Indian private equity’s characteristics

That’s due in no small part to some peculiarities, for example the fact that investors are currently paying a 30-50% premium in private deals – if they can find them – compared to the public markets. Sources say there is simply too much capital in India these days. Not surprisingly in this case, and as discussed on the India panel at the recent AVCJ Forum 2010 in Hong Kong, this has driven many to a disproportionate number of PIPEs.

No private deals? Look at PIPEs

One investment philosophy followed by some is to look at the listed and unlisted spaces as essentially one. Gulpreet Kholi, MD with ChrysCapital Management, explains, “It’s simply a risk/reward issue for us. Unless you’re a control investor, we have the same rights, the same documentation in public companies as we do in private companies. The bottom line is PIPEs are where we see the big opportunity because one of the challenges around private equity in India is exits.”

Nevertheless, this unusual strategy raises questions about the private equity value-add that justifies the two-and-20 model.

Says Mukund Krishnaswami, founding MD of Lighthouse Advisors India. “We get asked this by almost every LP we see [about PIPEs]. To some extent there is real value add. But there’s also a fair amount of smoke and mirrors… the value add is the influence that you can have on a promoter as they grow their business. Whether that’s contractual, as in a traditional private equity transaction, or because you have a board seat and influence that takes time to exert over a few years on a PIPE, it doesn’t make a difference.”

Harjit Bhatia, chairman and CEO of Asia Growth Capital Advisors takes a very different view – away from PIPEs – claiming that deals without the premium are available – in the $250 million range – but funds have to look. questioning the notion that deals simply aren’t available in India in the $250 million

“The question is where do you find the deals? This much I would say: they’re not in Delhi or Mumbai. You need to go to more distant, interior locations – just as you have had to in China for some time now. It takes a lot of effort. But they are available, and without this premium.”
He offered unspecified examples from his own experience, when his firm invested money at 10x earnings in 2007, the NASDAQ’s pre-crisis high. Since then they’ve doubled and tripled, and the listing has been accomplished.

Kohli isn’t convinced, however. In the end, all is dictated by returns, he says, and a differentiated strategy only heightens the risk of diminishing returns.

Value add

Anil Ahuja, Head of Asia with 3i Group, says that while there is smoke and mirrors in the value creation process, there is also validity. But, this is a longer, more hands-on process. “Only when the sponsor starts to see that what you are saying is in their interest – and not simply a function of your own agenda – will you begin to influence the company. Without that, once you’ve given them the money they’re gone.”

Krishnaswami added that funds need to be proactive in communicating what they can add to the company, and how they plan to do that, or risk significant push back from promoters. “It’s like getting married and then realizing your spouse wants you to change the way you dress,” he said. “But she didn’t tell you until after the deal was done.”

The mysterious fund roster

Another curiosity about the Indian market is that nobody seems to have any clear idea as to the number of funds operating on the Subcontinent: 173? 258? Something more like 400? The total varies depending on the source, and the definition of a private equity fund.

In terms of bona fide private equity funds, excluding international players and infrastructure funds, Kohli estimates the number of serious fund managers to be a much lower 15-16. And, he seems room for perhaps an extra 10 in the $300-500 million space.

Bhatia takes the opposite view, opting for inclusion rather than exclusion as a rule. “The number of people able to do deals is large, because of the huge amount of capital availability,” he says. He thinks the 400 figure is low, citing the fact that there are a lot of rich people, a lot of brokers, a lot of banks and a lot of people who have made money in many ways, who are likely now engaged in playing out an informal PE role through family offices.

Exits

While the subject of funds is undecided, exits are decidedly rare, say fund managers.

According to ChrysCapital’s Kohli, “We have seen deal after deal after deal in which the asking price is lower than revenue. I think that’s why there haven’t been many exits; the price they paid going in was too high, or they didn’t achieve the projected growth trajectory. I’m not generalizing: certainly there are funds who have done it .But I can count them on my hands.”

Anil Ahuja offers some detail as to the way he looks at IPOs, noting off the top that this route is by far the favored way to exit. “When you start thinking seriously about an IPO, “you start with estimating its size. It needs to be $500 million minimum to get respectable research coverage. Below that number, banks won’t take the company seriously.”

He adds, “If the exit point size is $500 million, the optimum size of the company at entry is $150-200 million, or it will be impossible to generate the $500 million two years out.”

And, “if the entry price is $150-200 million, you are taking a 25% slug which should be about $50 million,” he conjectures. “The point is you are obviously going to need sizeable funds, or you’re going to need much longer hold periods or much higher growth trajectories that the 20-odd percent that’s baked into the numbers I’m talking about.”

Lighthouse Advisors’ Krishnaswami looks at the lower end of the spectrum. “It’s basically a question of where on the risk-return spectrum you want to be. We operate in the lower mid-market space, where we make investments of about $5-15 million,” he explains. “And what we’ve found is that there is significantly less competition relative to the set of opportunities, just because India is a small company market… we’ve found that in going through the IPO process with two of our companies presently, at a market cap of less than $200 million you can get pretty good local research coverage and pretty good liquidity. Of course, while you may not get the ability to exit fully at IPO, the idea in the space where we play is to get the company to a point, and the capital from the IPO. And this is what drives the company to the next level.”

So as India’s private equity market matures, it seems to be moving away from one-size-fits-all to a more stratified and differentiated structure.

Further reading

India private equity: taking up the challenge

• South Asia
• 24 Nov 2010

India emergent

• South Asia
• 24 Nov 2010

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• Topics
• South Asia
• Performance
• GPs
• 3i Asia Pacific
• Anil Ahuja
• Harjit Bhatia
• ChrysCapital Management
• Gulpreet Kohli