Mumbai: A cocktail of high inflation, high interest rates, volatile stock markets and political uncertainty may force limited partners (LPs) that invest in private equity (PE) funds to go slow on India and look for better returns elsewhere.
Wholesale price-based inflation was 8.23% in January, down from 8.43% in December, but still higher than the Reserve Bank of India’s year-end projection. The Indian central bank has raised its key policy rates seven times in the current fiscal and may raise them even further to rein in prices.
“We realize that a lot of our companies or investments are pulled down by this and we may have to change our risk-return profile for India,” said Anubha Shrivastava, managing director (MD)-Asia of CDC Group, the development finance institution of the UK government. One of the biggest investors in PE funds in India, CDC has so far invested at least $1 billion (Rs4,500 crore today) across 17 funds. CDC has eased up on investing in new funds.
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A fund manager at a UK-based PE fund, which has invested $800 million in the country, points out that for the past two months, its investment committee has not discussed a single invest proposal involving India. He declined to be identified given the sensitivity of the issue.
“Real estate and infrastructure projects (in India) have become untouchable as they (LPs) fear the issues of environment, land allocation and corruption in government will hamper their investments,” he added.
And these things couldn’t have come about at a worse time. Many PE firms in India are now in exit mode and if returns from their older investments are not in line with expectations, they may change their allocation to India.
“Money will get reallocated if risk-adjusted returns are better elsewhere. I think there is renewed interest in Brazil and Latin America; China continues to grow very well, and there are also other emerging economies in South-East Asia and Africa that are getting interest from LPs now,” said Praneet Singh, MD of Siguler Guff and Co. Lp, which has $9 billion under management and a dedicated fund for Brazil, Russia, India and China.
According to him, all these economies will compete with India for allocation by LPs.
Only 26% of the total PE investments made in the past decade has been realized and money returned to LPs, according to data from Cambridge Associates Llc, an investment adviser to LPs. Roughly one-third of this has offered 100% or more returns. This essentially means the track record of PE fund managers currently raising funds is mostly based on unrealized performance.
PE firms signed 376 deals and deployed $8.3 billion in 2010, up from 331 deals worth $4.7 billion in 2009, when the industry was struggling in the wake of a global slump, according to VCCEdge, a financial research firm. The peak year of PE firms’ investment was in 2007 when $17 billion was deployed.
Shrivastava of CDC said poor returns from PE exits will hit LP allocations to India.
In 2010, PE firms made exits worth $5.4 billion, up from $2.1 billion in 2009—the highest in four years—according to VCCEdge. “Investors are becoming more sophisticated and the ones who have not invested in the emerging markets are weighing their options closely,” said Shrivastava.
Another issue weighing on the minds of investors is the fact that private firms in India, unlike in other markets, do not come at a high discount to the public companies.
“Many segments of the global LP community are nervous about the PE valuations in India. The level of concern regarding high-entry valuations in India is quite substantial, and the valuation environment remains quite high even after the recent correction,” said Wen Tan, managing partner at Squadron Capital Advisors Pvt. Ltd, an investor in Asian PE funds.
Since the beginning of the year, the Sensex, India’s bellwether equity index, has fallen 11.15%. It is currently trading 17.1 times estimated profit of current fiscal ended March, down from 19.3 times in December.
According to Sandeep Aneja, founder and MD of Kaizen Private Equity, an education-focused PE firm, funds looking to raise money should do so within the next six-nine months after which it will be very difficult to raise money even for people with track records. “This is because the political risk is more obvious now than ever before and also there is a capital overhang in the PE market where funds are moving from doing private investments to public market investments,” he added.
Kaizen is raising a $100 million fund.
One of the casualties is the real estate sector, hit by the bribes-for-loan scandal and corporate governance issues. Shahid Usman Balwa, MD of DB Realty Ltd, was arrested by the Central Bureau of Investigation (CBI) in February over his alleged involvement in the allocation of second-generation telecom spectrum. DB Realty was also named in the bribes-for-loans scandal unearthed by CBI last November.
DB Realty was in the midst of raising money from PE firm Starwood Capital Group.
While PE fund managers estimate that around 20-25% of the total PE money will be absorbed by the infrastructure sector this year, LPs are concerned about risks involved. The Planning Commission has forecast infrastructure spending to go up from $514 billion in the 11th Plan (2007-12) to $1 trillion in the 12th Plan (2012-17). Since commercial banks do not have long-term resources and the corporate bond market does not have enough depth, investors say these projects will largely rely on PE capital.
“Investors will be extra careful about core infrastructure investments, and investments that involve direct contact with government bodies for approvals,” said Singh of Siguler Guff.
Dalip Pathak, MD of Warburg Pincus Llp, said factors such as red tape, inadequate infrastructure and poor governance would push up the cost of capital. As the perception of risk increases, investors expect high returns, he said. “Obviously, increased risk relative to other investment options may also lead to some outflow of short-term money,” Pathak added.
Warburg Pincus has invested $2.5 billion in India.
Graphic by Ahmed Raza Khan/Mint