The mood is sombre in private equity (PE) and venture capital (VC) circles. It?s not without reason. The cycle of economic growth is slowing down in countries such as India with projections for the next financial year rather bleak. Nobody is cheering, neither investors nor promoters. It doesn?t help when there is a general squeeze on budgets, both on the investor and promoter end.
Caution is indeed the buzzword these days. Investors in specific are abiding by this principle in letter and spirit. Sectors that have traditionally enjoyed good private equity and venture capital support such as IT, internet and healthcare are slipping on investors? preference list, for now at least. As a fund manager with a private equity firm admits, ?I would rather wait and watch. No point in rushing into transactions at the moment.?
What fund managers are unwilling to divulge though is that limited partners?the real investors?have actually tightened their purse strings significantly in the last one year. This has been worse following the credit crisis in the US and Europe in the second half of 2008. ?Lehman Brothers? bankruptcy in September last year set the alarm bells ringing,? says Jagannadham Thunuguntla, chief executive officer at the New Delhi-based merchant banking firm SMC Capitals. ?Many limited partners have asked their fund managers not to make new investments,? he adds.
Clearly, a liberal view to investing is long over. It?s time to get tough and this is visible in the average ticket size of deals in the last one year. It was down to $34 million in 2008 as against $48 million in 2007, says SMC. That?s a comedown of about 29.16% in the deal size alone in 2008. The number of deals above $200 million was merely 9 in 2008 as opposed to 17 the year before.
In terms of the number of deals announced in sectors such as IT, internet, healthcare etc, the scorecard in 2008 versus 2007 is as follows: IT and ITeS saw 55 deals announced in 2008 as against 67 in 2007, says the merchant banking firm. Pharmaceuticals, healthcare and biotech saw 22 deals in 2008 as against 35 in 2007. Telecom, in contrast, says SMC, saw marginally higher activity in 2008, with deals announced numbering 15 in comparison to 10 the year before.
Data, however, from Venture Intelligence, a research service focused on private equity and venture capital, shows that investor interest in telecom is actually down a bit. The number of deals in 2008 in telecom was 10 as opposed to 13 the year before, it says.
?It?s a marginal difference,? points an expert. ?Investor interest in telecom is there,? says Madhurima Das, associate director, corporate finance and investment banking, PricewaterhouseCoopers. ?There is growth to show with telecom operators increasing their subscriber numbers month on month. Naturally, they need money to ramp up operations. That?s where PE steps in?.
At a time when debt and public equity are difficult to get on account of jittery lenders as well as a nervous stock market, private equity does present a viable option provided promoters and investors are able to see eye-to-eye on valuations.
From the looks of it, that isn?t happening at the moment. By some accounts, the disparity in promoter and investor expectations on valuations has never been worse. Says Amit Bubna, assistant professor of economics, India School of Business, Hyderabad, ?In a recession if promoter expectations come down to an extent, investor expectations of a comedown are more. The divergence or mismatch in valuations as a result of this is great.?
But greater investor interest in telecom indicates that some amount of parity in valuation expectations has been achieved, which is why deals are happening. At least, Bharti and the Aditya Birla Group seemed comfortable with their investors in 2008. The latter announced a $640-million (or Rs 2,560 crore) transaction with Providence Equity Partners for an approximately 20% stake in the wholly owned but unlisted subsidiary of its telecom company Idea Cellular. The firm in question was Aditya Birla Telecom (ABTL) and this was said to be one of the larger deals last year by a PE player. Bharti, in contrast, offloaded about 2% stake to Kohlberg Kravis Roberts & Co (KKR) in its tower company for $250 million (or Rs 1,000 crore).
While telecom enjoys decent support from investors, that is hardly the case with allied sectors. Says Sunil
Kolangara, director, private equity, UTI Ventures, ?In my view, this year will be decisive for technology. What was happening this far is that technology seemed to be a relatively easy business model to promote on account of the cost arbitrage it offered. Investors therefore were willing to back these ventures. So it was not surprising to see the high level of PE activity in the sector over the years. In my view, PE interest in technology services will be down this year. But I do see interest in content management firms though.?
This point is also reiterated by Sandeep Malhotra, senior director, business development, ICICI Ventures. He says, ?I think the interest in something that is discovered will not be there.
Investors try and look for something unique in technology. That is what will bring revenues at the end of the day. Conventional IT services are out of my view. Yes, IT products could see activity, provided they are niche and interesting?.
The interest that PE and VC firms are showing in niche services can be highlighted by the following case in point. Ads Network Avenues is a Mumbai-based firm promoted by two telecom-consultants-cum-entrepreneurs Shaunak Joshi and Satyajit Kanekar. The firm has a service that brings together telecom, DTH or IPTV operators and advertisers/content providers.
?Basically the service beams out advertising messages to the subscriber base of the telecom, DTH or IPTV provider?on whichever platform it is sitting. Messages are sent after consent of the subscribers. So it is focused and measurable and not intrusive. We?ve been doing dry runs of the service since September last year. The response of operators and advertisers to the service has been great,? says Joshi
What Joshi and Kanekar are looking out for is seed funding to the extent of $1 million. They are hopeful of getting the investment given that the service will be officially launched in March this year. ?We are targeting the NRI community in the US to begin with. We will subsequently get into the domestic market,? says Joshi.
As small businesses such as that of Joshi?s and Kanekar?s brim with optimism following investor interest they have managed to generate, reverse is happening in healthcare. The idea there is to try and plug into the growth prospects of the business unlike IT where niche ideas are gaining credence among investors. If firms are able to demonstrate they can scale up quickly, that would be great, say investors. ?Healthcare is a population-based sector. I see investors interested in the business despite deals coming down last year. Growth potential is there,? says D Thyagarajan of Mumbai-based Carnation Consultancy, a firm which provides risk advisory, PE and loan syndication services.
At a time when growth in general seems to be a distinct possibility, anything that assures it is welcome.