Dan Tennebaum - The Case for India at India Capital (EP.387)

30:03And I think coming from India, China demands and deserves a degree of admiration for what they've achieved. They have delivered wealth in industrial buildout at a scale that India has not yet begun to touch. Having said that, there does seem to be this distinction where not withstanding China's superior growth over the last couple of decades, India, it's translated far better into investor and shareholder returns. So if since 1999, when I started my career, China's GDP growth has been 16x versus 8x for India. But China's index performance on that 16x GDP growth has been 2.5x. And India's index performance on that 8x GDP growth has also been 8x.

30:57And without knowing China really well, I don't know all the reasons to explain that. But when I think about these stories of these lean capital efficient Indian companies, that may go some way to providing an explanation where Indian households are less leverage, Indian companies are a lot less leverage. Private sector debt to GDP in India is like 53%. I think in China it's 195%. So that free flow of discounted, maybe non-discerning capital in China has never really been the case in India. And what's come out of it is businesses with really good capital allocation. Return on equity is higher. Maybe one corollary of that is almost everything you find in the Indian public markets is fully private sector.

31:50About 5 % of the companies are majority government owned. I think in China, it's 30 or 40 or more percent. So there's sort of a structural difference between them. If China, the labor force is pretty built out in GDP per capita imply a middle income type country, India is in most regards 15, 20, 25 years behind in overall economic output and in terms of where these industries are at. So now that India is at$2 ,500 GDP per capita, this is if you track China's progression where a lot of these sectors really began to explode. So I think it's just a difference in kind of having those sort of tailwinds at India's back in a way that other East Asian countries have enjoyed and benefited from.

32:41And now it's India, where there are a million people joining the labor force each month and a million more moving from the hinterlands to the cities. So I think the basics of the case for India are low penetration, high growth, simplistically speaking, coupled with the fact that that growth seems to translate quite efficiently to investment performance. So with that backdrop of growth and really strong potential for growth in the country, the translation of stock performance, and then the opportunity to add value, you mentioned that John and you had kindred spirits in how you thought about investing.

33:21So what is that philosophy of how to go about approaching the market? I think in a nutshell is that research matters. I have a journalist friend who's fond of saying that India is a vast orchard of low-hanging fruit. In a sense, that's true, that you can identify easily a dozen sectors where it's small, it's going to grow, this is all going to go to the moon. But on the other hand, this observation that in many cases, it's not the largest, the highest profile, the indexed constituent representative of a particular theme that's actually going to do best from a shareholder or return on equity standpoint.

34:03And it's that appetite to roll up our sleeves and try and understand if there's a different or more interesting way to participate in it. That has been key to John's success in building the firm. John early on distinguished himself and saying, I'm going to actually do the work. I'm going to read the constitutive documents of these companies. I'm going to read shareholder letters from 10 years ago and try and understand what the business model of these stocks actually are. Then I came to this with some consulting experience and with a venture toolkit that was really heavy on that kind of fundamental analysis as well.

34:45And that's turned out to be persistently a differentiator in the Indian context. So when you have that analytical capability, you still need to narrow the filter and decide what you're looking for to go dedicate the time to dive in. What are the types of names that you look to buy? Simplistically, what we're looking for is strong earnings at an appropriate valuation. and earnings is really just an output. There are a lot of other things from balance sheet to cash flows to brand and management quality that go into it. But as an outcome in India, that's tracked really, really well over the long-term with share price performance and in our own portfolio as well.

35:25So mechanically, that's what we're trying to find, our long-term earnings. And less generically in the Indian context. We're looking for areas that are sunrise opportunities that are amenable to research where it's possible to identify companies that can do even better than the underlying business. And over time, we've come to feel that all the elements of that sentence are important. There are companies in industries where penetration is eight decades behind the US, but capacity is due to come in the next five years that will all strip US, Europe, Japan, Russia combined. That's more our playing field.

36:07Within that, not everything is equally amenable to research. So for instance, India has a cadre of generic pharmaceutical manufacturers, some of them very high quality, many of them with their success and their trajectory, highly dependent on things like patent litigation with IP holders in New Jersey that were just not well positioned to diligence. By contrast, you have cement companies, three dozen publicly traded in India, many of them specific to one region or even one micro market, where if you can roll up your sleeves, you can understand supply and demand dynamics pretty well. And then lastly, gold standard is if that will allow us to come to a view of a business that may do a little better than the rest.

