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: Jun 5, 2009

Rajendra Hinduja, 61, is brimming with energy. Men of his age, having sold their family business for a hefty price, might look forward to more leisurely pursuits, but he is busy crafting an epoch of transformation at his garment exporting firm in Bangalore. “I never remember being so busy,” he says.
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. Their ambition is to move closer to the top league of BPO firms in India.

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. They have to work hard to achieve high volumes at modest profit margins. And in the world of investment, they are both out of fashion. Textile and BPO don’t make money for the investor, so goes the belief.
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 in the process.

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. Even industry players were taken by surprise by his confidence in textile and BPO, especially these two companies. So, after 20 months and with the onset of global recession that has made most assumptions as worthy as a bounced cheque, many have started asking whether the Blackstone Hypothesis is working. But then, what is the Blackstone Hypothesis?


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. When stock market conditions improve, Blackstone will get its chance to exit.

Take the German chemical company, Celanese. Blackstone bought it in 2004 when chemical companies were out of favour and delisted it from the stock exchange. The firm put in $650 million in equity and almost immediately got back $500 million through a junk-bond offering. And when chemicals came back in favour, Blackstone did an IPO for Celanese and made a tidy profit.

Gupta has to adapt this approach to Indian markets, where stock valuations will eventually depend on operational improvements. Having worked in Hindustan Lever and Citibank, Gupta has the right mix of business and financial experience to spearhead Blackstone’s business in India, which along with China, is seen as the most important emerging destination.

But the killer app will have to be Blackstone’s ecosystem. Globally, the PE firm’s investment portfolio comprises 55 companies with cumulative revenue of $90-100 billion. About 800,000 employees work in these companies that include Nike, Hilton Hotels and Travelport. “If a fraction of business from our global companies lands up with Intelenet, they can grow several folds. That’s the icing on the cake,” says Blackstone’s managing director Amit Dixit, who initiated the Intelenet deal.

Two and Two Equals Five

Blackstone’s arrival has changed things at Gokaldas considerably. Hinduja continues to provide leadership, but as an employee. He is also effecting changes that he couldn’t carry out as owner. There lies the power of the Blackstone association.

A senior executive in a firm that buys Gokaldas products for retail chains in Europe says: “We do see a new sense of purpose, a desire to become more customer-centric from Gokaldas management Earlier, they were quite content with their position in India apparel industry.” A benchmarking study commissioned by Blackstone to document the exact time taken by workers in different countries to make a similar shirt had found Indians were only 60 percent as efficient as the Chinese. Hinduja, earlier as the owner of Gokaldas, had not addressed the issue lest the workers complain of overwork. “We had learnt to live with it.”

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. Without openly emphasizing productivity, Hinduja’s team weeded out waste. A store counter was set up in some factories so workers could get components at one place, instead of getting them supplied at their desk. The result: a 40 percent jump in productivity at the Euro factory. Mattew Cyriac, Blackstone managing director and Gokaldas board member, calls such gains low-hanging fruits.

Similarly, Hinduja was also freed from the burden of day-to-day administration so he could focus on strategic initiatives. Blackstone has appointed a general manager to oversee Gokaldas. Gautam Chakravarty, an ex-Hindustan Lever executive, finetunes human resource policies, currency hedging decisions and even entry into new markets. Hinduja, with introductions from Blackstone, has met with key decision makers at Hilton Hotels and Ralph Polo, owners of famed garment brand Polo, to talk business.

Change Agent
At Intelenet, consulting firm McKinsey evaluated 20 parameters to gauge a call centre agent’s productivity. Some recommendations were difficult to implement. An agent was only allowed three bio-breaks for 15 minutes each and every other minute had to be accounted for. Says Amit Dixit, Blackstone’s investment manager for Intelenet: “The process was painful.”
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. The intent is clear: “Intelenet will now be the pivot for all our investments in the space.”

Network power is kicking in too. Intelenet is negotiating a deal that may well be its largest outsourcing contract—at least three times larger than its current $50 million deal. Chip Shore, an Intelenet board member, is patching up the BPO firm’s executives with senior management in companies in the Blackstone family. “The introductions were more than mail-connect kind. Blackstone actually seconded people to work with us to talk to companies,” says Kumar. With all the action in the last 18 months, Intelenet’s revenues have ballooned to $225 million in 2007-08 from $94 million in the previous year.

Brave New World?

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 and markets meltdown. Its cumulative investments of $730 million are now worth only 30 percent of the original value. Gokaldas has lost 71 percent of its value since Blackstone’s $165-million deal. Intelenet is unlisted but if WNS and Genpact’s valuation declines are anything to go by, the investment has lost two-thirds of its value.

So is the Blackstone Hypothesis a mere conjecture? Stephen Schwarzman, the head honcho at Blackstone, would be watching closely. 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, taken together, both investments account for half the total money that Blackstone has invested.

