Mumbai: Large buyout funds are likely to be out of favour in 2009 for those investing in private equity funds, with less than 20% finding such funds attractive, a survey has shown.
This could benefit Indian funds as limited partners, or LPs, look for investment choices other than big buyout funds, defined by the survey of at least $5 billion in size.
The January survey by London-based placement agent for private equity funds, Almeida Capital Ltd, revealed 24% of 150 respondents said they would like to increase allocations to India, ahead of 23% rooting for China, at a time all regions were seen as less attractive. However, more than 80% said market conditions would have little or no effect on their ability to invest.
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“LPs, many of whom have exposure only to the mega-funds from Europe or the US, have to rebalance their portfolios. That should benefit Indian GPs (general partners) if they are able to package their stories well and run effective fund-raising campaigns,” said Richard Sachar, managing director of Almeida Capital.
Limited partners include pension funds, insurance companies, endowments, family offices, asset management firms, fund-of-funds and charities, which invest in private equity funds. A placement agent helps private equity funds, also called general partners, in raising and structuring funds.
As many as 56% of the respondents said they would decrease allocation to large buyout funds in 2009, with just 2% saying they would increase it over the year.
“Brand names and reputations have undoubtedly been damaged and LPs will have to work harder to find good investment cases to recommend to their investment committees, who would previously be positively influenced by such aspects,” the report said.
The survey is based on what LPs would like to invest in, said Sachar, clarifying that it may not be what they end up doing. “Many LPs’ wings have been clipped and I am not saying that it will be easy for GPs to raise an India-dedicated fund,” he said. “But India has now become an inevitable and permanent part of their investment strategy.”
“They (LPs) remain convinced that the asset class (private equity) will continue to generate attractive returns over the long-term and they will look harder and further afield for investment opportunities. It’s more bad news for the mega funds but potentially good news for private equity managers who invest in special situations, lower or middle markets or in emerging markets, and create value in their portfolio companies rather than rely on leverage.”
Not so long ago, at an October conference in Mumbai, Renuka Ramnath, managing director and chief executive of ICICI Venture Funds Management Co. Ltd, which is raising a $1.5 billion fund, had hinted at the possibility of Asia and India finding greater favour among LPs.
“One consistent message I’ve been getting from pension funds and other long-term investors while fund-raising is that their allocation to Asia is going to quadruple,” she had said at the time. “….Whether it’ll happen in the next five years or 10 years, I don’t know. But higher allocation of capital from the West to the East is bound to happen.”
There are others, however, who are not so gung-ho about India’s appeal in an environment where funds are hard to come by. “Even an India fund would be difficult to raise in this market,” said Chip Greene, partner and Asia head for The Parthenon Group, a Boston-headquartered consulting firm.
The low appeal of buyout funds among the LPs surveyed by Almedia is not hard to fathom. Most leveraged buyouts, or LBOs, are suffering from the churn in credit markets. An LBO uses the assets of the target company as collateral to raise debt, which partly funds the acquisition. Under favourable market conditions, such a deal gives a private equity firm multiple returns on investment, but in a credit market meltdown, the tables are turned.
A December 2008 report from The Boston Consulting Group and University of Navarra’s IESE Business School even warns “at least 20% of the 100 largest leveraged buyout private equity firms—and possibly as many as 40%—could go out of business within two to three years,” largely on account of an unmanageable debt burden.
There have been few LBOs in India, largely because there just aren’t enough worthwhile opportunities. One of the largest LBOs in the country was at least two-and-a-half years ago in mid-2006, when US buyout specialist Kohlberg Kravis Roberts and Co. took over Flextronics Software Systems Ltd (now called Aricent Inc.) in a $900 million deal.
“For buyouts to happen, there first need to be attractive targets. Next, they have to be available at the right valuations. And third, there needs to be access to leverage,” said Srivatsan Rajan, partner and head of Bain and Co.’s private equity practice in India.
“In India, it breaks down at the first level because most promoters are not willing to give up majority control.”
Graphics by Sandeep Bhatnagar/Mint