36:56And that can look like a bunch of different things. But for instance, you'll tend to see historically very fragmented industries in India where there are 300 publicly traded bank and non-bank lenders that are beginning to give way to concentration where the top three or five or six are accounting for an outsized share of top line and especially earnings. So that's ultimately what we're looking for. You have this underlying growth story, even if you're talking about a cement company, maybe that's tied to real estate that's growing. How do you think about the different high level lenses of growth versus value, quality versus the cheap asset in what your sweet spot has become?

37:38I think your point is well taken that there are growth businesses like cement, like power, like real estate that from a US context, we say, oh, they're pretty mature sectors. In India, they're not mature at all. So that's one thing that I think you have to take into account in India that where growth is may not be entirely where you expect it to be. In terms of sort of thinking about growth versus valuation, we are now, and this is typically the case, a few turns cheaper than the index. We do have a valuation filter in what we're looking for. Having said that, if you are, I think, creative about where you look for it, sometimes it's not as much of a trade-off as you might expect.

38:29So by way of example, one of the fastest growing in, by some distance, the highest return on equity participant in the power sector is trading at eight times earnings. You can pay a whole lot more because if you say, okay, India's got all this power investment company, and now the whole country is connected to the grid, which it wasn't before. People can afford to pay electricity. What I need is power generation and you can buy it. There are any number of companies that have IPO'd and those roadshows have been standing room only and the listings are a dozen or a hundred times oversubscribed. But if you have the time and appetite, you can look all sorts of other places in that ecosystem.

39:15There are distribution utilities, there are equipment manufacturers, there are specialized engineering companies. And as it turns out, there is a specialized lender to power transmission companies that earns a 22 % ROE that's fantastic. So there are trade-offs and you do have to have a filter, but creativity and research which will get you a long ways too. How do you go about narrowing the filter from this universe of 5 ,000 companies? So typically we meet anywhere from 50 to a hundred companies a year. And that's one source of ideas and hypotheses. Another is that we have built our own proprietary database that you would never do in a more mature market.

40:00But in India where data disclosure is really good, but data aggregation isn't so good, that's allowed us to do some pretty classic filters for earnings, consistency, quality, things of that nature. From that, it's pretty hypothesis driven where we have an idea that we think might be interesting. We do on the order of 25 research projects a year, anything from six to 12 weeks testing out those hypotheses. So something considerably short of, I don't know, KKR sending six McKinsey teams to crawl over a deal for a year, but an unusually intensive piece of research for Indian public markets. And out of that, the bar is pretty high.

40:45A busy year might be two or three names in what is today a 16 position portfolio. What is an example of what that deep dive research looks like? Sometimes it can be research on a discrete issue. So for For example, there can be a company with a piece of land on the balance sheet where it's only been required to record at cost. And it could have been acquired 80 years ago and they don't have to tell you where it is. It's a matter of sifting through land records, figuring out where the contiguous parcels are, peering over the fence wall, seeing what's there, valuing it. That type of thing, which is just hard for other types of investors to do.

41:23Usually it's something more integral to the earnings trajectory of a company. So for instance, we decided that there was something interesting about a natural gas pipeline that had monopoly position distributing gas to a rapidly industrializing region. And it was being priced like a stranded asset because the cost of natural gas had come up. And in the world of valuing a pipeline, you know the capital investment, you know the operating cost, the pricing's fixed. It's all about how much volume you can get through there. So the notion was really interesting area, but maybe there won't be anyone buying this natural gas because it's too expensive vis-a-vis power in the grid.

42:08And that was a reasonable rough and ready assumption to make for the sell-side analysts covering this company, which was a billion dollars in market cap. And the same analyst was also covering 29 other companies in its industry, some of them with a billion dollars in market cap. And he was very bright, very thoughtful, but there had to be drag and drop assumptions. If you have sufficient research bandwidth, what we were able to do is actually speak to the customer base that would represent 85 % of the customers for this pipeline and construct the demand curve. And then you find surprising things.

42:49You find that if you're fertilizer company, the substitute isn't power from the grid. They're using this feedstock. So it's NAFTA and that's the relevant price in comparison. And if you are a tile manufacturer, what you're using this gas for is actually to fire a kiln. And so your substitute is cold and you construct a totally different demand curve that says even pretty expensive gas, people may want this. And that's typically what we're looking to do is develop that type of differentiated view on the earnings trajectory of a company. And it's not always right for sure, but in the Indian context, whereas when I think about my US experience and it doesn't matter how small the company, how novel the research approach, there are a lot of other people pouring over the same idea and the differentiated edge is going to be small and short-lived.

