India exits: Cashing out

ChrysCapital's partial exit from Intas Pharmaceutical to Temasek Holdings in September makes for a familiar story in India. The GP had invested across two rounds: the first, in 2006, came via Fund III and saw ChrysCapital take a 12.47% stake from ICICI Ventures for $11.8 million; the second, six years later, involved the acquisition of a 4% stake for $57 million via Fund V. Temasek purchased a 10.16% stake from ChrysCapital, representing the slightly diluted Fund III investment.

The original plan, however, was to take the company public in 2013.

"The company is in a very attractive sector, has strong management, and good mix of exports and domestic sales - everything about their story was in order," says Ashley Menezes, a managing director with ChrysCapital. "We filed a draft red herring prospectus but the problem was that the public markets were not conducive at that time, so we eventually sought a secondary exit."

Despite its aborted attempt at an IPO - of which there were actually two, the first coming in 2012 shortly before ChrysCapital made its second investment - the exit produced a satisfactory return. According Menezes, assorted macroeconomic headwinds, including a 28% drop in the Indian currency against the US dollar, the sale generated 13x multiple. The GP still retains a stake in the business through Fund V.

Open and closed

Intas Pharmaceutical is one of number of notable exits completed in India this year after a protracted dry spell. Not all have been on such favorable terms, but liquidity events are picking up pace as GPs move to take advantage of both improved investor sentiment and better performing public markets.

The election of Prime Minister Narendra Modi earlier this year has arguably helped create an environment in which the industry can begin to deliver the returns it has been promising for years.

"Windows have opened for short periods and closed again. Essentially we have been fighting all sorts of headwinds, from internal issues such as government policies and a complete lack of reform, to the external issues such as the global financial crisis, the currency crisis, and the fed tapering," says Atul Kapur, co-founder and managing partner at Everstone Capital. "With the new government coming in, there is renewed hope that the policies enacted will be investor friendly, which will provide a boost to the capital markets."

But what happens when the music stops? While the exit environment has improved, the broader issue for private equity is whether the spike signifies a fundamental shift in the market or simply a short-term boost in activity. Once the honeymoon period ends - and it most surely will - can India maintain the momentum needed for a sustainable flow of private equity exits?

At first glance, AVCJ Research data supports the idea that exits are on the up. There have been 109 deals so far this year, the most since 2010, when Indian private equity firms took money out of 116 companies. Meanwhile, the amount transacted in 2014 stands at just over $4 billion, less than the $5.2 billion and $5 billion for 2013 and 2012, respectively. The shortfall in value is likely due to the fact that the increase in volume mostly comprises small growth capital investments exited via the public markets.

Indeed, when exits from 2014 are broken down by type, those of the open market variety are shown to have nearly doubled year-on-year, with $2.1 billion from 58 transactions compared to $1.6 billion across 32 deals in 2013. As with exits in general, 2010 was the last time such highs were reached.

"I think the public markets have been more receptive over the past few months," says Pawan Singh, managing director for India and Southeast Asia at Bain Capital. "A lot of IPOs have a long lead time so I don't think you will see exits via IPO really coming to pass until next year some time, but a much of what you have seen so far is folks who have held positions in public companies making an exit."

Anatomy of an exit

Many of the exits in 2010 were investments made during the 2006-2008 period when India's private equity market was at its most frothy. Over that three-year period, investments totaled $36.6 billion; however exits over the following six years have amounted to $23 billion, which suggests that a number of deals have yet to be realized.

Intas is a member of the class of 2006-2008. So too is Nigilri Dairy Farm, the business behind convenience store chain Nilgiri's, which Actis exited this week to Future Group at what is expected to be a loss. Another transaction saw Providence Equity Partners sell 2.3% of Idea for around INR14.1 billion on the open market. The PE firm originally bought a 15% stake in the business for around INR18 billion in 2006.

As for IPOs, recent activity has been slow. There have been three private equity-backed offerings so far this year, with total proceeds of $91 million. Last year, two IPOs raised $214 million. In 2010, 26 offerings generated proceeds of $2.2 billion. However, of the 15 draft offer documents that have been filed with domestic regulators since April, seven have private equity investors.

