Markets India podcast May 2023

Narayan Shroff (NS): Hello, and welcome, everyone, to our periodic podcast for Barclays Private Clients India. I’m Narayan Shroff, part of the India Investments team, and I will be your host for this podcast. 

In the next few minutes, I will share a quick synopsis of our macroeconomic perspectives and market strategy, followed by a short interview with our guest Vikram Gupta. Vikram is the Founder and Managing Director of IvyCap Ventures, and has a career spanning over 25 years in private equity, business consulting, mergers and acquisitions, strategy, and operations across several industries. He has held leadership positions across various well known companies in India and abroad. 

But, before I invite Vikram to share his insights on the private markets in India, a quick update from me. 

India continues to dominate the headlines as the fastest growing large economy, but there is no choice as it will need to expand and attract investments quickly enough to support a great demographic profile and, in turn, support global growth. While not a mission impossible, it could be a hard act to achieve. 

While the US Federal Reserve and the ECB show every sign of bearing down on inflation, despite the tighter financial conditions from the recent troubles in the banking sector, the Indian central bank surprised the market by keeping the key lending rate, or the repo rate, at 6.5% in April. RBI’s pause in rates is largely attributable to its intention to allow past rate hikes to percolate through the system and its comfort with the inflation trajectory.  

As such, we believe that repo rates have peaked and that central banks will hike again only if the incoming data provides a compelling case for it. 

As markets adjust for a rate pause and anticipated cut, the yield curve is likely to steepen with the shorter end of the curve dipping more than the longer end. Credit spreads remain attractive for investors with appropriate risk appetite. A blended portfolio of three to five year government bonds and high quality corporate assets is one way to play the market over the next 18 to 24 month period. The strategy can provide healthy returns primarily by locking in higher accruals with the rolldown effect while a steepening in the curve would add capital gains.  

The Indian corporate earnings season is providing some colour on the state of the impact of slowing global growth and health of the local economy. Among the highlights that have popped up so far, a new deals slowdown in the information technology services underlies a lowering of full year guidance for some of the biggest players in the sector. Meanwhile, sales momentum chugs along amongst vehicle manufacturers.  

Bank profitability levels are encouraging, with some household names reporting highs for their return on assets and net interest margin ratios. As such, investors will likely remain enthusiastic about prospects for the sector.  

In addition, capital expenditure, or capex, remains in vogue, reflected in high capacity utilisation and demand for production linked incentive schemes. The Nifty50 index trades in a narrow range around its long term average but, within the broad based equity markets, niche opportunities can be found, especially amongst the small and mid cap companies.  

While we continue to like domestically oriented businesses like auto, consumer durables and nondurables, capital goods, and infrastructure, at current valuations, some opportunities can also be found in some export sectors such as pharmaceuticals. 

While Indian equities, and assets more generally, have much going for them, many risks should be borne in mind. The coming monsoon season may hit the economic production, the only question is to by how much. In turn, this has a risk for the inflation outlook and so the direction of interest rates. Also, while the oil prices may be under downward pressure from weaker global growth prospects, any surge in the price over sustainable period, say over $100 a barrel, although not our base case, could hit India’s economic outlook and company profit margins. 

Less visible, and in the medium term, the approaching central government elections early next year do not seem to be reflected in the market volatility levels. As is seen in the Nifty50’s VIX index, or the fear gauge, which is close to a five year low, according to Bloomberg data. This means that the equity risk premium is not very attractive, underpinning our neutral stance on Indian equities. 

The volatility seen in the markets globally this year highlights the importance of diversifying portfolios to reduce long term investment risk. In this respect, investing in private markets, across both debt and equity, can make portfolios diversified. And on that note, let me invite our guest for the podcast.  

Hi, Vikram, thanks for joining us today.  

Vikram Gupta (VG): Hi, Narayan. Thanks a lot for having me on this show. 

NS: Let me start with the obvious question investors have today, which is around the funding winter and valuation down rounds. Do you see this as a major concern or an opportunity? 