43:40In India, sometimes you are the only person doing that kind of work, particularly in the context of other investors that have to cover every other emerging market or every other AsiaX Japan market. For your experience in venture capital, you had some great entrepreneurs and some swindlers. I'm curious how you layer in your assessment of management teams onto your investment decisions. It's absolutely critical, but not always in the way people looking at India from the outside. might think. I think there is a view of India that's probably been advanced in some cases by fund managers that 90 % of entrepreneurs are crooks and you have to know all the right people who will tell you who a small proportion of honest ones are.

44:29That hasn't been my experience. I think there are great stewards of capital and there are less good stewards of capital just like everywhere else. and the telltale signs aren't that much different than they are elsewhere. People will tell you what they're going to do and then you compare that to what they've actually done over a period of time and it says a lot. Have they enriched themselves with warrants, with deals, with affiliated companies that they own? It's right there in the financial statements. Their lenders will talk to you and say this person has been a great, reliable person to do business with or they're not.

45:06Their distributors sometimes have decades of experience working with them and it's been a pleasure or it hasn't been a pleasure. So what I would say is absolutely critical consideration, but the way you access and answer those questions in India is not so different than the way you would anywhere else. It's deeply important because there are still landmines. Just in the time I've been investing, there have been permanent losses of capital, in one of the largest banks, in more than one of the leading telecom companies, in the largest brick and mortar retail company, one of the big software companies.

45:42And these were not obscure micro cap companies. They were big, they had articulate CEOs and sophisticated IR functions, and they had nearly unanimous buy ratings from bulge bracket companies. And they look a lot on the face of them like the companies that have done great in those businesses. But what distinguishes as them, at least in my experience, wasn't that you had to sort of know someone on the inside. It was just that you could see something in the publicly available data that was probably going to tell you. Very seldom have these things gone bust. And afterwards, people said there's absolutely nothing that would have suggested this.

46:19Usually there's something in how they've allocated capital, how they've done business with associated companies, margins they earn that are not consistent with their peers for the same work, something's there that's going to give you a red flag. How do you include their government or regulatory environment in your assessment of companies? It is important in the Indian context as it is anywhere. I think there are some sectors where because of policymaking, it's very, very hard for a long-term investor, which is not that the policy is bad, but it's unpredictable. For instance, for oil marketing companies, the government has historically changed policy quickly and without notice about how they get compensated and when and in what form.

47:10In other areas, the regulator is a positive boon. In the Indian banking sector, which is small and fast growing, growing, there have been relatively few asset quality collapses in part because the regulator has been fairly strict in what they allow banks to pursue and what they don't. So a typical Indian bank, although it's growing quickly, its business model is pretty similar to a typical American bank in the 1950s or 60s. They gather deposits, they lend, and not a whole lot else. accumulate a few views along the way. The other thing that can be a little surprising is occasionally a large government role is actually a good thing.

47:56I mentioned that only 5 % of the companies are government-owned, and that works out to be about a couple hundred of them. A lot of the time, it's, I don't want to touch it. It's going to skew incentives. It's going to diminish returns. Every so often, the role of the government is perfectly fine. They're a great shareholder because they like to keep their companies focused on doing one thing, and they're always happy to have dividends. What are some of the other important risks you think about? For us as long-term investors, it's entirely about permanent loss of capital. And that can be hard to keep an eye on because in the shorter term, there's this massive share price volatility, and it can be a headwind and a challenge or it can be an opportunity in being able to buy things that are a little bit beaten down, but it can obscure the fact that over time, there are very few companies that have gone under because of oscillating market sentiment.

48:54Really, it's about the underlying quality of the business and that's what we are most attentive to. One that gets less attention than it deserves is compliance and back office risk, which in India is not immaterial, that just executing an investment business takes a lot of care and attention. So at the time that we were first investing and for many years thereafter, after, most shares were held in physical form in share certificates of 100 shares. So if you were buying and transacting at anything like institutional scale, you would have sheafs of share certificates. And there were times that we had to buy an airplane ticket, one for a custodian, and a second airplane ticket in the seat next to them for a box full of share certificates so they could be physically delivered to the buyer so the trade would close smoothly.

49:54Now, today, these shares are held notionally. Settlement is T plus zero, but there is an enduring issue that, boy, you better be attentive to some of the unique compliance requirements because they lie dormant, they lie dormant, and then they come in bite you if you haven't been following them closely. When we build out India Capital, the big more visible effort was we're going to build this fantastic research function and hire bright, thoughtful people with all these skills, but the less visible but equally important part, if you want to sustain as a firm for three decades as you can, is that we're going to make sure that we are always executing efficiently and that the compliance is sound.

