India exits: Diamonds in the rough

India's private equity market represents a massive case of arrested development. When it comes to making investments, GPs face little difficulty. Bringing that money back at the rate promised has been another story altogether - one that LPs are increasingly tired of hearing.

"That's the constant refrain of investors," says Kunal Shroff, lead partner at ChrysCapital. "They understand India's a large and fast growing economy and is better positioned than most other emerging markets - but enough time has passed that one can now study the track record of funds, and the lack of exits and realizations is where India falters the most."

Like Shroff, many PE professionals acknowledge that the country's historical weakness in exits is holding the industry back. The more difficulty that LPs face in recovering their capital, the less likely they are over the long term to continue supporting private equity firms.

However, industry participants also say India's exit market should by no means be counted out yet. Many point to long-term trends that presage an improvement in ability to exit, while others see plenty of opportunities for fund managers with the right investment approach and the ability to be flexible when looking for liquidity. While exits are likely to remain challenging for Indian GPs for the time being, most believe the market holds promise over the long term.

Unrealized dreams

Exits have never reached the same heights as investments for India's PE industry: AVCJ Research records more than $112 billion invested in the country over the last ten years, while exits come to just below $56 billion - a difference of more than half. While investments peaked in 2007 and 2008, at $18 billion and $11 million respectively, the expected corresponding spike in 2011 and 2012 never materialized - in those years the amount achieved through exits was just $3.1 billion and $5.3 billion respectively.

The number of exits has also remained low: while exits reached a momentary peak of 125 in 2010, the preceding and following years both recorded fewer than 70. The level did not rise above 100 again until 2013.

That investments made in 2007 and 2008 were difficult to exit is hardly surprising, given the devastating effects of the global financial crisis. But in India the effect has been especially pronounced amid the country's nascent private equity industry.

"It was the first cycle of exits for India deals around 2008, and that's exactly when the global meltdown happened," observes Pratibha Jain, a partner at Nishith Desai Associates. "So it was a combination of factors, and it's extremely unfair to blame just the Indian market for it. Markets the world over tanked, including the public markets."

But fair or not, the stumble in 2007 and 2008 set a lasting precedent that has long been a source of irritation for LPs. Trends do seem to have improved in recent years, however, with the number of exits steadily climbing - in every year since 2013 the total has exceeded 100. The dollar amount for exits has also surpassed that of investments so far this year, albeit only slightly.

The improvement has not been lost on the industry, but skepticism remains strong. Market participants feel that long-term history must be weighed against the recent gains, which may only be temporary.

"Whilst last year saw good realizations out of India, on an overall basis realizations remain anemic relative to the amount of capital invested in India - this remains a negative point for India," says ChrysCapital's Shroff. "As opposed to getting multiples of your investments, you've still only getting a fraction of what was invested. Only a quarter of the cost basis has been exited thus far - so the realized track record really needs to pick up, and that sustained momentum has yet to be seen. ChrysCapital, on the other hand, has realized $2 billion since 2011 compared to $1 billion that it has invested over this time period."

In many ways India's exit dynamic remains idiosyncratic. Unlike China, for example, IPOs have never been a significant source of liquidity here. Instead trade sales and open market transactions - often involving what were PIPE deals in the first place - have dominated both in the number of exits seen and the dollar amount raised: over $30 billion worth of exits since 2010 have come from trade sales, with more than $12 billion realized via the open market.

IPOs have shown signs of picking up in recent years, with the numbers growing from two in 2014 to 10 last year and 14 so far this year. Industry participants see this as a welcome sign, but this avenue is considered shaky at best due to possible shifts in investor sentiment that are beyond GPs' control.

Capital flight?

One example of an unwelcome, albeit inadvertent, outside intervention is the Indian government's recent removal of INR500 and INR1,000 rupee notes from circulation. Not only does this remove cash from public market investors, it also takes money from precisely those companies where the industry has seen the most promise in the recent past.

"Financial services has been one of the sectors where PE has invested significantly in the last 4-5 years, and consumer's not that far behind," says Vikram Utamsingh, managing director at Alvarez & Marsal. "When you look at the IPO market recently, valuations in these sectors has fallen and so the issue's going to be that it doesn't make sense to go IPO right now because you're not going to get the right valuation. And that may lead to a pullback in other sectors as well. So any private equity firm that has a portfolio company that they want to take public is going to wait to fully understand the effects of the recent demonetization for at least six months before they revisit that."

With IPOs likely to remain difficult for the time being, investors continue to see the way forward in the country's more traditional exit pathways. Trade sales, for instance, whether as secondary deals with other PE firms or as exits to strategic buyers, have always been a robust option, with foreign players particularly interested since they often find PE-backed companies more appealing than those without such support. Private equity involvement is seen by many buyers as providing a certain advantage in professionalism over other Indian companies that is particularly attractive to strategics who are unfamiliar with the local market.

"Deal certainty has tended to be higher with private equity-backed companies because there's a stronger understanding of what value-add another private equity investor can bring," says Rupen Jhaveri, a director for India PE at KKR, which sold its stake in Alliance Tire Group to Japanese tire manufacturer Yokohama Rubber earlier this year for $1.2 billion. "They also have a strong sense of corporate governance, so if the price being offered is compelling, private equity investors may be more apt to take the bid."

Domestic buyers have taken the trade sale route as well; earlier this year Oak Hill Capital Partners sold its stake in the Indian branch of business process outsourcing company Vertex Data Science at a reported valuation of INR2.5-3 billion ($37.4-$44.9 million). The PE firm, along with GenNx360 Capital Partners and Knox Lawrence International, had paid $426 million for the entire company in 2007, including its UK headquarters and other operations along with the India assets.

