Mumbai: The new year will see the emergence of a new cycle for private equity (PE) funding driven by less un-invested capital—dry powder in fund parlance—and fund managers familiar with the risks of doing business in India, according to investors.
After a lacklustre 2012, with the number of PE deals falling by about 24%, investors said 2013 will see a flurry of activities not only in the currently preferred consumption-driven segments but also in sub-sectors of infrastructure, manufacturing and industrials.
The new year will also see enhanced emphasis on structured deals, including equity, bridge, debt and mezzanine funding, as investors look out for greater security of invested capital. Mezzanine finance is a hybrid of debt and equity.
“Mezzanine funding has great potential in India and will become more prominent. This kind of funding provides greater security of capital due to downside protection structures and equity like returns on the upside. It is an attractive space to be in,” said Darius Pandole, partner, New Silk Route Advisors Pvt. Ltd.
In 2012, both volume and value of deals dropped steeply, with PE firms making 268 transactions worth $7.59 billion, compared with 352 deals in 2011 worth $11.45 billion and 303 deals worth $9.2 billion in 2010, according to estimates by VCCEdge, which tracks investment activities.
In the first half of the next fiscal year, the manufacturing sector is expected to revive and may see investment interest. Infrastructure sub-sectors that are not too restricted by regulations, such as renewable energy, logistics and port services are also expected to be attractive.
“As momentum resumes, an increase in ticket size of investments is natural—from $10-15 million to $20-25 million and from $40 million to $50-75 million,” said Bharat Banka, chief executive, Aditya Birla Capital Advisors Pvt. Ltd, the private equity arm of the conglomerate.
Meanwhile, exits continue to be the biggest challenge for PE investors. Experts say trade sales and revival of the primary market are expected to fuel PE exits in 2013. Whether the returns offered through these exits will be in line with investor expectations remains to be seen, they add.
“One would suspect that returns generated would be moderate—exit multiples would unlikely match up with entry valuations paid four-five years ago,” said Archana Hingorani, chief executive and executive director, IL&FS Investment Managers Ltd.
Here’s the 2013 outlook for the industry by four top PE investors:
Good exits catalyst for investments:
I see 2013 to be a better year for the PE industry compared to last year, with market sentiment back and the government’s reform measures in bringing the economy back on track.
The economic recovery will heighten activity in the PE industry and see several opportunities in an improved policy environment. I am hopeful of several positives in the Indian economy in the coming year, assuming the US solves its fiscal issues in January and there is no deterioration in the European Union or other parts of the global economy. The Indian investment cycle could see an upturn in 2013, which should augur well for the economy with the support of increased foreign institutional investor (FII) interest in India and continued robust domestic demand.
The fundamental promise of the Indian economy, the robust functioning of our democracy and the lack of similar opportunities globally should attract good amount of investments in 2013.
However, the Indian PE industry faces concerns over lack of good exits. In this industry, good exits act as a catalyst to attract investments, and all PE players would like a few exits.
It will be very good for India to provide a few good exits. Notwithstanding the longer term horizon which PE players have, and flexibility in timing the exits, lack of exits can impact fresh inflows if the environment for exits does not improve over the next 12 to 18 months.
Exits through strategic sales rising
The opening up of foreign direct investment in multi-brand retail, insurance, and pension sectors has helped set the country back on a path of reform and growth. Besides, government initiatives vis-à-vis legislation such as the Companies Bill, 2012, aims to further promote the standard of corporate governance. There has also been an increased emphasis on government investment and development of infrastructure.
These progressive policy actions are economically positive and enhance the opportunity for private equity participants to take part and contribute to the growth of India.
The pace of private equity exits in India has been slow, but is gaining momentum. Selective exits through strategic sales have increased, and continued strong appetite and demand for differentiated initial public offers (IPO) exist. We continue to focus on businesses and deals with strong management teams displaying consistent track record of growth, strong margins profiles, and sustained returns on capital.
The firm’s portfolio is also well-placed across leading industries to capture growth in the expanding Indian economy.
Selective exits through strategic sales have increased
For the Indian PE industry, 2012 saw a perceptible drop in investor interest.
With destinations such as Indonesia generating higher investor interest, India is not even among the top four preferred investment destinations in Asia despite having one of the most compelling investment opportunities in the region and strong underlying support systems to monetize value creation.
The challenge for 2013 is therefore to rebuild investor confidence.
Early 2013 is expected to see a reversal of the interest rate cycle. This would drive back investments and, coupled with other policy level changes being announced with regular frequency over the last few months, would significantly improve sentiment.
A natural outcome would be an increased focus on exits and showcasing returns, which in turn would provide a strong base for the revival of fund-raising plans by late 2013.
Opportunities for primary transactions would continue to be significant; the need would be to stick to a bottom-up approach. Power, for instance, is going through pain, but it does not take away the value-creation opportunity there. With a higher asset-management skillset, commercial real estate could be attractive. Consumption-led themes would also be attractive, though valuation matchmaking would be an issue.
IDFs (infrastructure debt funds), REITs (real estate investment trusts) and PE NBFCs (non-bank financial companies) would add a much-needed layer of an asset sub-class with commensurate risk-adjusted predictable returns.
Another expectation for 2013 is that trade sales and revival of the IPO market would fuel PE exits. However, one would suspect that returns generated would be moderate—exit multiples would unlikely match up with entry valuations paid four-five years ago. But completion of the fund cycle should provide higher degree of confidence to limited partners (LPs), who will then look to deploy capital with a more select band of general partners.
2013 may mark beginning of a more profitable cycle
(Darius Pandole, partner, New Silk Route Advisors Pvt. Ltd)
In 2013, we could possibly see the emergence of a new cycle for PE in India—driven by lesser dry powder, and a more mature and experienced PE industry that has gone through a couple of completed investment cycles. Investors have gained from experience. They are more cognizant of the risks of doing business in India and have become better in pricing these risks and adding value to portfolio companies.
Promoters are more aware of the value that VC (venture capital), PE can provide and of working in a symbiotic manner with external investors. This collective experience should lead to improved performance in terms of return on investment.
Additionally, there is likely to be a slower pace of fund raising, with fewer first-time funds. The quantum of exits has been low thus far, and there is an immense focus on exiting portfolio firms. As a consequence, 2013 is likely to see more exits. I think, 2013 could be the beginning of a more profitable cycle for PE investors and we would be cautiously optimistic in entering this new cycle.
Sectorally, the broader consumer space in India continues to gain traction. A play on the young, upwardly mobile, middle-class Indian consumer has immense potential. Also, infrastructure sub-sectors not too restricted by regulations such as renewable energy, logistics, port services, etc. would be interesting.