India IPOs: Staying afloat

The listing of VRL Logistics on April 15 likely came as something of relief for New Silk Route Advisors (NSR). On its first day on the Bombay Stock Exchange, the transport services provider opened at INR288 a share, a 40% premium to the offer price. This followed a INR4.6 billion ($72 million) IPO, which was 74x oversubscribed and priced at the top of the indicative range.

And then the offering represented a part-exit for NSR, which generated INR3 billion by divesting two-thirds of its 22.5% stake and secured a 2.47x return. At the time of writing, VRL was still above its IPO price, trading around the INR279 mark.

NSR was not so fortunate with Ortel Communication, which was the first private equity-backed company to list in India this year. Ortel's IPO priced at the lower end of its range, at INR181, and was just 0.75x subscribed, which meant NSR was able to sell only half the shares it wanted. The stock opened at INR160 and the subsequent recovery has been modest. It is trading at INR170.

There have now been five listings in India so far this year, and three of the companies have private equity investors. Of MEP Infrastructure Developers, which had its debut last week, theme park operator Adlabs Entertainment, and energy firm Inox Wind, only the last fared as well as VRL.

"Not only do you have a lack of IPOs, but the few that have happened so far have not all been great quality businesses," says one industry source. "We haven't had an exciting, big name business that has made retail investors, or the big institutional investors, say, ‘Here is something we really want to run hard at.'"

Underwhelming

While there has been a pick-up in the number of IPOs in India in recent weeks, activity is still somewhat muted when one considers the performance of the public markets over the past 12 months. Part of this can be put down to the simple fact that macroeconomic tailwinds have been slow to filter through to the IPO market, but that does not offer a complete explanation of why momentum has been so slow to gather.

It is not just an issue of quality companies, but also a quality listing process, free of regulatory obfuscation. Improvements have been promised and their successful implementation is vital to private equity investors under pressure to return capital to investors.

According to AVCJ Research, the two PE-backed IPOs exits completed so far this year - Ortel and VRL Logistics - raised around $157 million and generated $57 million for their investors. Adlabs, backed by ICICI Venture Funds and Jacob Ballas Capital, did not represent an exit. Already, IPO exit activity in 2015 matches that of 2014 when just four PE-backed offerings raised $141 million between them. These included two exits worth $58 million.

However, the market is still some way off its previous peak in 2010, when 24 PE-backed IPOs raised an aggregate $1.9 billion and generated 12 exits, returning $288 million to investors. This was partly because the public markets were performing well at a time when US and European markets where still reeling from the impact of global financial crisis. PE exits as a whole saw a lift that year with proceeds of $4.3 billion from over 121 deals. These included 52 open market sales, which returned $1.45 billion.

Exit activity dropped off the following year, with $3 billion generated from 63 deals. The economy was a factor, but so too was the harsh truth that GPs were sitting on portfolios built up during the pre-crisis era of exuberance when many PE firms paid over the odds. Even if managers were able to secure exits, the multiples were often not high enough to generate a positive return.

There has been an incremental increase in exits every year since - in 2014, there were 131 PE exits in India, which returned $4.5 billion to investors - but this has not been reflected in IPO numbers. Open market sales and trade sales continue to dominate, accounting for 97% of capital returned last year.

Not ready, not willing

There are a number of reasons why PE-backed IPO have been slow to materialize. As previously mentioned, one factor is the length of time it has taken for companies to see the benefits of India's recent economic revival on their balance sheets. This means that a number of would-be candidates simply have not been ready to list.

"It has taken around three quarters for companies build up traction on their balance sheets, so we haven't see too many good quality filings since the change in government," says Anup Bagchi, executive director at ICICI Securities. "It has only been since September that the number of listings has started to improve."

Even so, not all the public offerings completed in recent months have performed to expectations. Gupta Prashant, a partner with law firm Shardul Amarchand Mangaldas (SAM), notes that the poor reception for likes of Ortel and Adlabs was mostly down to aggressive pricing. "It depends on the valuation that a company is willing to offer," he adds. "I think there is still good demand, and capital available for reasonable valuations and better run companies."

Others have echoed Bagchi saying that few companies that have received private equity backing in the last five years are mature enough to go public. However, some observe that a lot of private equity investors, and the promoters they back, are not convinced IPOs are the best option considering the other possible exit avenues.

"If you look back 10 years, promoters wanted an IPO because it was the best ultimate source of capital for a long period of time and for entrepreneurs it was an ambition," says one Indian GP. "But I think that has changed a little bit because of the hassles you face, dealing with regulators and movements in stock prices - it makes you think twice."

Bureaucratic obstacles

The issue that comes up time and again with IPOs is the process of dealing with the Securities and Exchange Board of India (SEBI), and time it take for listings to be approved. This has been the root of criticism leveled at Indian regulators who are understood to take as long as a year to green light some offerings.

It is in part due to the heightened scrutiny of companies rising from SEBI's responsibility to protect retail investors - the number of retail investors participating in the Indian equities market is low and the regulators want more people to get involved. According to Bloomberg, less than 1.5% of the country's population invests in securities, compared to 10% and 18% in China and the US, respectively. As such, regulators have struggled to balance the needs of small investors and those of the market.

"With SEBI you can get into all sorts of delays. You submit the documents, they then come back with comments, and the process goes on until those comments are cleared. It can take anything from a two-and-a-half months to six months, on average" says SAM's Prashant. "We have had one or two issues that have held up documentation with SEBI that normally would not hold it up with other regulators."

A common sticking point is the concept of the promoters and the lock-in of shares. SEBI requires that at least 20% of a promoter's post-issue capital be locked-up for three years. However, in the case of private equity-backed companies the promoter often doesn't hold as much as a 20%, while the largest shareholder is typically a financial investors looking to exit.

