India agritech: Green shoots

A revolution is taking place in Indian dietary habits. The mix of foods that have underpinned domestic nutrition for generations is changing, with the traditional dependence on grains giving way to demands for more protein, diary, fruit and vegetables.

In a country known for the prevalence of vegetarianism, meat consumption has doubled in the space of a decade, with 5.5 kilograms consumed per capita every year, according to a report by Credit Suisse. Dairy consumption has also been increasing steadily, with a compound annual growth rate of 4% outstripping that for cereal. Demand is soaring for eggs, fish and edible oils.

Much of this is driven by the country's emerging middle class, which now has the purchasing power to seek out more variety and more convenience. Ernst & Young estimates that India's global middle class - i.e. those defined as such by the standards of any country - numbers around 50 million, or 5% of the population. It is expected to reach 200 million by 2020.

"They expect better value-added foods and they are not satisfied merely with staple foods," says Rajesh Srivastava, a general partner with Rabo Equity, which manages an India Agri Business Fund. "Consumers are more demanding and that is creating an opportunity for private equity."

Bottlenecks

The flip side is that the agricultural sector has struggled to keep up with this growth as it grapples profound inefficiencies. Supply chain issues, for example, mean that food wastage in India is among the worst in the world, with 40% of all fresh produce ultimately destined for the garbage can.

The sector is also extremely labor-inefficient, with around 50% of the workforce is engage in some form of agriculture despite the sector contributing just 16.6% of GDP.

These issues can be addressed through improvements and innovation throughout the value chain - from farm gate to market stall. Private equity is seeking to play the role of facilitator by identifying and supporting businesses that offer the best solutions.

PE investment in the sector is nascent but is on the rise. A recent report produced by KPMG and the Federation of Indian Chambers of Commerce and Industry (FCCI) found that last year private equity accounted for 3.8% of all investment is agriculture, including logistics and agricultural equipment manufacturing, compared to 0.8% in 2008. The venture capital share has grown to 1.6% from 0.2% over the same period.

AVCJ Research data also suggest that PE activity in core agricultural industries is increasing. Last year saw $135 million committed to the sector across five deals. The bulk of this came from one transaction - Temasek Holdings' $104 million acquisition of a 20% stake in Godrej Agrovet, an agribusiness company focusing on animal feed, oil palm and agri-inputs and poultry. It is the largest deal in the space to date.

Most investment in agriculture, however, has unsurprisingly been characterized by smaller cap deals focusing on early- and growth-stage investments. Sub $25 million deals accounted for 22 out of 38 transactions since 2008, while 18 of those under the $10 million mark.

"Our working theory is the most innovative companies in India are start-ups - young, fresh businesses looking at old challenges in new ways," says Mark Kahn, a founding partner with early-stage agriculture investor Omnivore Partners. "Large corporations in India often under invest in R&D and innovation, so essentially it is going to be the entrepreneurs that really solve these very difficult bottlenecks."

These bottlenecks are traced back to five scarcities in Indian agriculture: land, water, soil, supply chain and labor.

Firstly, the country suffers from a high degree of fragmentation in land ownership. According to the United Nations, the average size of an operational holding is 1.6 hectares, with about 81% of farms having land holdings of less than 2 hectares. This is largely a result of successive iterations of the Land Ceiling Act, which limits the amount of land that can be held, making it difficult to achieve production efficiency through scale.

Water conservation problems are also linked to government policy, with subsidies on water rates leading to poor management and eventual shortages. Sub-oar irrigation and overuse of pesticides and chemical fertilizers, meanwhile, have helped deplete soil fertility. Supply chain obstacles are created by a lack of adequate storage and cold chain logistics and poor transport infrastructure.

Finally, labor issues involve a shortage of skilled labor. Census data indicate that the number of farmers in India has plunged by 9 million since 2001, principally as a result of rural-urban migration.

Tech inroads

To date, many of the companies working on solutions to these problems have done so through technological innovation.

One of a number of recent investments in this area is IvyCap Venture's investment in Thomson Reuters' information platform for Indian farmers, Reuters Market Light, which targets the country's small-hold farmers by providing agricultural, weather, market price and crop information via mobile phones. It has served more than 1 million subscribers across 50,000 villages and 17 states with five million farmers impacted by the service.

"It is not just about inventing something new, it is about getting the right technology from wherever it is available and customizing it to the Indian market," says Hemendra Mathur, managing director with the Small Enterprise Assistance Funds' (SEAF) India Agribusiness International Fund. "What is important is where technology is differentiated and whether you are ahead of the curb in terms of competition."

The application of technology to agriculture is particularly in common in early-stage deals.

Three of the seven investments made by Omnivore, for example, have involved some sort of technology play. These are Stellapps Technologies, which builds automation tools integrated with cloud data analytics; cloud-based agribusiness supply chain software provider FrontalRain Technologies; and Euravaka, which makes on-farm diagnostic equipment used in aquaculture.

