Indian tech VC: Where’s the exit?

If there's one country that's god the NASDAQ analysts excited, it's India. Following the unprecedentedly successful IPO by travel website MakeMyTrip last summer, all eyes are trained on the nation's technology sector for the next VC-backed startup to favor an overseas listing.

It remains to be seen whether there will be a flowering of Indian IPOs on US bourses. Domestic firms are obliged to go public locally before venturing overseas, which means an overseas incorporation - and potentially a tax hit - stands between a portfolio company and NASDAQ. But industry participants are optimistic.

"MakeMyTrip carved the way and clearly was a phenomenal success so I think there are at least four or five portfolio companies in each VC portfolio - so about 20 companies - that could consider listing overseas in the next 18-24 months," says Vani Kola, managing director of Nea-Indous Ventures.

Nelson Griggs, head of Asia Pacific for NASDAQ OMX, told the AVCJ Forum in Hong Kong earlier this month that he expected 4-8 Indian listings next year.

Minimal track record

Activity would need to pick up significantly for this to occur, though, as in the past five years only three other PE or venture-backed Indian firms in the tech space have listed abroad. Digital media producer DQ Entertainment and Genpact, a business process outsourcing firm (BPO) firm backed by General Atlantic and Oaktree, listed in London and New York respectively in 2007. A year earlier WPO, a BPO business in the Warburg Pincus portfolio, also listed in New York.

Research published by LGT Capital Partners and INSEAD in July, meanwhile, suggests that private equity investments in India are currently half as likely to result in an IPO exit as investments in China.

There is certainly no shortage of suitable candidates. Significant opportunities exist in the internet and wireless segments, despite historically being areas neglected by venture capital due to low levels of broadband penetration. By the end of 2012, India is projected to have 110 million internet users - and 35 million are expected to go online via their mobiles.

Manik Arora, managing director of IDG Ventures India, sees MakeMyTrip's popularity as a direct result of this growing consumer demand for mobile. "We will see many more companies in the internet and mobile ecosystem," he predicts. "They're not just going to be domestic companies, but global players."

The offshore services segment - including a number of firms backed by GE Capital - has also received a boost in recent months, thanks to the demand for software products and related services from US-based enterprises.

Why though would firms in these segments prefer to list in the US rather than locally? Superior valuations is a key reason. "The concern for most technology entrepreneurs is that if they list in India they might not get the valuation they are looking for," says Sudheer Kuppam, managing director of Intel Capital Asia Pacific.

IT services companies that have gone public locally get a "reasonably rich" multiple if they're a tier-one entity, but tier-two and tier-three businesses rarely reap multiples of more than 1x. "Most of the investors in India are not tech-savvy," Kuppam continues. "Even if your company is growing well and is in the consumer internet sector, they would probably attribute a tier-two or tier-three midcap multiple, which means you don't get the valuation you deserve."

Another important consideration for institutional investors is liquidity. Trading volumes are modest in India, especially for smaller-cap companies, so generating ongoing shareholder liquidity for anything other than a large-cap firm is a challenge. What makes things worse, says Kola, is that most of the shares offered are subject to a three-year lock-in period, as opposed to mere months if listed in the US. "You can imagine why it is difficult to be tied in for another three years when they've already invested in the company for six or seven years," she says.

Listing overseas can also be an excellent way of raising capital for firms that are not yet profitable - as was the case with MakeMyTrip. In the absence of a track record of income generation, a company must go through an onerous procedure to win regulatory approval for a domestic IPO.

"It would be a waste of time to go public in India if you don't already show profitability," says Kola. "If you're part of a company in a new industry and have made the choice to trade growth for profitability, you'll find they have better acceptance of that model in the US."

The case against

Not all industry participants see MakeMyTrip as a game-changer in terms of India IPOs simply because there is not yet evidence to suggest it has triggered a new trend. Srinivas Chidambaram, managing director of Jacob Ballas Capital India, argues that the country's e-commerce sector is still in its nascent stages, describing India as a "check and cash economy." He estimates that it will take five years before a reasonable number of companies gather sufficient momentum to be considered candidates for US listings.

"MakeMyTrip is the only example of an overseas listing I can think of in the last five years," he says. "One swallow doesn't make a summer - it just happened to be in the right place at the right time."

Another possible reason for MakeMyTrip being an outlier rather than a trend-setter is India's practice of selling early-stage stakes to secondary buyers. Unlike in Silicon Valley, VC investors frequently buy out earlier-stage investors, paying a significant premium in the process. As a result, many VCs in India know there's a good chance they will attract plentiful follow-on capital in the home market and so they eschew IPOs for secondary and trade sales.

This consideration is also weighed against the risk that a firm might become an orphaned listing in an offshore market which doesn't appreciate its value.

Nevertheless, there appears to be a consensus that going public in the US can provide significant opportunities for Indian tech firms. The appetite for their products and services certainly exists among a technologically cognizant investor community, which in itself can allow businesses to achieve higher valuations.

But even if the predictions of accelerated activity in this sphere ring true, the implications for Indian venture capital are unclear. Certain segments of the tech space, notably e-commerce and mobile, are already attracting lofty valuations. A spate of offshore IPOs at high multiples might consolidate or inflate current price levels, but at the same time a spike in competition could pave the way for a series of bad investments. In this sense, MakeMyTrip posed many questions, but the answers are not yet forthcoming.

"It was a landmark event in India and since then, many entrepreneurs have had the aspiration and the desire to follow it," says Kola. "We're going to see some great companies come out of the 2006 vintage."

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• Topics
• South Asia
• Venture
• Exits
• India
• Venture
• Exit
• IDG Ventures
• Manik Arora
• Sudheer Kuppam
• Intel Capital
• Vani Kola
• Jacob Ballas Capital India