50:37What are some of the hidden potential snags today that are the equivalent of losing your physical certificates back in the day? They have to do with expectations, especially of foreign portfolio investors, of which there are now a few more, that are sometimes interpreted as letter of the law that isn't actually going to be enforced in spirit. That these requirements that you can't actually raise capital from India, if you're a foreign portfolio investor, the expectation that you can't actually sit in India and make your investment decisions. The regulators will sit quiet on these things for a long time.

51:18And then every few years, they'll take an interest. And you have these situations where good investors suddenly have to have an asterisk in their NAV because they say we have an unquantifiable contingent liability because of this issue. And I think most of those get resolved in a reasonable way, that they sort of wind their way through appeals. And eventually, at a senior level, there is an enlightened policymaker says, you know, this is fine, but that can take years. When you roll all this up, if you took a static look at your portfolio today, I'd love to hear some of the metrics. It was just basic valuation metrics, basic business characteristic metrics of growth in that portfolio as a whole.

52:02Valuation metrics, we traded about 17 times forward earnings versus an index that today trades at about 21 times forward earnings. And that really runs the gamut. There are things that are small and fast growing and optically expensive. And you've got the eight times earnings company, you have a large position that is trading in its first percentile valuation band that's traded more expensively 99 % of the time. It's a 16 position portfolio. So we are pretty concentrated. We don't churn it much. There are five-year positions and eight-year positions, and there's a 22-year position in the portfolio.

52:44And we're happy to hang on to stuff as long as it's delivering the kind of underlying business performance that we want. It's pretty distributed by sector, but the overlap with the index is not high. And then in terms of earnings growth, we have managed to deliver over the past five years about 60 percentage points of excess earnings growth versus the index. And you don't always get paid for that immediately. Sometimes you don't get paid for it at all for a while. But over time, we find that the catch-up happens in lumpy and unpredictable ways, and it tracks share prices pretty well. With that concentrated low turnover portfolio, curious how you make investment decisions when you're making changes.

53:32The bar is pretty high. We have to be pretty excited about something on the way in. And equally so, we're generally not exiting because the share price didn't do what we thought it would over a period of time. Every so often, they're really pleasant surprises. We have a share price target for everything, not as a binding matter, but just to trigger a conversation. Every so often, things hit their five-year or three-year share price target in six months, and they're in and out of the portfolio a lot sooner than we thought. But usually, a position is exited because something changes in the approach.

54:13We had a 15-year position in the auto component sector that had done really, really well. It had been a fantastic entrepreneur who had found ways to increase the scale and the breadth of his business. He was doing just something called a wiring harness, which is a very low end good. And then he expanded it to rear end mirrors and dashboards. And it had been wonderful to participate in his journey. And then at a certain point, they let it be known that they were thinking of getting into defense components and that this was going to be a strategy that would be spearheaded by the relatively young child of the entrepreneur who had until then been running, I think like a music streaming business.

54:57And I think they'll do fine, but it's a really different business with a different entrepreneur. And it was a good moment to reevaluate where we could deploy capital. In a situation like that with a long-term hold that's been very successful, how do you think about when to give them the benefit of the doubt to say, okay, we know this kid's young and he hasn't done it before, but father's still there. This is an adjacency. Maybe it's a bigger market. That decision point of let's see what happens compared to, you know, we're going to move on. It's incredibly hard and we don't always get it right?

55:32That same company we already owned during the global financial crisis. And they'd been entirely India up until then. And then this entrepreneur said, hey, I've got great news. I've bought this company in Europe. It was nearly free. You're going to love it. And we, and the few other very long-term investors we knew in respect who were in the company, were all sort of scratching their heads. This is not a moment to extend your balance sheet, to take on debt to make this acquisition in a market you've never been in. And it was a flip of a coin. We could have ended up selling it. There was no real insight.

56:08We happened to stick around and the patience was rewarded. He had bought this thing out of a private equity investor that was eager to get out of it. And he ended up within a few quarters earning as much in EBITDA he paid for it. You just don't know. At the margin, I think we try and be more patient than not. Everyone takes that view, but I think in the Indian context, what we found is anything that starts to approach tactical trading in and out of a position for any reason has a pretty limited success rate. I think since 1990, I want to say the index is up 17-fold in dollar terms. If you take out the top 25 trading days, it's up 0.3x in dollar terms, which may be true in other markets as well.