VG: Narayan, this is a very important and relevant topic in the current context. We have observed a few very interesting developments over the past few years. We’ve all seen during COVID 2020, the US printed trillions of dollars, which subsequently found its way to various asset classes, including private assets. This led to a significant increase in liquidity in the system, ultimately leading to a surge in inflation. 

The spike in asset valuations in 2021 can be attributed to the demand for assets being much higher than the supply. In India, series C and D deals exceeding $50 million to $100 million witnessed a massive surge, with investments substantially increasing during that period. Investors were willing to accept deals at much higher valuations. Even from an IPO perspective, 2021 was a bumper year. India witnessed a new trend in IPOs with startups like Nykaa, Zomato, and Policy Bazaar going public. 

In response to the high inflation, we know the Fed intervened by raising interest rates from zero to 5% in a short span of time. This tightening of liquidity in the market gave rise to multiple issues in 2022. The banking system’s response, particularly banks like SVB, was influenced by the mismatch of their assets and liabilities caused by a series of these events. 

Having said that, Narayan, the correction that occurred in 2022 was necessary. Several funds had raised significant capital and were deploying it in series B, C, and D onwards. A substantial amount of that capital focused on India is still sitting with funds. In my view, almost $20 billion to $25 billion of dry powder is waiting to be deployed. These funds are looking for opportunities for corrections in valuations. On an average, we have observed 30% to 40% correction in valuations when we are looking at the deals, and these corrections we are seeing from the peak in 2021.  

However, despite these corrections in 2022, the growth in seed to series A investments has continued with all these years from around $1.5 billion in 2020 to almost $4.5 billion that we are expecting in 2023.  

At IvyCap Ventures, we’re excited about the investment opportunities in early to growth stage companies. This valuation correction, in fact, is perfect from our perspective. Typically, funds have a 10 year life cycle, and during that timeframe we will observe at least one down cycle and at least one up cycle. If we invest during the down cycle and look for opportunities to exit during the up cycle, it’s an ideal scenario for investors investing in the venture capital space, Narayan. 

NS: Thanks, Vikram. This is, indeed, eye opening, especially the amount of dry powder you mentioned is available in the industry. Vikram, you’ve seen the full cycle of private equity/venture capital investing in India across five funds over the last 15 years and working across the value chain from incubator, seed to series A and beyond. Can you share some of your key insights on the evolution of VC/PE industry in India? 

VG: Sure, Narayan. The venture capital ecosystem has evolved significantly over time in India. When I started IvyCap Ventures in 2011, there were hardly any VC funds in India. Even the regulations governing venture capital funds in India were not mature at that time. In fact, it wasn’t until 2013 when SEBI came up with guidelines governing the alternative investment funds in India.  

Times have changed and the scenarios look very different today. As per my understanding, there are over 700 fund managers and over 1,000 registered funds with SEBI in India, including VC funds, private equity funds, and late stage funds. However, most of these funds have come up only in the last two to three years and are still in the process of fundraising. The next few years will be critical in determining the fate of many of these funds. We anticipate that some of these funds may consolidate, while others may even fail to secure enough capital to close their funds given the current market situation. 

I had set up my first private equity fund in India, Narayan, when I was working with a large business house in the year 2008. During that time, I raised $100 million focused on healthcare and life sciences sector. I raised this fund mainly from Indian domestic institutional investors in the middle of the global financial crisis. That was a huge learning experience.  

During this experience, in fact, I realised that venture capital was all about partnering with the right people, whether it was about fundraising or investing. With that learning, I established IvyCap in 2011 with the primary focus on building a platform around the IIT and IIM alumni.  

Across all these years, I’ve witnessed a substantial growth in the mindsets of entrepreneurs, incubation centres, accelerators, and investors. The most significant advantage for us at IvyCap is our vast global IIT and IIM alumni ecosystem. We effectively leverage this alumni ecosystem, and we have also set up a platform called IvyCamp to engage with the seed to pre series A startups, mainly focusing on tech entrepreneurs. Our aim is to support these startups early on, provide mentorship and guidance, and connect with them. You know, we have mentors, accelerators, incubators and corporates on the platform.  