The S&P BSE Sensex Index is currently trading at all-time high of more than 28,300 points. It has gained over 6% since the start of October and around 36% since the start of the year. The currency crisis of last August and September, when the Sensex briefly slipped below 18,000 points, seems a long time ago.

However, the benefits India has felt go beyond what is happening in the public markets. Indeed, a recent report by brokerage CLSA notes that an equities pullback would be no great surprise. The recent gains are a factor, but so too is the fact that there is no evidence to suggest a general investment revival is at hand, no uptick in quarterly growth is expected, and projected corporate earnings are uninspiring.

Nevertheless, CLSA remains convinced that, "in a world characterized by a lack of growth, India is the best equity story globally on a five-year view." This is based on a conviction that Modi can lay the foundations for a broad-based investment recovery, with the first specific details on policy reforms likely to come in the February 2015 budget.

Shankar Narayanan, managing director with The Carlyle Group, is in some respects even more bullish. He argues that the improvement in the macroeconomic environment is reflected in growth steadily coming back on track, a fall in inflation - the wholesale price index has dropped to a five-year low of 1.77% in October - a drop in the current account deficit, dovish monetary policy and an expected interest rate cut.

"The new government has been focused on creating an investor-oriented climate, bringing greater certainty to the regulatory environment, introducing business-friendly policies and strengthening international trade relations," he adds.

A number of industry participants note a strong government with a clear political mandate can deliver the structural reforms required to make a stuttering India growth story even better.

"Over the last six years the fundamentals of the economy has always been strong," Sudhir Variyar, managing director at Multiples Alternate Asset Management, said at this month's AVCJ Hong Kong Forum. "That was always going to play out at some point in time, given the demographics, the growing consumption demand, and urbanization - all of which continue to be drivers of growth."

Meanwhile, a number of specific policy initiatives are expected to aid exits by attracting trade buyers - or at least make the process of selling to a strategic player easier.

Hari Buggana, managing director of life sciences-focused GP InvAscent, points to retrospective taxation as one area of change. It has been an issue of contention, with the previous government seeking to impose capital gains tax on offshore transactions that involve onshore assets - perhaps years after the fact. The Modi administration has said it will not bring new retrospective litigation against companies.

"These buyers are scared that the governments will make a retrospective claim for tax so they require all kinds of protections that the seller may not be in a position to give, which means negotiations take a long time," says Buggana. "Since the new government has signaled against retrospective taxation, buyers have become less skittish. From that point of view it should take less time whereas once it would take months."

Slow strategics

As yet, the surge in open market activity has not been replicated in the trade sale arena. AVCJ Research data show that trade sales account for 48 of the 109 exits that have taken place so far this year, with proceeds totaling $1.67 billion. This is well down on the $2.9 billion from 59 trade sales in 2013. Once again, it is worth noting that the capital overhang mainly comprises minority growth capital investments, as opposed to the control deals that are most suited to trade sale exits.

But, equally, the broader M&A market have also yet to show any significant increase in activity. According to Thomson Reuters, inbound M&A stands at $10.1 billion across 280 deals, versus $15.7 billion and 288 deals last year, and $9.1 billion across 315 deals in 2012. Outbound activity is even lower with 113 transactions generating $2.4 billion, compared to $7 billion from 105 deals last year.

However, private equity industry participants predict a revival in strategic investor appetite, albeit at a slow pace. Gopal Jain, co-founder and managing partner of Gaja Capital, is currently in the market with his second fund, targeting $225 million, and looking to make exits from his first vehicle. He expects M&A activity to pick up in the next 6-9 months, with trade sales rising accordingly.

"In emerging markets, exit markets are fickle. You need more than one leg to the table, you need more than one way to exit a company," he says. "You can see why our companies would be excellent IPO candidates but also why they would be attractive M&A targets. It's a question of which market offers us the better option and the size of our stake in the company."