56:58But it's a important reminder, I think, for us not to try and be too clever about second guessing those situations. So alongside of that absence of technical trading comes tremendous volatility. How do you think about risk management of your portfolio or just weathering the volatility that's going to come? So share price volatility absolutely is a feature of India in an enduring one. Mostly we're thinking about are the businesses holding up okay? So when Russia had invaded Ukraine and the cost of oil was going up for everyone and India's a net energy importer and inflation was high and rates were rising, the share prices went all over the place.

57:42But what we were mostly thinking about is how our company is going to do operationally, which are the ones who have any direct exposure to these things, and not many of them did. Our portfolio is 90 % domestic facing by design. But in an inflationary environment where all of their input costs were going up, which are the ones that have strong pricing power and can raise prices accordingly. And we spent a lot of time thinking about it. And some of it we got mostly right. There were some negative surprises. We owned a car company. We thought they've got three times the market share of anyone else in the country.

58:19And it took them a minute to raise prices. They did, but there were two or three quarters of margin compression. By comparison, we own real estate developers and suddenly all their steel and cement was more expensive. But in the end, they were able to raise prices by more than the increased input costs. And they're smarts, they didn't announce it. But if you sort of track closely like to like, you saw they were doing absolutely fine. Those are mostly the kind of questions we're asking ourselves. The other side of that is just making sure our investor base understands what it is they own, understands that there's going to be some volatility along the way.

58:57So in periods of extreme volatility, we try and communicate even more. And the outcome of that was I was already India Capital during the global financial crisis. And I can recall getting these questionnaires from investors just kind of checking up, are you okay? I think one of the endowment investors sent us a spreadsheet and the field was, please let us know your capital outflows. And it could only be a positive number. And it turned out remarkably, we had net inflows in those years. Not much, very minimal, but no outflows, ton of luck, but also because we were able to communicate people well.

59:35They knew we were in liquid companies, so their capital would be there if they wanted it. In that alignment has served us pretty well. Typically, when you go through those periods, it sounds like you're doing everything you can with communication and more communication. You're still closer to the assets than your investors. So you can see what's happening in the businesses and get some confidence that it's just a price move in the markets if the businesses continue to be strong. What have you seen in other periods of the impact of volatility and your performance at times on fund flows in your business?

1:00:09So what one always hopes for is when things are beat down the most, that's when people will be most eager to invest. And that's unfortunately very difficult to actualize. So that process of saying market's down, NAV is down, companies are doing great. We've had some success and some not of getting follow-on commitments. I think what has worked well is it's resulted in pretty sticky capital. So we haven't seen the kind of outflows where people are having a knee-jerk reaction to distress. In terms of what leads people to invest, I think it's changed a little over time. That India for so long was a really boutique specialized market where it was one or 2 % of all country world index.

1:01:02So when I first joined, I had exactly the wrong idea. I thought, oh, it's a small specialized market. We'll get small investors. And it turned out to be exactly the opposite. It was only the really big ones with a lot of team strength and bandwidth and appetite and the ability to stick their necks out there who were really looking at that esoteric process. When the fund was first launched, going back all the way in our history, It was launched with all$14 million because after passing around the hat for two years, that's all the money we could find. And half of that was from Soros in the public domain.

1:01:37And it was really only people like that that were willing to take on what was that perceived level of risk. I think in recent times, we've seen the addressable market has probably expanded where there's a realization not only is India just mechanically a larger part of the world in emerging markets index, but I think there's an awareness that it's a difficult market to invest in for a manager alongside six other things. It's hard to unearth the really special opportunities. It's hard to avoid the bad ones. And I think that's led to more people who didn't always have sort of contrarian specialist interest in India considering a single country allocation.

1:02:24When you have conversations with prospective investors who aren't investing, what do you hear as some of the most common misperceptions of people's perspectives on the market? There are two I hear a lot right now. One of them is that everyone else has already done it. So I'm late to the party. So why should I bother? That feels like it should be true. There are a bunch of articles now in mainstream publications about India. It seems like there must have already been a lot of foreign portfolio flows. And the reality is over the last few years, there's been money in, there's money back out, there's been money in.

1:03:00Net flows from foreign allocators are functionally zero to India. What's been fueling the market is domestic investment, which over that same period is something like$55 billion. And there are 75 million new mutual fund investors, which even in the Indian context is a big number. And pension exposure to India has gone from zero to a few billion, but that's out of$300 billion of pension assets that historically weren't in equities at all, and now they're in a little. So I think that's one misperception is that you've missed the bus. The other is that valuations must be expensive. And because India has had a relatively decent run, that too feels like it should be the case.