During all these years, we have seen India has emerged as one of the top three countries in the world in terms of number of startups as well unicorns. While people have been enamoured by the concept of unicorns, we believe that this concept doesn’t give a true picture from the investors’ perspective. At IvyCap, we focus on the concept of dragons.  

A dragon is a company in your portfolio that generates cash returns of more than 1x of the entire fund size. For instance, in 2015, we invested $2 million in a beauty and personal care platform called Purplle and took a 30% stake in the company. Later, we sold that stake to Sequoia and VerlInvest for around $45 million, which was more than the entire fund size of $40 million.  

This one company returned cash that exceeded the entire fund in just one single exit, making it the first dragon in an Indian VC portfolio. We firmly believe that dragons are what investors genuinely value, and while we witnessed one dragon in a fund one, we are targeting and hoping for four more dragons in a fund two, which are on track to achieve the dragon status. 

Today, IvyCap Ventures is one of the largest homegrown venture capital funds in India, managing $530 million in assets, all domestic capital except for the IIT alumni, which comes from different parts of the world, including the US, Japan, Middle East, Europe etc. We are excited about the opportunity that the future holds in the coming years. 

NS: Thanks for those insights, Vikram. What has been your and your partners’ key drivers in venture capital investing? What are your core investment philosophies? 

VG: You know, Narayan, our investment philosophy is based on our belief that India’s economy, which is currently at around $3.5 trillion, is likely to grow to $25 trillion dollars in the next 25 years or so. If India continues to grow between 6% to 8% per annum on an average, there are ideas and opportunities everywhere. It’s all about execution, and execution is all about the teams.  

Our philosophy of investing through the IIT and IIM alumni ecosystem helps us filter the right quality of entrepreneurs upfront. We critically assess teams based on their mindset, passion, skills, and teambuilding abilities. With the team being our first filter, we evaluate the sector, business model, scale potential of the businesses, and the capital efficiency mindset of the entrepreneurs. We also critically evaluate upfront the risk associated with exits for our investments in a five to six year timeframe of our investment. 

As an instance, when we invested $2 million in a lingerie company called Clovia in 2015, owning a 30% stake in the company, which at that time was generating around $100,000 in monthly revenues. Last year, we sold the company for nearly $120 million to Reliance, a huge conglomerate in India. The company was founded by an IIT Delhi alumnus solving an important problem in the lingerie space and building the company with very limited capital. 

In the past five to six years, Narayan, we have had several profitable exits, primarily through M&A. One of our portfolio companies BlueStone is also looking to do an initial public offering.  

BlueStone is another example of success in the jewellery space. Contrary to the belief that people will not buy jewellery online, BlueStone started as an online jewellery platform and then expanded their offline presence. Today, they have about 150 stores across India, making them the top omnichannel jewellery company in the country. 

Narayan, we’re also focusing on making our companies ESG and SDG compliant, Environmental, Social and Governance, and also Sustainable Development Goals compliant. We have started mapping the SDG goals framework during the due diligence stage itself to identify areas where the companies can require assistance in enhancing their ESG and SDG goals. This approach, in fact, has already been beneficial to our companies and we will continue to add value as they grow and seek further funding.  

So, Narayan, I just want to add one very important thing since we’re talking about our investment philosophy here. And something that personally drives me is this entire angle of endowment, which is very important to understand. What we do as a fund, a significant part of our profit, which is called carry in a venture capital fund, we’ve actually committed to give back as endowment to the IITs and the education system of India. The idea there is that, you know, the alumni who are contributing to our funds, we’re calculating the proportionate amount of profits going back to their respective alma maters from our profits and, hence, you know, encouraging the endowments across the country.  