The possibility of a trade sale exit will become even more essential further down the line. Bain's Singh, points out that even if the public markets continue to absorb some of the exit volume in the near term - few would bet on this remaining the case indefinitely - there will still a number of strategic players targeting mid-market portfolio companies.

"A reasonable amount of these assets - originally acquired by mid-market players but have since quadrupled in size - will end up in the being a target for larger investors," he says. "As the companies grow they are face issues that can be solved by someone who is more global."

The question is whether this deal flow will be substantial. Clearly not all companies seeking to secure an exit via a trade sale or secondary are going to make for attractive targets. Two defining factors will be sector and scale.

First, certain sectors are always going to be more attractive targets for strategic investors, notably pharmaceuticals and IT services. These tend to be cash-rich and low capital intensive businesses, but they provide investors with a strong foothold in a fast growing part of India's economy. Indeed, there have been seven exits this year within these sectors. In addition to ChrysCapital selling its stake in Intas, Fidelity Growth Partners made a partial exit from Larus Labs to Warburg Pincus.

"What should be noted is that large international investors want to write big checks, so they represent a good mode of exit for smaller growth capital providers," says InvAscent's Buggana. "A lot of the plumbing and wiring has been fixed by the first investor, so governance is in good shape, the financial processes are there and a growth strategy is in place - so it makes for an attractive investment."

For the same reason secondary sales are also likely to be an increasingly prominent feature of the market, with larger global GPs targeting assets coming out of mid-market portfolios. However, classic sticking points include the availability of quality assets in which global players are interested and then agreeing a price. In many cases, GPs cannot realistically expect a good exit multiple, especially if they paid over the odds for the asset during the 2006-2008 boom period.

Bain's Singh notes that some investors have sold businesses at lower multiples than they bought them, but have held the assets long enough that growth has to a certain extent offset the multiple contractions. "On average people will exit at a lower multiple," he says. "My guess is most GPs will have to take a call on whether they continue to hold or take money off the table."

Three of a kind

What remains to be seen is whether the current short-term optimism can translate into a better exit environment in the longer term. The performance of India's economy will doubtless come into play, but a lot still depends on the quality of portfolio companies coming out of GPs' portfolios and also these managers' ability to time their exits well. There will continue to be winners and losers.

To some, the exit market essentially boils down to three different portfolio company types. First, those with attractive businesses and strong governance will either find a private equity sponsor or exit via the public markets. The issue is less about finding an exit route and more about when the investor wants to sell and what it thinks the company's future performance is likely to be.

Second, there is raft of typically smaller companies that private equity investors had difficulty exiting a year ago but can now take public on the back of the public markets rebound. There is also the option of a trade sales if the M&A pipeline opens up. The last category comprises troubled cases that are tough to sell regardless of external conditions, usually because of a problem with the company or the industry in which it operates. No one really knows how big this group is.

"My guess is a lot of them will find an alternate solution, selling to a private equity sponsor or back to the entrepreneur," says Singh. "But people will still have a hard time exiting."

Needless to say, a shift towards control deals would help solve some of India's exit woes. In these situations, private equity firms would no longer be limited by an alignment of interest with entrepreneurs that only holds firm as long as the objective is an IPO. They could pick their mode of exit - secondary sale, public market, trade sale or dividend recap - and to a certain extent their timing as well.

In the meantime, ChrysCapital's Menezes points out that India GPs will need execute more discipline if they are to achieve attractive exits. In a growth environment there is always a voice in the back of the head suggesting the investor delays selling in order to try and compound value indefinitely.

"One has to be disciplined to resist that temptation," Menezes says. "You have to know when to take your chips off the table. The general feedback that LPs have given us is that most GPs in India are not very discipline towards making exits. I don't think there will be people always seeking an exit when LPs expect them to; I think a lot of it is going to be based on individual compulsions."

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• Topics
• Exits
• South Asia
• Expansion
• India
• Exit
• Trade sale
• Sell down
• IPO
• Gaja Capital Partners
• Everstone Capital
• The Carlyle Group
• ChrysCapital Management
• Bain Capital Asia