Reuters Market Light is also interesting in that, while it is technology-based, it taps into the broader theme of commercially empowering India's 93 million small-hold farmers, by offering access to information and markets that have traditionally been closed unavailable to them.

SV Agri follows a similar line. A portfolio company of Aspada Capital Advisors, an early-stage investor that manages the SONG Fund, backed by the Soros Economic Development Fund in partnership alongside the Omidyar Network and Google, SV Agri is looking for ways to aggregate production from small-hold farmers to supply large food processors.

The company is essentially a B2B play operating in the processed potato supply chain, supplying companies such as McCain and FritoLay with potatoes to be turned in fries and potato chips. The company works with up of 6,000 farmers across five states to produce potatoes to a standard required for processing by larger firms.

"It is basically like a fast food potato, so it has to be a certain size and have certain kinds of sugar so it fries better," explains Tom Hyland, co-founder of Aspada. "If you have a farmer with half an acre of land, actually making him grow produce to some sort of specification and then getting it out to the market can be very tough logistically. We need to have a whole supply chain that links to the industry."

Hyland maintains that such aggregation plays are also beneficial to small-hold farmers who can find selling produce at a clearing house both time-consuming and expensive. Without any scale, these farmers are rarely able to fair price. "By aggregating from these guys, we pay them a fair price, a better price and they get paid on time," says Hyland.

Strategic opportunity

In many cases these companies make for an attractive acquisition target for both domestic conglomerates looking to find solutions to supply chain issues and foreign multinationals in search of partners that can help them expand their local footprint.

"Quite a few multinationals from across the world are planning to have their operations in India, says SEAF's Mathur. "The problem is when they come to India most industrial players struggle when they realize they have to source from thousands of farmers."

The only significant exit to be demonstrated in the space to date was to a overseas strategic investor: earlier this year Qatar's Hassad Foods paid Standard Chartered Private Equity $135 million for a 51% stake in Indian rice maker Bush Foods Overseas.

The move was seen as a way for Hassan to leverage India's production capabilities to service its global distribution network. The deal is expected to set a precedent, and not just with overseas players. A domestic conglomerate might see M&A as a more appetizing proposition than developing its own supply chain in a particular vertical or geography from scratch.

As such, investors - particularly those focusing on later-stage, growth investments - do so with a strategic exit in mind. "The work starts as soon as you invest and you have to start filtering out what strategics are looking for," says SEAF's Mathur. "There is no point growing a business if the company buying it has a different strategy."

Most industry participants agree there is more consolidation to come about as businesses scale up, in part to meet the needs of India's middle class, and the industry in general becomes more adept at meeting consumer needs. The logic goes that this will lead to larger check sizes. Rabo Equity has set its sights on a $200 million second India Agri Business Fund - compared to $120 million for the first fund - in anticipation of this.

"There will be buyout opportunities," says Rabo Equity's Srivastava. "I would imagine in two years' time we will see larger deals in areas such as logistics, agri-inputs and fertilizers. It may not be happening yet but it takes time for people to understand the sector."

SIDEBAR: Cultivating growth - Indian politics and agriculture

India is essentially a nation of farmers. While the agricultural sector may not command as large a share of the economy as before, it is still a significant part of the national landscape. As such government has a huge role in sector.

"Agriculture employs a lot of people so it is politically sacred," says Tom Hyland, co-founder of Aspada Capital Advisors. "There are around 700 million people involved in agriculture in some form or another so ultimately the government is going to be an important player."

This is influence is not necessarily benign. For example, an agricultural subsidy program has been in place since the Green Revolution of the 1960s, which was intended to aid food self-sufficiency, lower food prices and benefit farmers. While there have been benefits, policy is unable to keep in step with changing food demands, leading to a misallocation of resources.

The fastest-growing areas in food demand are vegetables and meat products, and demand for grain products is declining. Yet rice and wheat crops account for three quarters of agricultural land and 85% of gross value crop output, causing a surplus of these crops.

Additionally, input subsidies have resulted in detrimental environmental impacts due to resource overuse, as farmers have no incentive to moderate their consumption of freely available resources, notably water.

On other hand, the introduction of the so-called Food Safety and Standards Act of India (FSSAI) - which consolidates laws relating to food and lays down a framework for regulation across manufacturing, storage, distribution, sale and imports - has been lauded by some as a leap forward in organizing a fragmented sector.

"This has redefined standards for the product as well as food processing," says Hemendra Mathur, managing director with the Small Enterprise Assistance Funds' (SEAF) India Agribusiness International Fund. "These standards will drive unorganized players in the food industry to upgrade and organize. They will also push up exports."

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• Topics
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• Rabobank Private Equity