1:03:46But when you decompose it, yes, returns have been okay, but because earnings growth has been pretty strong, for the large cap index, it's 75 % or 80 % EPS driven and about 20 % or 25 % multiple expansion driven. Whereas for the United States, it's exactly the opposite. And for EM index, it's 100 % multiple expansion driven. India is more expensive on a price to earnings basis than, let's say, the EM index. and some of that is a function of India and a large part of that is a function of China, just dragging things down and what's going on in both countries. It's been more expensive pretty much the entirety of my investment career.

1:04:30So that may be a persistent enduring feature that when you have companies in the Indian index and we don't own them, but they 100 % return on equity, they're just always going to trade at a higher multiple in a nickel mine. And Indian companies in aggregate equally are less leveraged, higher return on equity, faster growing. So there's just probably always going to be a gap. But because the earnings performance has been strong, India's premium to the world index has actually come down. It may not be exactly what people perceive. You look at the US, say the S &P 500 is dominated by the MAG-7, which has certain implications of what that means for the valuation of the S &P 500.

1:05:12What is the composition of the most popular indexes in India relative to the types of companies that dominate it in the concentration? Fortunately, it's pretty representative. So you don't have a situation where one company has an absolutely outlier share of it or one index. So you have within the index consumer staples and automotive and banks and technology. It's pretty eclectic. Having said that, with 5 ,000 stocks, there's going to be something that's not captured in the performance may be very different from the rest of the market. Sometimes that's meant that much like the US, there have been periods, usually where the tide is going out in terms of enthusiasm for India, where there will be a handful of companies that account for all of the index performance.

1:06:02And that can make life difficult as an active fundamental investor, much like it has in the US. Sometimes it runs the other way. So right now in India, most of the market is valued very much in line with historical averages, certainly for the large cap index. Very small companies are actually unusually expensive right now, where there are small cap indexes trading at a three or four or five turn premium to the larger cap index, even as the market has grown and there are more participants, there are, as I see it, enduring pockets of really striking pricing inefficiency in both directions. So if you have a landscape today where in the broad index, it's say stark average, some of the small cap index might be expensive.

1:06:53How are you feeling on your portfolio? Pretty good. In our portfolio, top two positions, one of them I mentioned is at eight times earnings. One of them is in its first-band valuation multiple. We trade three or four terms cheaper than the index. In aggregate, we are finding opportunities that are appropriately valued, sometimes that even feel cheap. But it's an interesting thing seeing smaller companies being so much more expensive. In a different context, you could sort of construct a case why that should be, that the best of them are growing really well off a small base. They're the scrappy insurgents.

1:07:37They'll grow into their valuations. And there's an element of truth in that. But in India, sometimes it's the larger companies that are growing faster, that it is the top banks that are growing assets in earnings faster than the rest of them, that it is one or two car companies that are generating all the earnings in the industry. It's not always the largest, but the best run couple who are usually not the micro caps are growing particularly fast. And you can see in some cases why that would play out. We're longtime investors in banks. And it used to be absolutely that small could be beautiful.

1:08:17Just like in the US, if you ran a really well-managed regional bank, you could do great. And then you flash forward to today where three quarters of the transactions don't even have to come into a branch. and it's your investment in technology that matters, in your national brand, in the trust you have among depositors, and it's very different companies that are poised to thrive in that environment. And you can see it beginning to play out. There are reasonably large banks that are growing faster than system and fairly small banks that are struggling to find their footing, but it is remarkably early in that evolution.

1:08:58The system itself is small. India's largest bank is smaller than China's 11th largest bank. Its largest six private sector banks put together are one seventh the size of ICBC. I'd love to hear an example of something that's emblematic of this approach of finding that research differentiation from what the market thought that you're excited about? We ended up looking at the power sector to sort of pick up that thread again. We found our way to power transmission finance. And optically, you would say, if you did the work we did, you would say, this is the company you should love and definitely be invested in.

1:09:44But there were a couple of reasons why, even though it was already a$3 billion dollar market cap company and should have been reasonably visible. There was almost no one there in it. None of our pure foreign institutional investors, very little domestic institutional investment, very little research coverage. And some of it was just kind of how the company was managed. They had never attended an analyst conference. They were pretty sporadic in terms of quarterly earnings calls. If you got their investor presentations, they would just be scanned copies of their financial statements appended with these comments in a baffling array of colors and fonts.

