No exits in this market
Outlook Business - December 13, 2008
Nitin Deshmukh
The flow of private equity funds into India will be a cause for concern going ahead, compared to what we have seen in the last few years. Pension funds and endowments, which constitute a major chunk of the money that comes into the country, are facing a huge challenge to earn returns on the large investments they have made, especially in the US and Europe.
Having said that, Asia has been on the radar of many of these funds. They have been spending more time in Asia, particularly in China and India, over the last 18 months. Despite the turmoil in the world financial markets, they will find it difficult to ignore these two countries. Therefore, at some point, even though they have standard allocations in terms of how much goes to these emerging markets, these allocations will see a change. While their own cash flows will continue to be under pressure for the next 18-24 months, my understanding is these funds would want to look at a higher percentage of fund allocation to Asia.
We had budgeted for only one company from our portfolio going public this calendar year, and it has filed its draft red herring prospectus. But that IPO may get postponed. Next year, three companies in our portfolio will be ready for IPOs
Many PE funds, especially the first-time funds in their enthusiasm to do deals, invested in companies at high valuations for about two years, until December 2007. A lot of money, especially from global funds, has gone into listed companies, or what are called PIPE (private investment in public equities) transactions. Given the significant value erosion that has happened in the listed space, all these funds are on the back foot now, facing some tough questions on investment strategies and valuations from their investment committees sitting elsewhere (outside India) and limited partners.
Today, many limited partners are showing proactive interest on advisory boards. Most private equity funds usually have an advisory board of limited partners. Earlier, such boards were not as active as they are now. Now, these advisory boards are closely reviewing investments on a quarterly basis, looking at the due diligence process being adopted by the funds and so on.
Who stands tall?
So, in India, what kind of private equity funds will continue to raise capital? We have very few funds that have a good track-record of returning money across multiple funds. One of the key factors that will determine a fund’s ability to raise money, besides its track-record, would be its investment strategy: differentiation in a crowded market, whether investments are in unlisted or listed companies, entry valuations, stakes, value addition and so on. Funds that are focussed and disciplined in their investment strategies and processes are more likely to attract money on a continued basis.
Kotak Private Equity
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Funds under management
(including realty funds)
$1.4 billion - Investment in India
$350 million - Investment focus
Growth investments across sectors and real estate - Current portfolio (selective)
BVG India, DRS Logistics, Home Solutions Retail, ICOMM Tele, Siro Clinpharm
Another important question is about the fund size. From an India perspective, what would be an appropriate fund size? Various players raise funds depending on the strategies they follow. While venture funds in India, typically, raise $100-200 million, growth funds raise $200-600 million, depending on whether it is the first or a subsequent fund.
Late-stage investors, PIPE investors and buyout funds, on the other hand, have been targeting funds between $500 million and $1 billion. If you were to ask us whether we could deploy a $1 billion fund in the growth PE space now, my answer would be ‘no’. But can we handle a $500-600 million fund? Yes. We have demonstrated the ability to do deals in our previous fund, each with a ticket size of $30-40 million. We have so far stayed away from PIPEs, as they did not make sense in terms of valuations and we were not sure how much we could be involved with the company we were investing in. But today, if we are able to get the entry valuations right, and if there are opportunities to take significant stakes in the companies and influence their managements through a board position, we will look at such deals.
Mirror reading
Going into 2009, the investment environment will certainly be sober. Given the
global situation, export-oriented businesses will be impacted. Many of the global companies are probably going to curtail their growth plans for now. For private equity, the prospects of deploying capital in such companies will, therefore, not be as appealing. I expect consumption-led and infrastructure service industries to continue to grow. Given the market environment, which will remain tight for the next 18 months, there will be pressure on many of these companies to look at private equity as an option to shore up resources to meet their growth plans.
We are anxious going into 2009, as we don’t know how the capital market will shape up next year. If the market stays depressed for 18 months, we will be tested"
The big worry in the medium-term is on the exit front. If exits get impacted, returns too get affected. All the efforts put in to build a good portfolio will go in vain. While we are happy with the kind of portfolio that we have built, if the capital market continues to be depressed for the next 18 months, we will be tested. We had budgeted for only one company going public this calendar year, and it has filed its draft red herring prospectus. But its IPO may get postponed. Next year, three companies in our portfolio will be ready for IPOs.
We are going to be anxious going into 2009, as we don’t know how the capital market will shape up next year. It doesn’t matter what kind of track-record you have set in terms of building a portfolio of investments. The bottom line is that, ultimately, you will be judged on returns.