In fact, we help set up India’s first endowment fund at IIT Delhi in the year 2019 which was launched by the Honourable President of India at the President’s House where they invited me, my family, IvyCap team, and the initial alumni who had contributed to that fund. And, honestly, that was a very high moment for me because that, actually, initiated an era of endowment funds in India. And, today, following those footsteps at least another five to six institutions have created their endowment funds on the same template, something that I’m very, very excited about. 

NS: Vikram, that brings me to my next one. What are some of the key sectors or themes you see playing out over the next five to 10 years? Also, since you are closely working with the IIT ecosystem, how many innovation or startup ideas do you see coming in the hard economy versus the soft economy? 

VG: You know, presently, we are effectively engaging with over 6,000 startups coming from the IIT and IIM ecosystem and we’re engaging with them through our IvyCamp platform. In early days we noticed that majority of tech startups were focused on software development rather than on hardware. But now, we have been observing many startups coming up with the hardware ideas, particularly those focusing on IoT technologies, camera vision, drones, and robotics. These technologies are being applied in sectors like agriculture, healthcare and also real estate. 

One such company in our portfolio is MIKO, which has created a companion robot for kids. They are ingeniously utilising both the mechanical and software aspects of the hardware to interact with children. This company’s growth is remarkable, and majority of their growth has happened through worldwide sales in multiple geographies. 

AI and machine learning are other areas where we are noticing a large number of startups, especially in early to growth stage companies. These applications are prominent in multiple sectors including fintech, insuretech, retail, and healthcare. Similarly, we are observing hardware and software technology applications in banking and financial services where robotics is being used for customer service. 

Overall, we are excited about the way things are shaping up. We are witnessing some very disruptive ideas that are likely to scale substantially in the next few years. Of these 6,000 startups that we are currently engaging with, we are seeing ideas across the board, with hardware startups still less in number, constituting maybe around 10% to 15% of the total mix. 

NS: Those were some interesting insights, indeed, Vikram. My last one. Why do you think now is a good time to invest in the VC/PE space in India? 

VG: As I mentioned earlier, Narayan, this is an opportune time to invest in the Indian startup ecosystem due to the large opportunity given India’s demographics, penetration of internet, smartphones, and digital finance. Currently, India boasts approximately about 95,000 registered startups, of which an estimated 25,000 have secured angel or seed funding as per our own estimates. Only around 4,000 of these startups have raised series A funding, while around 107 startups have achieved unicorn status at least once. 

Valuation expectations have fallen significantly since 2011. The market is not coming back in our view in a hurry given the uncertainty around the global banking system including what happened recently with SVB. The long term story of India, however, is still very strong.  

If you selectively choose high quality entrepreneurs and startups and invest in them, you can acquire a stake in them at the right entry price and help them achieve substantial growth, given India’s long term story and its economic growth potential, with the potential to grow from current $3.5 trillion to $25 trillion which I already mentioned earlier. 

Venture capital funds like ours are also building a balanced portfolio that has substantial US dollar revenues and, thus, mitigating the risk of exchange rate depreciation as well. A large number of Indian startups and entrepreneurs are developing solutions that are not only relevant to the domestic market, but also possess the potential to solve global problems. Many Indian startups are leveraging cutting edge technologies to tackle global problems. They are creating pioneering products and services that are affordable and accessible, not just in India but also in other countries. 

For instance, our portfolio companies MIKO and Elucidata have successfully scaled up in the US. MIKO generates around 70% of its revenues in US dollars, while Elucidata, which is an AI based drug discovery company, is focused on solving drug discovery and development problems for the US pharma and biotech firms by aggregating data across the value chain of the pharma.  

Furthermore, the Indian government’s initiatives, such as Make in India, Digital India, have made Indian businesses more competitive, enabling them to leverage global opportunities. The government’s focus on infrastructure development, ease of doing business, and skill development is creating a favourable environment for businesses to thrive and expand globally. 

Overall, we believe this is a great time to be investing in India. 

NS: With this, we come to an end of our podcast. Thank you for listening to us. Stay healthy and invested, and wish you a great year ahead.