% of the business. Clearwater’s investments also include the operationally-intensive private equity-like turnaround situations, which can make up between 25% and 40% of the total.
Dwelling on another successful investment venture, Petty gives the example of Jamna Auto Industries Limited, headquartered in Delhi with 4 major plants across India and the fifth largest maker of truck springs in the world. This is another example of a company that was fundamentally sound but had some operational issues at one of its plants. While this deal was in the public domain, Clearwater was approached by multiple intermediaries regarding the transaction. Winning a deal in such a scenario, Petty emphasizes, is contingent on being locally based and possessing the analytical capability and willingness to dedicate the requisite resources and capital. In such situations, it is not just offshore capital, but the ability to settle in local currency that clinches the deal. Clearwater provided all this and helped Jamna Auto through that phase with a capital infusion. Today, Clearwater owns a minority shareholding in the company, sits on the board and is their largest creditor.
Throwing light on the strategy it follows and the earnings that accrue to Clearwater from such projects, Petty says that the firm generally buys assets at a favourable enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio. Petty acknowledges that sometimes earnings are low and in those cases, the focus is beyond EBITDA, and also on the assets. In terms of the strategy, Clearwater invests in both listed and privately held companies though exits take longer in the private companies. In the case of a public company, the focus is on the internal rate of return (IRR). However in a private venture, the deal is less focused on IRR. “So we tend to think like a private equity firm in terms of the duration of money and absolute dollars,” explains Petty.
The operating model for Clearwater is fundamentally different from a typical private equity firm in terms of the type and number of transactions undertaken as well as its portfolio construct. Clearwater undertakes a far wider number of transactions so the portfolio has three to five times as many transactions. “Three quarters of our exposure is in terms of debt instruments as it affords downside protection with the option on the upside of helping a company turn around,” Petty says. Clearwater invests in relatively smaller companies, helping them on the rebound or funding their rebound. The debt capital of such companies is mostly in place and Clearwater helps with its refinancing.
The latest fund venture of US$900 million for Clearwater closed in June 2007 – just before the subprime problems in the US began to surface. Petty believes that Asia has not been dramatically impacted by the subprime problems, when assessed in terms of the effect on most of Asia’s financial institutions. On the issue of the medium to long-term impact of the subprime crisis on Asia, Petty says that the disconnect between business sentiment in Asia and the US is transitory. “A relative value comparison round the globe would mean that the pricing of transactions in Asia cannot stay too much tighter in spread or valuation than worldwide transactions. So Asia cannot price in a bubble. Nevertheless, historically there have been reasonably long periods of market disparity of one to two years where substantial pricing differentials have persisted. The ensuing capital movement ensures that no region can live in isolation,” he says.
Petty believes that “the US has a finite time to unwind long-dated assets with relatively short-term borrowings and the corresponding underlying value, but it is essentially a US problem.” It is the valuation of real estate in the US that is the core problem, and that is something that will be resolved in the course of time. Petty indicates that the impact from the subprime problems has been minimal for Clearwater. The firm had net gains on their CLO (collateralized loan obligations) for the year and had solid performance across all their funds in 2007.
A long-term interest in China
Apart from Korea, India and China, Clearwater has a presence in Southeast Asia, where it operates out of its Singapore office. Clearwater continues to conduct transactions in Malaysia, Thailand and Indonesia, and while Petty concedes that there are fewer transactions in these countries on a relative value basis, the firm is, as of now, continuing to execute special situations in each of these economies. Clearwater’s presence is minimal in the Philippines and Taiwan.
Elaborating on the role that Clearwater envisages for itself in China, Petty explains that Clearwater has a long term interest in the country. The improvement in the efficiency of the banking system and the new bankruptcy law in China would make the regulatory environment more amenable to executing transactions. “The Chinese government also understands the benefit of global capital in the restructuring business specifically, perhaps more than it did three years ago,” Petty believes. These factors will pave the way for Clearwater’s active involvement in terms of the restructuring of individual companies, and not limited to state-owned enterprises. Hence, Petty foresees a steady increase in Clearwater’s exposure to China from its current level of 5%. In view of these developments, Clearwater has set up an office in Beijing, which became operational in 2007.
Commenting on the latest fund Petty says, “Clearwater is broadening modestly by geography and particularly by analytical depth, very much staying within the special situations pan-Asian niche.” In this context, does surplus liquidity in Asia pose a challenge for a company like Clearwater? Petty dismisses this concern in the light of Clearwater’s mandate to work with the smaller enterprises. In addition, he says, “there is plenty to do in terms of infrastructure build-out in India, large and small projects in Korea and even in the financing of buyouts where successful entrepreneurs and private equity firms need to restructure or revisit the time frame of the leverage on their balance sheets.” India and Korea will continue to be the mainstay of the investment initiatives of Clearwater, he adds.
A large number of companies below the top 50 in each of these jurisdictions offer transactions between US$10 million to US$75 million. Entrepreneurs in this segment benefit by partnering with Clearwater to grow enterprise value, on the debt side of the balance sheet or potentially even the equity side. This is an under-served space that constitutes the sweet spot for Clearwater.
Commenting on the nature of the regulatory regimes in Asian countries and whether this constituted a deterrent, Petty explains that Clearwater has, over the years, built an expertise to understand local laws in the regional economies, and in fact, 5 persons in their team of 80 are lawyers. The company ventures into partnerships only where the risk-reward assessment is favourable. “It is a very western attitude to say that these economies have opaque or grey regulations, when in fact there is increasing clarity in most markets, which have had a framework in place for some time now and are functioning pretty smoothly.” Specifically, since 1997, the regulatory environment in each of these economies has been substantially enhanced from a creditor protection point of view, Petty adds.
To illustrate the interplay between the local and national regulatory regimes in these rapidly changing economies, Petty cites the case of CESC Limited, a fully integrated energy utility company in Calcutta, India, with a presence in coal mining, power generation and distribution. While the Power Authority of India at the national level had approved a new rate at which CESC was to charge for power from their new plant, the mayor of Calcutta, at the local level, believed that consumers could not pay for the power at the proposed rate. The settlement between the local and national authorities eventually happened, but in the interim CESC had reached a stalemate with its creditors. The company agreed to pay the interest on the debt but was unable to service the principal component and asked for, and received, a standstill on principal payments. Enter Clearwater. Clearwater first invested in CESC in 2002 in offshore debt instruments, the company was restructured in 2004 and CESC was finally able to buy back its debt at a discount and offer extensions of maturity on other debt. In the buyback, Petty acknowledges, “we were sellers back to the company at a discount, which that helped them clear some of their debts, while also remaining a long term lender to a company we continue to respect.” Clearwater still holds loans in CESC today.
Striving for leadership
Petty believes that the negative noise about private equity is uncalled for although he concedes that some firms have been involved in questionable transactions. Petty sees Clearwater as a contender for the leadership slot in the business. “I feel we are a positive influence on economies,” he states. The closing of its Fund III which raised US$900 million is a testimony to its credentials. “It is not just a question of the size or the amount of money that is managed. What is important is providing the very best credit analytics and truly supporting companies through difficulty and making strong returns for investors,” Petty says. The sheer enormity of executing these commitments is what drives him, he says.
Understandably, the overwhelming range of the mandate is also the reason why there are limited players in this field. Petty reiterates that there is no intention to take the fund to the US or dramatically outside Asia. “The intention,” he concludes “is to create the best fixed income and special situations firm in Asia” – a mantel that no single entity unambiguously holds today.
