Mumbai: As bidding gets more competitive and valuations increase, private equity (PE) investors are looking to cut out intermediaries and carry out deals sourced through their own research and networks.
Typically, merchant and investment bankers scout for good investment targets and bring them to the notice of PE investors. But funds are displaying a growing taste for “proprietary deals”, in which they directly discover and contact firms trying to raise money.
Exclusive:KPMG’s Utamsingh (left) and SMC Capitals’ Thunuguntla say private equity funds are showing a preference for proprietary deals.
“PE houses don’t like it (intermediary deals) because unfortunately, the investment bank doesn’t contact just three-four PE firms, they contact 10-15 and so it becomes very competitive. That automatically raises the bar on valuation,” said Vikram Utamsingh, executive director and director (private equity) at audit and consulting firm KPMG India Pvt. Ltd.
An October 2009 report by KPMG on the domestic PE industry said deals sourced from investment banks, which accounted for 31% in 2008, are expected to decline to 29% in fiscal 2010. Proprietary deals, which formed 26%, are expected to increase to 27% in fiscal 2010, the report added. The 2008 version of the report stated that despite the majority of deals reviewed by PE houses being sourced by investment banks—51%, self-generated deals accounted for 25% of completed transactions.
Jagannadham Thunuguntla, equity head at New Delhi-based investment bank SMC Capitals Ltd, agreed with Utamsingh, and said, “PEs nowadays prefer to get their hands on deals not available to other PEs.”
He said the trend was particularly true of funds that have been in the industry for long and have long-standing relationships with promoters.
Such relationships make negotiations simpler. “Since the competition is kept at bay, deals can get concluded faster. Typically, in most of the proprietary deals, the post-investment relationship is stronger,” said Alok Gupta, managing director and chief executive of Axis Private Equity Ltd.
He pointed to a 2008 investment his fund made in Hyderabad-based Vishwa Infrastructures and Services Pvt. Ltd, which builds water and sewage networks. “We knew the company for two years before the investment,” Gupta said.
“Most of our deals are proprietary deals. Our preference is to originate deals ourselves,” said a senior official of a PE firm that is backed by a corporate house, adding that a PE fund needs a “very good network” to be able to generate deals on its own. The official did not want to be identified.
Earlier this year, TA Associates Advisory Pvt. Ltd made a $45 million (Rs207 crore today) investment in Micromax Informatics Ltd using the proprietary route, as was a Rs550 crore investment by KKR India Advisors Pvt. Ltd in the privately held investment firms of Analjit Singh.
An impending investment in Asian Infrastructure Pte Ltd by a group of PE investors is also proprietary, said an investment banker familiar with the development, but who declined to be named.
“The PE deal volume declined almost 50% last year. This is because the valuations increased as the capital markets recovered and the competitive bids for deals pushed the valuations further up,” said Thunuguntla.
Now, promoters are also beginning to understand, and sometimes prefer, the dynamics of proprietary deals.
“From our side it was a strategic disinvestment, which we were looking (at) and not for purely monetary reasons. So we selected TA Associates from all the potential partners,” said Vikas Jain, co-founder and business director at Micromax, about the decision to deal directly with TA Associates.
At the same time, limited partners (LPs), who are the primary investors in PE funds, view the ability to carry out proprietary deals as a unique differentiating factor.
“Every LP is asking us ‘Show us your deal flow, your deal sourcing and how are you different’,” said a partner with a PE firm, who requested anonymity as the firm is in the fund-raising mode. “(Otherwise) Why would they pay us 2/20 (2% management fee and 20% outperformance fee)?”
This is happening more often now, he added, because LPs feel that the valuations are high, especially in India and China.
But intermediaries are not going to go out of fashion any time soon. While a majority of the deals in mature economies such as the US and parts of Europe are proprietary, PE investors in India simply cannot do without intermediaries.
The geographical spread of the market is too vast for any PE firm that has a handful of employees to actually cover, pointed out KPMG’s Utamsingh. “Private equity is still a very young industry in the country. So if you go to these tier II and tier III cities, there is a lack of general understanding of this industry,” he said, adding that those are the regions not served by PE funds, where merchant banks are required to educate companies.