The purpose of our letters and occasional blogs is to provide transparency in how we are thinking with the goal of creating stronger alignment with partners who want to think and act long-term.

Two companies in our portfolio – STAR Health Insurance and Restaurants Brands Asia – have existing Private Equity (PE) shareholders looking to exit.   Everstone is looking for a buyer for its stake in RBA.  Similarly, there are a few PE investors in STAR who are looking to sell their stake. 

PE funds have a finite life and need to return capital.  The shadow of these exits often results in a weakness in stock prices till the exit is complete.  For example, one of the PE investors in STAR sold a large stake via a block deal last Friday at a discount to the prevailing market price which resulted in a 8% drop in price.

We got two interesting questions from a partner recently on this topic.  

1. Is it prudent to bet on companies with PE ownership if ownership will keep changing?
2. If one is aware that a PE exit is imminent, are we better off waiting before buying?

Is it prudent to bet on companies with PE ownership if ownership will keep changing?

A key question we ask in our evaluation process is “who are we betting on?”. 

1. To be clear, PE ownership is not preferred as it is not a permanent ownership mindset.  If one needs to exit within 5 years, PE incentives are aligned to shorter term outcomes. 
2. However, there are many examples of PE owned companies who have partnered with professionals and created immense value.
3. Hence, we need to guard against rigid ideology else we will unnecessarily narrow the playing field. 

Hence, we believe the better approach is to look for longevity in the leadership team and if the decision making and incentives are aligned to long term outcomes.

1. In the case of RBA, the bet is on Rajeev Varman (CEO) and his team.  In our mind, they are the permanent owners, and the PE promoters are financial investors.   Rajeev has spent his entire career of ~30 years in the QSR industry and ~25 years within Burger King.  He is also a >3% shareholder in RBA and been with the company since inception.
2. In the case of STAR Health Insurance, both West Bridge and Rakesh Jhunjhunwala’s family are patient capital.  West Bridge is one of the few PE firms in the country that has very long duration capital (the other being Nalanda). And the leadership of STAR Health Insurance has been together for over a decade. 

If one is aware that a PE exit is imminent, are we better off waiting before entering?

If one is playing the long game, waiting for an even better entry price by risking a significant longer-term upside makes no sense to us.  You are then optimizing for short term outcomes.

1. For example, our thesis on RBA is that they will have ~700 Burger King restaurants in India by 31 March 28.  That would imply about 3700-4000 Cr Revenue and 450-500 Cr of Operating Cash Flow vs. ~Rs 33 crores in FY23.  Add some option value from Indonesia and we believe this could lead to significant value creation from today’s price.  
2. It would make sense for us to wait for an event ONLY if the company depended on a primary equity raise to fund this growth.

The market has no obligation to give us the liquidity when we want it.   

1. We own over a 100 Cr position in STAR Health and over a 50 Cr position in RBA at prices we find very acceptable.  If we wait for the overhang to get eliminated, there is no guarantee that we can build such meaningful positions at acceptable prices as many others are waiting to act as well.   The elimination of an overhang results in very steep price moves.
2. Playing this short-term game may make sense for investors looking to deploy small corpus, or who aim to beat the market in short time horizons.  However, it will not work with larger pools of capital. 

Lastly, if something is important, but unpredictable, it is not very useful as a variable for decision making.

1. The macro is very important.  But unpredictable. Hence, no point in trying to forecast Oil prices, exchange rates or interest rates.
2. Similarly, one can never know when ownership will change and at what price it will change.  RBA has vacillated between 85-130/share in the last 2 months.  We do not know if price moves suggest the overhang is behind us, or the market is repricing its perceptions of longer-term outcomes.

If we want to perceive the future with more clarity, we need to cultivate more stillness.  One of the attributes that help is not trying to optimize the long and short time horizon simultaneously.  Hence, we focus on the 3-4 key variables that matter for long term value creation and excluding everything else, including, in this instance, what others holding the stock may be doing.  Any steep declines due to the actions of others is not risk, but a further buying opportunity, as long as our investment thesis is intact.