The numbers say it all. At an announced value of $7.10 billion for the first half of 2008, private equity has seen its best six months this far. At the same time last year, the PE deal value was $6.82 billion. It was $3.5 billion the year before. PE transactions have been on the rise no doubt. But what stands out this year over the last year is the rush for private equity.
By some estimates, the number of deals at the end of this year will outdo the figure (405) achieved last year. Says Dhanraj Bhagat, partner, transaction advisory services, Grant Thornton, the agency that tracks PE in India, ?The trend of a large number of deals happening this year is there.? PE shops scouting for investments are also more this year. Says A Murugappan, executive director, ICICI Securities, the investment banking and broking subsidiary of ICICI Bank, ?The spread is a lot more.?
The question then is: why is there this rush for private equity? The answer to an extent can be found in the environment that surrounds corporate India at this point. Reserve Bank of India has just announced its first quarter review of its annual monetary policy for the year 2008-09. The objective is to suck out excess liquidity from the system in an attempt to rein in inflation hovering at over 11%. The result is that the bank loans will be dearer. It already is thanks to previous rate hikes undertaken in the wake of monetary policy measures implemented by the central bank.
For instance, one-year corporate loans attract an interest of about 11% as of now. Loans of longer duration (three to five years) have an interest rate of about 12.5% currently. The new 25 basis-points and 50 basis-points hike in the cash reserve ratio and repo rate, as announced in the monetary policy review by RBI, is likely to take interest rates up further on corporate loans by another 25 basis points.
So, one-year and five-year corporate loans, according to banking industry sources, will attract an interest rate of about 11.25% and 12.75%, going forward. Loans above five years duration will attract an interest rate of about 13.25%. This naturally makes debt a not-so-very-exciting proposition for companies at this point unless they decide to borrow for short periods, where the interest rate stands at about 10.5% per annum, which, following the CRR and repo rate hike, will go up to about 10.75%, according to banking industry sources. But going for short-term loans can be tedious, which company promoters are well aware of.
What?s left then is equity. Here too the signs are not very positive. With the Indian stock markets fairly choppy since January this year, most companies are deferring their initial public offerings (IPOs) and follow-on public offerings (FPOs) for now. This is obvious from the number of issues that have been launched in the first few months of the current financial year over last year. It was 11 between April-July 2008 as against 30 between April-July 2007.
All of this then leaves very little room for companies to mobilise funds at least in the domestic marketplace. That?s where private equity is turning out to be a bit of a boon to many. As the chief executive of a company reiterates, ?At a time when both debt and public equity are difficult to get, private equity is becoming an interesting option for companies to consider.? This despite the fact that the internal rate of return (IRR) that PEs demand from companies they are investing into is anywhere between 25-30%.
A key reason for this happy marriage, conditions notwithstanding, is valuation. From the private equity point of view, the gloomy environment has ensured one thing: fair valuation. Says Parth Gandhi, managing director, Vision Global Investments, which has an India-focussed infrastructure fund, ?Promoter expectations have become realistic. When I compare the scenario now to say end of last year the difference is stark. Valuations seem to be fairer at this point.?
It?s easier then for private equity players to make inroads into a company and for promoters to seek much-needed capital when ?expectations are in line with each other?. As Sudhakar Ram, chairman and managing director of IT solutions company Mastek, says, ?How the equation works varies from business to business.?
When the equation is set right, there is nothing to prevent a PE player from making an investment in a company. It?s worth noting here that a straight equity pick-up by a PE player in a company is on the decline these days. The accent is on structured deals like the use of debt and equity to make inroads into a company. For example, take the case of Spicejet-Wilbur Ross investment announced a few weeks ago. The US-based investor has said that it will pump in some Rs 345 crore (or $80 million) into the company. Though the contours of the deal haven?t been spelt out yet, chances are that both debt and equity could be used to structure the transaction, says Kishore Gupta, director, Spicejet.