"What may happen is that the original guy who started the company has seen his stake diluted a lot and there are a lot of PE investors not willing to be named as promoters or controllers," says Sandip Bhagat, a partner at S&R associates.

The second major issue is the use of proceeds. Under the current rules, companies must disclose the purpose of the issue and explain how the capital will be deployed. Typically regulators are looking for minute details on capital expenditure projects the company is looking to undertake, such as building a manufacturing plant.

Additionally, no more than 25% of the proceeds can be used for general corporate purposes. This could be a big obstacle down the line for fast-growing technology start-ups, particularly in the e-commerce space. These companies often operate without any tangible assets and demand flexible capital that can be spent on either marketing or hiring talent. As such, they don't necessarily meet SEBI criteria.

The restrictions have not totally precluded technology start-ups from listing locally in the past. One of the most high profile examples is Just Dial, which raised INR9.5 billion in its IPO in 2013 giving a partial exit to Sequoia Capital, SAIF Partners, Tiger Global, ECGS and SAP Ventures. However, some of the more recent VC-backed success stories - notably e-commerce marketplaces Flipkart and Snapdeal - are expected to list overseas.

"Given the onerous rules placed on new offerings most, if not all, technology IPOs will take place outside of India," says Ravi Adusumalli, general partner with SAIF Partners.

Road to reform

To encourage more home-grown companies to list locally, SEBI has started to tackle some of the bigger issues. Last month it issued a discussion paper on regulatory reform and the establishment of alternative capital-raising platform for start-ups.
In the document SEBI said it recognized the need to accommodate the increasing number fast-growing start-ups and that these companies are "loss-making and belong to sectors for which there are no comparable financials ratios available." Hence, it concluded, they require differential treatment.

Among the proposals outlined is a provision that allows for general corporate purposes to be the main use of proceeds, which means that companies need only disclose broad objectives rather than granular details. Another important provision is that promoters are not subject to a lock-up period of three years for a minimum of 20% of the post-issue capital. Instead, shareholders investing in start-ups at the time of listing must hold to their shares for at least six months.

The caveat is that only two types of investors - qualified institutional buyers (QIBs), including family offices and non-banking financial companies, and non-institutional investors (NIIs) - will be allowed to invest in shares of these start-ups. Retail investors are restricted.

"The good news is the government is taking note, it has been listening to PE and VC investors, and kind of trying its best within in the frame of the rules to improve the process and make it a little less stringent," says Sasha Mirchandani, managing director and founder of Kae Capital.

However, there is still a question hanging over the amount of time it takes to secure a listing under the current system. While setting up a new platform will expedite the process for VC-backed start-ups by taking retail investors out of the equation, the portfolio companies of private equity investors might not be suited to this route. (It is not clear what the criteria are for listing on such a platform.) As such, they might not be able to escape the logjam.

Furthermore, even if the new platform offers an attractive outcome for venture capital-backed start-ups to list locally, there are other reasons why these companies may seek to go public overseas. In particular, it is widely thought that US investors would be more receptive to these companies, leading to higher valuations. The example that repeatedly comes to the fore is MakeMyTrip, a travel-booking platform backed by SAIF, Tiger Global, and Helion that raised $70 million in its NASDAQ IPO in 2010. It now has a market capitalization in excess of $900 million.

"There is a concern that there will not be enough understanding in the Indian market for VC-backed start-ups," says Kae Capital's Mirchandani. "US investors are considered to be far more savvy and able to understand why a small-ish company like MakeMyTrip should be worth more than a billion."

This has been made more likely by recent regulatory changes designed to make it easier for Indian companies to access foreign bourses. In late 2013, the Ministry of Finance launched a two-year pilot scheme under which approved companies can raise capital overseas without listing in India. Previously, domestically-incorporated companies had to do a share offering in India prior to or simultaneously with the overseas IPO.

MakeMyTrip was able to work around this rule because it was domiciled in Mauritius.

Home or away?

The counterargument comes in two parts. First, there are no guarantees of success overseas - much depends on sentiment in the US market - and some industry participants express concern about the potential tax treatment of companies that go offshore.

Second, not everyone is of the same view as Mirchandani. Sandeep Aneja, CEO and founder of Kaizen Private Equity is optimistic that the domestic market will see more technology IPOs, provided regulatory hurdles are overcome. 

"Confidence is rising in Indian IPOs," says Aneja, "Everyone has got their eyes on e-commerce - the darling sector for investors at the moment - and that sector shows results it will start to impact other sectors."

SAM's Prashant worked on the JustDial IPO in 2013, and believes the company traded at premium to the valuation it would have got in the US. This is because Just Dial has no peers in the Indian market, whereas in the US there are potentially hundreds of similar platforms. As a result, it is attracted a lot of domestic money.

The same could perhaps be said of a lot of other upcoming start-ups in India, from Flipkart to taxi-booking platform Ola to property listings site Housing.com. However there is still need for regulators to convince entrepreneurs, and their investors, that domestic listings are an attractive and trouble-free proposition.

"I think they need to do a better job of marketing to the entrepreneurs that it is a good thing to list your company," say one industry source. "The quality entrepreneurs have to feel that having a listed company is a big deal, it means a lot, and not think: ‘It's a burden, it's a hassle, and I am setting myself up for pain."

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• Topics
• Exits
• South Asia
• Expansion
• Venture
• Regulation
• Growth capital
• Venture
• India
• IPO
• Exit
• Warburg Pincus Asia
• Kaizen
• SAIF Partners
• NSR New Silk Route Partners
• regulation
• SEBI