Private equity: the party has just begun

Updated: Nov 16 2005, 05:30am hrs
Private equity evolved in India in the mid-90s along with the growth in the software services industry. The early movers included funds like TDICI, Draper International and Actis. Investments were largely seed capital funding, relatively small in size and restricted to the IT segment. However, in the late 90s, many large global funds started investing in sectors like pharma, manufacturing and consumer products. A bulk of the investments was in unlisted entities. Mirroring the global frenzy during the dot.com boom, most funds shifted their focus to this sector. PE investments reached almost $2 bn during this period. However, the euphoria soon vanished, with the global tech meltdown.

After a prolonged era of inactivity, renewed global interest in emerging markets prompted the entry of several new funds in 2002-03 (Temasek, Merlion, Newbridge Capital) in India. The demand for growth capital spurred several large PE investments during this period, including Matrix Laboratories (Newbridge & Temasek Holdings/ investment of $190 mn), Moser Baer (Warburg Pincus/$113 mn), Suzlon Energy (Citibank/$22 mn) and Punj Lloyd (Merlion/$50 mn). Most funds were targeting larger deals; investments were sector agnostic, with a clear preference for publicly listed companies.

With a plethora of equity funding options, both domestic (IPOs/secondary offers) and international (FCCBs/ GDRs), corporate India today is spoilt for choice. While there are pros and cons of each option, both public and private companies across different growth phases can consider private equity an attractive option. PE in India has evolved from being a tactical solution for capitalisation to a strategic option for adding shareholder value.

Investors are focusing on long-term value accretion in their portfolio companies by implementing enhanced corporate governance practices and management reporting systems and by implementing industry best practices. Investors are keen to align their interests with that of the promoters and are readily funding war chests for potential acquisitions, either directly or through SPVs (auto component/manufacturing industry), specific projects (pharma industry) and recapitalisations (NBFCs). While pricing tends to be more attractive in public offerings/FCCBs/ GDRs, PE investors have bridged the gap through structuring deals.

One of the biggest advantages with PE investments is the credibility step-up taken by companies, post-investment. Institutional investors attach significant value to companies with PE investors. This leads to re-rating of stocks, thereby adding value to all stakeholders. The investment terms themselves have eased over the years, with PE investors focusing on minority protection rights and providing a broad strategic direction at the board level.

The demand for growth capital has spurred PE investments since 2002
It has now evolved into a strategic option for adding shareholder value
The next big surge in PE investments is likely to be in the real estate sector
Several unlisted companies also target PE investors in a pre-IPO funding round. This not only sets a valuation benchmark for the company, but also brings about value addition in reporting (quarterly reporting) and management governance standards, which are pre-requisites for a successful public offering. This is especially relevant with regulations like Clause 49 coming into effect. Recent examples include investments into HT Media and Suzlon Energy.

Most funds have a long-term horizon and have booked profits only after their investments have yielded significant returns. Notable exits include that of Warburg Pincus (Bharti Tele-Ventures), Actis (UTI Bank) and GE Capital (Patni Computers). The success of these funds has prompted new entrants including 3i, the Blackstone Group and Carlyle to set up base in India.

Investors today are no longer merely restricting themselves to providing growth capital but targeting niches like buy-outs, real estate projects and distressed asset acquisitions.

Mirroring the trend in Europe, management buyouts/buy-ins are gaining momentum. These buyout funds not only provide an alternative to strategic buyers, but also provide an opportunity to professional management for transition to an entrepreneurial role (ICI-nitrocellulose business-Actis). Unlike popular perception, the valuations offered by these funds are no different from that offered by strategic buyers. Most of these funds prefer to leverage such transactions and with debt financing becoming easily available, the buy-out market is likely to witness significant activity in the next 12-18 months.

The next big surge in PE investments is, however, likely to be in the real estate segment. With the relaxation of FDI norms this year, several dedicated real estate funds have started scouting for opportunities. These include ICICI Ventures- Tishman Speyer, HDFC and IREO (Indian Real Estate Opportunities Fund), amongst others.

In an industry wherein, historically, equity funding has not been easily available, the entry of such funds is likely to act as a catalyst for organised development. These funds provide complete flexibility in terms of structuring transactions (project specific/company specific funding), and are willing to invest across different types of projects (integrated townships/group housing/commercial properties/retail/hospitals/hotels). Several large transactions are likely in the next few months in this segment.

Funds are also evaluating investment opportunities in the distressed asset segment. These funds typically target fundamentally sound businesses with a turnaround potential and with an immediate need for debt restructuring. Recent transactions include investments in India Cements and Binani Cement.

The appetite for capital today is matched in equal measure by the ease of its availability. For companies seeking PE funds, the party has just begun.

The writer is CEO and country managing partner, Ernst & Young