Mumbai: The rise in the cost of debt across global markets will force the private equity (PE) business to build value through operational improvements and growth, rather than from leverage, according to a joint study by The Boston Consulting Group (BCG) and Europe-based IESE Business School.
The study, The Advantage of Persistence, said that though the global credit crunch has led to a drop in large PE deals, it is unlikely to curb the sector’s long-term growth as the basic elements of the business model remain intact.
The PE sector is expected to achieve an annual growth of 15-20% until 2011.
“India will continue to attract PE capital,” said Harsh Vardhan, a partner and director at BCG in India.
Such funds will have to build capabilities to deliver value as the equity markets are likely to soften in coming years, and these capabilities will be the basis of differentiation for PE companies, he added.
These funds cannot simply rely on “the multiple arbitrage model that worked well in the past,” Vardhan said.
According to the report, the capabilities and competitive advantages of top performers will either drive consolidation in the PE sector or stimulate a new round of global competition for capital, as other funds and public companies copy those capabilities.
Some key skills that will differentiate top performers are industry-specific expertise, the capacity to quickly implement operational improvement and turnaround portfolio companies as well as networking access to industry insiders.
“It will be crucial for some of the PE firms in India to specialize (on such capabilities),” said Saurabh Tripathi, another partner and director in BCG’s India operations.
PE deals in India will continue to be growth or PIPE (private investment in public equity) in nature, he said.
While mid-sized deals ($100-500 million, or Rs401-2,025 crore,) will continue in 2008, the PE market in India is unlikely to witness large buyout deals, Tripathi said.
PE firms, unlike other asset classes such as mutual funds or individual stocks, avoid reversion to average returns or ‘beat the fade,’ which makes a strong case for these funds outperforming the market over time, the report said.
The $300 billion uninvested capital accumulated by PE firms from the US and Europe through 2006 will be a powerful impetus for future deals, it added.
The report also said increased portfolio allocations into private equity by large pension funds such as the California Public Employees Retirement System are bringing in new capital in the PE sector.