Mumbai: The new year will serve a mixed dish for private equity (PE) investors in India. While high inflation, steep interest rates, volatile markets and political uncertainty will make it difficult for them to exit with good returns, 2012 will also provide a good vintage for funds pumping in money afresh since investors are expecting a bigger correction in the valuation of firms.
A good vintage, which refers to a fund’s first year of investment, helps PE funds derive good returns at the time of exit since they can buy cheap but sell at higher prices when the markets improve. About 120 PE funds, seeking to raise approximately $34 billion in 2011, are currently on the road, according to a May report by consulting firm Bain and Co. and the Indian Capital Venture Association.
The last time PE investors in India had a good vintage was when they invested in 2004-2005 and exited in 2007— a year that saw 114 exits worth $2.6 billion, according to VCCEdge.
“The economy is under stress and operational performance in the portfolio is unlikely to be stellar,” said Praneet Singh, managing director, Siguler Guff and Co. LP, an investor in PE funds. “However, it’s a good environment for new deals given the depressed valuations and exchange rates. I think some of the best deals of this vintage will be in 2012,” he added.
Exits will continue but at a slower pace. Many investors are expected to defer their exit plans by a year for the lack of good returns just as they did in 2011. There were 110 exits worth $2.5 billion in 2011 compared with 176 exits worth $5.4 billion in 2010, according to VCCEdge.
A slowdown in exits and returns to investors in PE— known as limited partners (LPs)—could affect India’s image as an attractive region for investment among emerging markets. According to industry experts, the return expectation of LPs has dropped to as low as 15-18% from 22-25%.
The reasons range from high inflation, volatile markets and slowing growth due to steep interest rates. The Reserve Bank of India (RBI) has hiked its policy rates 13 times since March 2010. The rupee depreciated against the dollar by around 17% this calendar year, becoming the worst-performing major currency among its Asian peers. Inflation has remained at near double digits for over a year. However, RBI expects it to cool down and close at 7% by March 2012.
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“Of the $68 billion invested in India over the last 10 years, only $22 billion has been returned,” said Arpan Sheth, partner and head of the India PE practice at Bain and Co. “So there will be significant pressure to exit over the next two years.”
Meanwhile, PE firms signed a total 463 deals and deployed $9.5 billion in 2011—up from 406 deals worth $8.4 billion last year, according to VCCEdge.
Infrastructure attracted $2.6 billion—the maximum investment in a sector this year. But investors expect investment in infrastructure to slow in 2012, especially given the slowdown in investments in power. Uncertainty over coal linkages, land acquisition and environmental clearance has made investors wary about the sector.
“Two important factors that the infrastructure sector rely on are the ability to access debt at reasonable rates and the ability to access land and receive permissions,” explained Archana Hingorani, chief executive, IL&FS Investment Managers Ltd (IIML). “Both these factors have been severely hampered in the last year, leading to a slower-than-expected development of infrastructure projects.”
Investors expect investment in sectors such as renewable energy, clean tech and urban infrastructure projects to increase in 2012. “The road sector will continue to be of interest to PE investors, particularly those companies that have access to both National Highways Authority of India and state projects, and a balanced mix of built, operate and transfer (BOT) and engineering, procurement and construction (EPC) revenues,” said Raja Parthasarathy, managing partner, IDFC Private Equity Co. Ltd, one of the largest PE investors in infrastructure.
“Most of the investment opportunities will be from companies that have shelved their listing plans, or companies that have to restructure their balance sheet, or the ones that have foreign currency convertible bonds coming up for redemption,” said Amit Chander, partner, Baring Private Equity Partners (India) Ltd.
Another trend that emerged in the second half of 2011 and is expected to continue is the importance given to due diligence and corporate governance. Consider the case of New Delhi-based Lilliput Kidswear Ltd, which moved the Delhi high court in October to prevent PE firms Bain Capital Llc and TPG Growthx from exiting the company. The two investors had accused Lilliput founder Sanjeev Narula of fudging the company’s financial accounts. Narula, in turn, alleged that the PE firms were trying to halt the company’s planned Rs 850 crore public offering and get a majority stake. The court has appointed SS Kothari Mehta and Co. as an independent auditor to probe the company’s book.
“Corporate governance was always important, but now it is in a bit of spotlight. PE funds are taking longer to get comfort on these issues,” said Singh of Siguler Guff.
This year also saw the emergence of specialized funds— not only in terms of different sectors, but also in terms of strategies. Earlier this year, the four founding partners of Sequoia Capital India Advisors Pvt. Ltd quit the firm to start a fund that will invest in publicly traded companies, or a private investment in public enterprises (PIPE) fund. IIML is also raising a $250-300 million PIPE fund. According to Sheth of Bain, specialization can give a fund an edge with promoters and with LPs.