Typically, structured deals involve the use of convertible instruments. An investor lends money to the promoter against issue of convertible debentures or preference shares. The conversion option, which is a switch to equity, is exercised after a span of time at a certain agreed price. Take the case of Rs 700-crore investment by a Goldman Sachs entity Golboot Holdings in Mahindra & Mahindra Ltd. Golboot has put in the money against issue of fully convertible debentures (FCDs) of the face value of Rs 745 each. The issue is mandatorily convertible into equity shares of Rs 10 each at Rs 745 per share (that is, at a premium of Rs 735 per share) at the end of eighteen months. ?On conversion, the issue will translate into an equity of 3.68% in the company,? says Bharat Doshi, executive director & group chief financial officer, Mahindra & Mahindra Ltd.
Though the conversion price from debt to equity is determined at the very outset of a transaction, it may not be necessary at an investor will convert at the same price if he feels his investment is under threat. He could choose to acquire a higher stake at a lower price or ask for repayment of the debt in case of underperformance by the company. ?Either ways, it is not in the interest of the promoter. Conversion at lower price means dilution and repayment of debt would be a cash outflow,? says Bhagat of Grant Thorton.
This is one reason why structured deals are so popular today because the investor can exert pressure on the promoter to deliver results in terms of financial performance. For those who are lucky to escape the dragnet, it is a momentous occasion indeed. For instance, S Kumars Nationwide Ltd (SKNL) recently announced that GIC, the PE arm of the Government of Singapore, was investing Rs 900 crore in its unlisted subsidiary Reid & Taylor India Ltd against a stake of 25.4%. It?s a straight equity pick up, which Nitin Kasliwal, vice-chairman and managing director, SKNL, makes no bones about. ?The promoter stake in the holding company is about 48%,? he says. ?Our objective was to make sure that we grow without diluting the stake in the holding company. That?s when we felt we could hive off our luxury textile business into a subsidiary and at some stage get an investor into it. That?s what we?ve done with Reid & Taylor.?
What Kasliwal has opted to do is something that most promoters do ? protect their shareholding by inviting investors to put in their money into unlisted subsidiaries or special purpose vehicles. The purpose is to unlock value without diluting stake at the holding company level. From an unlisted subsidiary point of view it could mean listing the company in the future, which Kasliwal is contemplating to do with Reid & Taylor three years from now. From an SPV point of view, it means getting finance for the project at hand. Companies in the infrastructure and real estate space do this often.
Take the case of the Rs 186-crore investment by Yatra Capital and Saffron India Real Estate Fund, both belonging to the PE firm Saffron Assets, in a Mumbai-based project of Parsvnath Developers. The project is a large one to redevelop the bus depot in the suburb of Kurla in Mumbai. It will also include housing for employees of city transport operator Bombay Electric Suburban Transport and commercial establishments spread over a 30,000 sq-mt area.
Parsvnath has floated a special purpose vehicle for the project diluting 30% stake to Yatra and Saffron. ?The value of the land acquired is Rs 620 crore,? says Pradeep Jain, chairman, Parsvnath Developers. ?At the rate of 30%, the two investors bring in Rs 186 crore, which will come into the SPV in phases.?
Why is Jain is excited about the investment? The reason is obvious. His land acquisition cost was actually Rs 45-50 crore, while the investment coming in is Rs 186 crore, which means that there is surplus money of about Rs 136-141 crore coming into the SPV. Plus, he keeps 70% of the equity in the SPV. ?It?s a win-win situation,? he says. This point is made by Atul Ruia, managing director, The Phoenix Mills Ltd, who has acquired key parcels of land in metros such as Mumbai, Pune and Bangalore successfully using investors to close land deals and quickly get started with his projects. He says, ?We believe in partnership with funds. We are transparent as far as our projects go. This helps because investors come to trust your product and execution capabilities.?
With PE money of course showing no signs of abating, there are many more promoters who could take advantage of these funds.