1:10:26And it just was designed to repel market participants and investors. But there were two things about the company that were in need of diligencing if you wanted to invest. The first of them is not withstanding this high growth, this high return on equity, they'd seen a surge in bad assets. If you were going to put money in, you had to have some degree of comfort that this was going to get resolved and it wasn't going to continue to grow. But from a research standpoint, what's great about project finance is you're not lending to million small borrowers, you're lending to a few dozen large ones. And in the event, what we found is there were 15 borrowers that accounted for 70 % of the bad assets.

1:11:11And these were power projects that you could actually go and see. Not easily. It might be a 12-hour drive from Mumbai, but they're there. And what we found oftentimes with the time and the appetite to do that work is in a lot of instances, they're almost completely finished. Even if there was an equity wipeout and the project sponsor was displaced, that there was going to be a lot of salvage value to these projects that were treated as if they were going to be complete write-offs. In some situations, the situation was even better than that, that these were borrowers who had never missed a payment.

1:11:46But because of the peculiarities of Indian project accounting, if commissioning was delayed by more than a certain amount, that they were deemed non-performing irrespective. and you could see we've got two units of this power plant and one of them's already been turned on and the other's finished and there's a long-term purchasing agreement, but we're not going to commission it for another two months. All of that in its entirety was a non-performing loan. So by doing that granular level of work, it was possible to ascertain with a pretty high level of confidence that the asset quality was actually okay and the resolutions would happen.

1:12:24That was one aspect of this company. The other one that was majority owned by the Indian government, which for a lot of folks is a non-starter and you can sort of see why. But in this instance, the more we got to know the company, its borrowers, its prospective competitors, what we came to understand was this time around, it was actually a positive benefit. Typically the issue with Power Project Finance is these are long duration loans. And if you have short tenor liabilities as a lender, you can't necessarily make them. But with government backing, this company could go to the global capital markets and borrow at the correct duration with an implicit sovereign guarantee, so it was cheap.

1:13:08And then in turn, they could lend into this uncrowded market where they could get a premium. And who are the borrowers? Well, in a lot of instances, they were affiliated with the government too, as these quasi-governmental entities that if you're a private sector bank, how do I ever get my money back? But if you are effectively an arm of the central government, you always get your money back. And with a 30-year track record, they'd always gotten their money back and they'd always prioritized earnings and returns and dividends over public policy objectives. So that is not a typical where something on the surface looks exciting, but problematic.

1:13:50And if you are outside the country, or if you have limited research capacity, you kind of have to leave those things untouched. But if you've got a lot of time and interest, those are things you can plumb over. And eight times out of 10, there's a reason not to own them. But every so often, there's something pretty exciting. In a situation like that, how do you think about the path from having done that research and understanding where there may be a variant perception of the information to the market or other buyers understanding that these problem assets really probably aren't as troubled as it seems.

1:14:28In the past, one of the hard things about India is you could be absolutely right about the operating performance trajectory in the transmission to share prices could be incredibly slow. You would see a company deliver exactly the numbers you had hoped for, and it was just crickets. And in the case of this investment, that was absolutely the case for three years. Five times earnings when we first invested went to less than three times earnings for a while. In the end, that process has become probably a little bit faster and more reliable in India because there are more domestic participants. Whereas a typical foreign investor, at least historically.

1:15:10Government-owned company, no thank you. I don't even want to know about the earnings or how the asset quality is resolving itself. In this company, it probably took two or three years of them consistently delivering high and accelerating return on equity, non-performing loans that went from 7 % to 6 % to 5 % to now they're at less than 2%. and it took at least half that time before anyone really noticed. In some of it, you just kind of have to wait. In some of it, occasionally we can play a constructive role. We are very passive investors. We don't think we know anything management doesn't about running a company.

1:15:51But in a case where the market-facing activities are so suboptimal as they were here, just building a good relationship and saying, hey, how about you attend a conference? and maybe instead of holding an earnings call that you don't always invite your investors to, there were times where the only people on the call, what if you just once a year, you do it in person and you bring a video that explains what you do. And that increase in visibility has been helpful. And then sometimes you just get lucky. This company, a lot of the loans they're making now are to renewable energy projects. And surprisingly, I think most people's perception of India is they are being dragged kicking and screaming to fulfilling their Paris climate commitments.

1:16:40In reality, 80 % of new generating capacity in India is renewable. Some way it's hitting people's screens for, let's say, as a sovereign fund or one with an ESG bent, that it's got a huge renewable component and its business quality is great and it's cheap. In some way, they're finding themselves much more central. but that we did not underwrite. It just kind of happened. What are you most excited about over the next couple of years? In India, it's almost entirely the domestic economy. And that's where most of our positions are focused. The growth is just so good there. And there are a lot of areas we are looking at closely and interested in, but they fall within two buckets.