Trading up

Secondary sales are also seen as healthy and promising opportunity, and many GPs have a well-established understanding of the potential of these deals. In fact, participants see this type of transaction as facilitating interactions among GPs that are unique to the market.

"In India a lot of exits occur through firms investing at different stages of companies' evolution: for example, as the business grows it is sold to a different kind of private equity firm," says Karan Swani, a director in the India private equity team at KKR. "You might see an early-stage venture capital fund selling a company to an Indian PE fund, and an Indian PE fund selling it to someone like us. Earlier stage investors have the opportunity to build a business from scratch to a certain level, and then we can take it to a very different level through cross-border expansion and activities like that."

Secondary sales are seen as particularly promising for the country's midmarket-focused funds, in light of the many global firms that are trying to gain exposure to India. ChrysCapital, for example, exited its 11% stake in Mankind Pharma to Capital International last year for over $200 million, a substantial multiple on its 2007 investment of $25 million, just a year after exiting its stake in Intas Pharmaceuticals.

"Given that there's significant dry powder trying to do $100-200 million investments in India, we believe that if the IPO markets are not conducive, then exiting to another sponsor could be a good fallback option," says ChrysCapital's Shroff. "If the portfolio company has reached a certain scale it could attract those quality buyers."

This pattern breaks down, however, at the larger end of the PE spectrum, since there are few firms of a similar size to sell on to. PE secondaries are still possible, as was the case earlier this year when Caisse de dépôt et placement du Québec (CDPQ) paid $155 million for stakes in TVS Logistics held by KKR and Goldman Sachs. But KKR's Swani says such opportunities tend to be rare, and KKR's exits are mostly by way of capital market trades and strategic buyers.

It is important to note that, despite the availability of these options, India's exit market is still seen as lacking. However, industry participants see signs of promise, both in continued growth of strategic interest and in increased government friendliness to exits. While lawmakers were previously reluctant to let foreigntake money out of the country, observers now see considerably better understanding of the needs of the industry

 "The government understands now that you have to allow money to exit for it to come back, just like you have to do for the stock markets, where it's significantly liberalized investments into India," says Nishith Desai's Jain. "I think the same understanding is now coming for PE exits, so that should also help. You'll just have less regulatory uncertainty in terms of exits."

 

SIDEBAR: Watching from the sidelines

With India's tech firms typically reluctant to invest in strategic acquisitions, Quikr, the online classifieds business that has embarked on a series of purchase aimed at expanding its reach into new verticals, stands out. Its bolt-ons in the last year include property search site CommonFloor, real estate aggregator Indian Realty Exchange, jobs site Hiree and analytics platform RealtyCompass.

A number of these acquisitions, like Quikr itself, are VC-backed. However, these have tended to be relatively small stakes: in the case of Hiree, the target had raised a total of $3 million from investors including IDG Ventures, according to AVCJ Research, while the Grabhouse acquisition reportedly valued the company at $10 million. CommonFloor represents a rare exception: media reports put the valuation of the Tiger Global-backed target at $120 million. But for the most part the liquidity resulting from these deals for VC investors has been small.

The example of Quikr illustrates some of the pressures that Indian VC firms when finding exits. India's internet giants in particular seem like they should have large appetites. But as in the case of Quikr, buyout offers from this area tend not to offer much of a reward to the targets' VC backers.

"In terms of the domestic internet strategics, most of their acquisitions have been very small. They're either stock swaps or small cash," says Ben Mathias, managing director at Vertex Ventures. "So I don't see them as being good exit opportunities at this point. There have been some acquisitions made by offline retailers who are trying to build internet brands. However, these have also been for small values. If you want a good strategic sale for an internet business you do want to target a non-Indian entity."

While domestic internet players are reluctant to pursue trade sales of significant size, other tech-related sectors do not have the same problem. Mathias says opportunities for sales have been much higher among IT services companies such as Wipro, which has made a number of acquisitions both in India and overseas. He attributes this difference to the fact that these companies can finance their own acquisitions, rather than being reliant on money from outside investors.

While trade sales are seen as possible if the right buyer is found, public market exits are considered even harder than on the PE side. IPOs are not unheard of in the venture environment - non-banking finance companies Equitas and Ujjivan filed for offerings earlier this year - but the path is particularly difficult for companies in the early stages of their development.

"In the last 12 months there have been a lot of liquidity swap deals," says Vishal Pereira, managing partner at CreedCap Asia Advisors. "But IPOs are out of the question for many of these companies because they still are not profitable."

Secondaries present another opportunity for VC investors to realize liquidity. Many of the country's largest internet giants, such as Snapdeal and Flipkart, have been through multiple rounds of VC investment, followed by PE investors picking up stakes.

However, industry observers say that secondaries sales still seem not to be tempting for many recently launched VC firms. These newcomers know the potential benefit of selling their stakes to other private investors, but may also feel that they can afford to keep their companies off the market for the time being while desire appreciates.

"They want to be the beneficiaries of the secondaries market, but they are also interested in seeing what other opportunities develop," says Pereira. "So a lot of them are just holding on and extending their holdings another few years."

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• Topics
• South Asia
• GPs
• IPO
• Trade sale
• Open market
• Secondaries
• India
• ChrysCapital Management
• Alvarez & Marsal
• KKR
• Capital International
• Caisse de depot et placement du Quebec (CDPQ)
• IDG Ventures