The meltdown has inspired critics to harp on their I-Told-You-So. “Not one investment of theirs is above water. And they have made these investments at the peak of the valuations. How can they ever hope to make money?” says the head of investment banking at a very large US firm.

“Akhil is trying to push water up the hill. Tell me, has the textile sector thrown up at least one company that can defy the miserable profitability and scaling challenges that the sector has? Is there an Infosys of textiles? No,” says the head of a large Indian PE fund. Such judgements may be a bit premature, considering PE is not like a mutual fund, to be evaluated frequently. However, truth be told, every investor wants returns and would not totally ignore such a drastic fall in valuations.

“In the first six months, investors in a PE fund are willing to listen to your talk about long term vision, strategy, After 12 or 18 months, they look at the prices you have invested and the current price of those investments and then they ask ‘What’s your exit strategy?’ Gupta will have to explain this as his two big investments are that old,” says the India head of a $1.6 billion US-based PE fund.


A Tough Task
The only way out for Gupta is to improve the core profits of the two firms. Adds the fund manager: “If you want to play the turnaround game — sustainable over three-four years — then you really have to know the business really well and you need to have people who know the industry.”

Blackstone’s appointment of an industry expert at Gokaldas shows it anticipated this need. But will this please Schwarzman and his investors? Even in this bleak scenario, he would expect the portfolio to return 20 percent annually over the next five years. What will it take for this to happen? A lot. 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. That’s a tough task.

“Gokaldas needs to learn a thing or two from smaller companies like Ambattur Clothing Company in migrating work to low cost locations outside India and to become a seller to China,” says a senior executive in a large buying house that deals with Gokaldas. But, isn’t Cyriac implying the opposite when he says it must grab sales from China? “Well you can try. But the Chinese are very proactive and they have closed 14,000 units in South China where costs had gone up and moving all that work to North China near the Korean border. So it may be more prudent to work with Chinese companies rather than go head-to-head against them,” says the executive. Blackstone will have to get Gokaldas to try low cost locations like Bangaldesh and Vietnam to increase margins.

Consider Intelenet. Blackstone bought Intelenet for $200 million, 12-13 times the earnings before interest, tax, depreciation and amortization. Now, orders from the West are drying up.
That’s not deterring Intelenet. A few years back, management consultancy Bain & Co estimated that if Blackstone’s portfolio companies outsourced 10 percent of their jobs, it meant at least 50,000 jobs for BPO companies. Says Kumar: “We have 3,000 seats in the sales pipeline purely on account of Blackstone.”

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. “There is a stickiness about offshoring contracts and they can’t be moved around on a whim or without a proper business case,” says Walden International’s managing director Rajesh Subramaniam.

Despite all the challenges, Gupta insists Blackstone will achieve its goal, even if not in exactly five years. “We may perhaps achieve it in seven, considering the slow pace of India’s infrastructure development and labour regulations.”
Industry peers and Blackstone’s investors are impatient to see results. Garment maker Premal Udani says the Blackstone experiment could help erase old fissures in Indian business. “In the current scenario, if Gokaldas can make large buyers to source from them, the industry could learn a much needed lesson or two.”

Investment is like alchemy:
Making gold from a raw substance. To Blackstone, it means finding companies that have a value that others don’t see but which need some refinement to extract that value. For Blackstone to get
interested, a target company should have the potential to yield three times the investment in five years.

Blackstone often goes against conventional wisdom and buys generally ignored companies at cheap valuations. Worldwide, it is the king of leveraged buy-outs. But it India, it has tried a different tack. It took the portfolio investment route with significant management control.

Its recipe?
Buy a majority stake, but keep the old guard. It ensures continuity. Happy with the money you have paid, the entrepreneur will only work harder to help you succeed. Improve efficiency. Leave no sacred cows. Then, build global scale. If valuations have to treble in five years, it won’t happen without tapping into new markets, taking more risk and widening the product portfolio.
Inject the board with specialist nominees.
(Five offshoring experts were parachuted into Intelenet.) Raise the bar. What is the best in the world? Get the company to match it.

Finally, use network power.
Get one portfolio company to outsource from another. (Gokaldas is already negotiating with Hilton and Ralph Polo, two such portfolio firms. And Intelenet might get its biggest ever order through this route

(This story appears in the 19 June, 2009 issue of Forbes India. You can buy our tablet version from To visit our Archives, click here.)

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  • Alok Anand, MBA

    Labour Extensive Industry will grow as India has more supply capacity than the actual demand on its own soil. <br /> <br /> But one needs to be very carefull as one strong jolt of recession will jeoparadise the entire Gameplan. So I will put it under "High Risk, High Reward" zone.

    on Jun 9, 2009
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