1:17:24Some of it's in the consumption basket with income per capita now at$2 ,500. You're going from a place where two-thirds of that was consumed by food and shelter and housing to a place where people really have disposable income. 300 million Indians are entering what, in the Indian context, is the lower middle class. And they're looking at buying their first car. They're spending a little bit of money on cosmetics because they can, their first home, and we're in all of those spaces. And in terms of their savings, they now have some and they're buying their first life insurance policy. There's no equivalent of social security.

1:18:06So that's important. They're investing in the equity markets. They're building bank deposits and we're in all those areas as well. So somewhat higher ticket consumption of the kind that grew manifold in China when incomes reached that level. The other side of it is the build out of credit in business investment, where credit penetration, which historically had been so low, and then through the COVID years had seized up, is now growing again. And on the opposite side of the ledger, there are borrowers now with Indian companies have their lightest debt equity in decade and a half. So they have the capacity to borrow and they're seeing end demand.

1:18:48So they have the incentive in capacity utilizations are pretty high. So participants in that ecosystem, I think are really interesting as well. And it's selective. The best cement company is not necessarily the one with the deepest pockets or that's affiliated with a global major. It's the cement company that's figured out how to sell it as a branded good and earns the higher price. And the best bank isn't necessarily the biggest or the one that's growing fastest this year. It's the one with the best credit quality that through cycle can be really capital efficient. So it's not always who you think, but things that address those themes, there's a lot that's really interesting to choose from.

1:19:31As you look at the business and the niche that you've occupied, talking to investors, where are you hoping to take it over the next few years? In large measure, continuing to do what we've done. It's a hard business, but it is a pleasure that we are able to focus on being participants in good companies for a long period of time. And that is a little bit because of the process we've built and a lot because of the type of investors we've been lucky to have. And I wouldn't want to radically change either of those things, but it's also really neat to be able to ride along with India's growth. And just by continuing to do what we always have, that is a scaling opportunity.

1:20:20And when I think about what is the what you have to believe about India, it's growing today at 6%, 7%, 7.5%. It's a larger economy now than Japan, but GDP per capita is still on par with Congo and Ivory Coast. So for that level of growth to continue, the ask in some ways is not to go to the moon and we all have the GDP per capita of Liechtenstein. It's over two and a half decades to hit the level of Peru and Ecuador and Botswana. And that's something a lot of countries have done over the last half century. And I think probably India can do too. Unfortunately, in the Indian context, businesses have managed to translate that pretty efficiently to earnings and share prices.

1:21:0690 % of the time, we're just trying to earn an economic return for our investors. But every so often, it's fun to think of that process of being along for the ride in India's emergence. Great. Dan, well, I want to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? I'm a longtime runner in India because that's exploded in popularity. It allows me to run alongside people from all walks of life, from industrialists to people who work with their hands for a living. And that's pretty neat. Is it a little less dangerous than it was a while back?

1:21:43A little. What's one fact that most people don't know about you? I was in 1997 credentialed on the anti-doping commission of the Copa America soccer tournament in Bolivia, where my responsibilities included transporting a sealed bag of urine samples from competing players from Santa Cruz de la Sierra to Chile. How did that come about? That may need to be a story for my next visit. It will drag us on to two hours, I'm afraid. What's your biggest pet peeve? In investing selective memory in myself and others, perfect recall for success is inability to remember failures. I think it's inimical to learning.

1:22:27Which two people have had the biggest impact on your professional life? Manish Sabarwal was the founder of India Life. Spent money he barely had on a plane ticket for me to come to India when he had no reason to think I had anything to offer. And I'm incredibly grateful for that because it started me on a path that I've loved and found really rewarded. John Thorne, who founded India Capital, also welcomed me in without any obvious reason to do so and treated me like a partner before I really was. And at some point in part handed over the keys to me. And that's a favor I can't really repay, but hope to pass forward.

1:23:09And hopefully the next generation of leadership is already toiling away somewhere, honing their craft at India capital. What's the best advice you've ever received? Well, for my life, as I look back, it was to move to India. It's been hard. It's been confounding, but it's been infinitely rewarding. All right, Dan, last one. What life lesson have you learned that you wish you knew a lot earlier in life? That it is okay to have unusual goals and take an atypical path to get there. and that it's worth having some confidence that that's going to work out. Dan, thanks so much for sharing your insights and this really interesting story about opportunities in India.

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