India private equity: taking up the challenge

Public markets also continue to see buoyancy, with no sign of a retreat. And foreign money is looking for a home. Yet, Indian private equity sometimes seems to lose in such a strong macro environment, and GPs are still having to work hard to demonstrate their ability to deliver value to promoters and real access to the mainsprings of the country’s growth to LPs.

India’s private equity environment

Looking at raw numbers in AVCJ Research data can give an overly optimistic picture of the status of Indian private equity. For instance, the number of PE firms in the market, logged at 182 in 2008, by end June 2010 had risen to 229, though anecdotal evidence points to an even larger total of up to 400 partnerships. Yet despite the proliferation of firms, PE remains underpenetrated in India even by Asia’s undemanding standards. With GDP growth on a steady upward curve over the past five years, 2009 saw overall GDP rise to over $1.24 trillion – but also saw PE fall as a percentage of GDP from 2007’s peak of 1.58% to just 0.33%.

Furthermore, India’s stock markets, already in bubble territory in January, saw the BSE Sensex close at just below 20,900 in early November.  “Asset prices are already peaking, with liquidity created elsewhere in Western markets finding its way to India,”  warns SG Shyam Sundar, Senior MD at IDFC Private Equity. Indian PE continues to confront a severe public markets challenge.

Indian GPs have few illusions about the challenges they face. “PE in India faces incredibly high competitive intensity, from both within and from the capital markets,” warns Amit Chandra, MD with Bain Capital. At least deal levels are reviving, according to AVCJ Research figures, with $3.9 billion invested in 1H10 versus $4.3 billion for the whole of 2009.

“The public markets have seen a sharp jump, making PE deals expensive,” admits Vikram Utamsingh, Executive Director at KPMG India. And, while he emphasizes that mid-cap companies are not seeing such high ratings, he concedes that “current public market valuations are slowing down PE investments, as the IPO market is certainly more attractive to business owners than raising PE capital.”

Despite the cautionary notes around India’s stock exchange performance, though, the country’s macro environment should be fertile for investment opportunities, believes Chandra. “Fast-growing markets tend to mask a lot of inefficiencies in companies or sub-optimal strategies, and PE players with strong portfolio capabilities have the ability to not only look at the bigger picture by stepping back, but also to help implement change management.”

How to add value

As this suggests, competition from the public markets can mask the fact that Indian companies often stand in need of real value add, and can benefit considerably from qualified private equity investors. The debate becomes more about the ability of those GPs to grow the value of portfolio companies.

Utamsingh cites the results of a KPMG survey completed in May 2010, titled ‘The Positive Power of PE Capital in India,’ focusing on some 15 private equity investments with significant post-investment value add. “According to feedback from the owners of these companies, the most important impacts of private equity besides providing capital, were: bringing about business model changes, which created new streams of growth or fundamentally changed the industry (e.g. the India Value Fund invested in Meru Cabs and helped shape the industry for private taxis); improving corporate governance by bringing in the right caliber of independent directors to the board; and helping attract professional management talent into the portfolio companies.” However, it should be noted that such a survey naturally tends to favor the most successful instances.

Paradoxically perhaps, Archana Hingorani, Executive Director at IL&FS Investment Managers, finds that the family nature of many Indian companies actually makes value add relatively easier. “Many, if not most, of the growth investments are in companies which have been, hitherto, run as a closely held-family business. Value creation can therefore be something as simple as enforcing a quarterly reporting discipline, regulatory, secretarial and compliance discipline, etc.”

But as Karthik Athreya, Director at Clearwater Capital, cautions, “There is no secret sauce – value creation comes from a combination of picking the right sponsors, and rolling up sleeves on asset management with the company, to help them achieve their business plans.”

Utamsingh also notes that private equity investors, partly through real or perceived strengthening of financial discipline, can be valuable at pre-IPO stage to improve the profile of the portfolio company and strengthen the credibility of the promoter, “which was particularly useful at the time of making a public issue.” This is one way, then, to work with rather than against the public markets.

Finally, public markets of course have helped create value for PE firms in one sense: by providing a vibrant exit environment. “Divestments are the flavor for PE in India,” avers Hingorani. “The month of August alone saw some 18 PE exits.”

Promoters and PE

The question of value improvement in Indian businesses also recurrently circles back to the role of promoters in the businesses. As one study identifies*, family businesses in India account for about 70% of sales and net profits of the country’s largest 250 private companies. Dealing with the promoters and business families is essential for any serious engagement with the higher levels of the Indian economy.

Unsurprisingly, Hingorani identifies one of the secrets of successful dealmaking in India as “promoter comfort – the ability to understand and appreciate the promoter’s mindset and work in a manner which gives him operational freedom to pursue his ideas, but within a framework which is acceptable to us.”

Athreya sees the promoters as something of a resource in themselves to the GPs. “Business families often have a great deal of resourcefulness in terms of building growth and value in businesses, so relationships with families might present several investment opportunities as well as repeat PE business.” This still leaves the question open of what the GP can bring to the table, though.
Chandra sees the personal context ramifying into promoter preoccupation

with a GP’s pedigree and experience with other families. “A PE investment is like a marriage, and so many entrepreneurs tend to be quite focused on relationships, brand name, and track record of managing relationships.” This is understandable, as working with promoters directly is often where GPs can differentiate themselves from other capital providers. “Board participation for providing strategic direction, inputs on business aspects that need greater attention, putting in place efficient financing structures etc is the next-level value add,” affirms Hingorani.

Concerns for 2011

Finally, Indian private equity’s apparent recovery over 2010, though welcome, appears to be instilling caution as much as hope for 2011 and beyond, as few of the industry’s primary short-term challenges appear to have been solved or mitigated. Fundraising, for one thing, remains muted. While concerned about “the public markets on full throttle,” Hingorani sees challenges in different directions, even international, citing the “form and format of PE regulations in the Western markets and how it impacts fundraising for Indian GPs,” as well as “direct investing by LPs” as causes for concern.

Although cautious over consistency of government policy, Athreya is broadly optimistic. “From a deal pipeline perspective, we think the opportunities are vast, despite [numerous] players in the country, and will continue as long as India keeps growing as it is today.”

At the end of the day, though, the question of real differentiation and value add still has to be faced. “My biggest concerns are that valuations are already quite rich and the industry isn’t doing anything serious to deliver value to portfolio companies,” says Chandra. And Utamsingh echoes this concern. “Very few PE firms are yet building out operating teams to work with portfolio companies.” And although strong IPO markets are providing “the silver lining” for GPs struggling to do deals, these have not yet translated all the commensurate value to their LPs. “India needs another good year of exits so that LP’s get to see the promised return,” he adds.

Indian private equity’s immaturity, even when compared to other new environments like China, provides some justification for this problem. Simple track record in successfully completed investments could solve many such perception issues. But until the industry has grown past it, the questions around its true contribution look set to continue.

Further reading

India emergent

• South Asia
• 24 Nov 2010

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• South Asia
• Performance
• Bain Capital Asia
• Amit Chandra
• IDFC Private Equity
• S. G. Shyam Sundar
• IL&FS Investment Managers
• Archana Hingorani
• Clearwater Capital Partners
• Karthik Athreya