Bangalore: Even as deals get more expensive in the crowded tech services, real estate, retail and financial services businesses, a bunch of private equity (PE) and venture capital (VC) firms are turning their attention to the country’s defence sector betting a policy change will boost local start-ups in the coming years.
The statistics first: Defence spending in India is at $24.5 billion (Rs1.05 trillion) for the year to March and growing at 14% every year. Of this, the defence ministry has earmarked nearly half, Rs48,007 crore, for capital expenditure. Out of every 10 dollars spent, $7 is paid to foreign makers of defence equipment and armaments; the remaining three are split among a raft of state-owned units and private manufacturers.
It is this domestic segment of suppliers that New Delhi wants to grow rapidly through what is called an offset procurement policy that mandates foreign contractors source components and systems from local vendors for at least 30% of the value of orders of more than Rs300 crore that they get from the Indian military. Indian companies are expected to get offset orders from global military equipment makers of nearly Rs40,000 crore up to 2011, according to the ministry of defence.
The market for private sector defence manufacturers in India (including outsourcing from defence public sector units and ordnance factories) is estimated to be $700 million, currently spread over nearly 6,000 small and medium firms.
Some of these firms, funders expect, will scale up and this is evident in the interest that big names in the private equity business such as Blackstone Group and UTI Ventures have taken in the sector. “We consciously go into the sector. The defence sector is growing, so the companies catering to its needs are also poised to grow,” says Raja Kumar, founder, chief executive and managing director, UTI Ventures. The firm co-invested in Hyderabad industrial and defence electronics manufacturer HBL Power Systems Ltd in 2005.
MTAR Technologies Pvt. Ltd, a precision engineering company from Hyderabad, raised $65 million from Blackstone last year.
MTAR has been supplying precision-engineered components for nuclear power, aerospace and defence applications in India for nearly four decades. It sold 26% stake and plans to utilize the capital for setting up a separate division for manufacturing oilfield equipment.
MTAR’s executive director S. Reddy predicts such investments in defence companies will grow but sees the government’s ceiling on foreign ownership of such firms at 26% as a potential hindrance, particularly for big investors. “For them (PE players), the degree of involvement is similar in all deals, big or small. So for them, it makes more sense to invest for bigger stakes and get bigger returns,” says Reddy.
Still, defence experts say investments from such investors is an encouraging beginning and rules don’t need changing yet. Former director of New Delhi-based think tank, Institute of Defence Studies and Analysis C. Uday Bhaskar says, “If a segment gets more attention, and investments keep pouring in and we also witness positive response of the private sector also, we can review the (foreign equity) cap later.”
Meanwhile,? other funders—read VC firms—are aiming at smaller companies as well. India’s first of its kind VC firm for funding small and medium enterprises making defence equipment recently got approval from the Foreign Investment Promotion Board. Named India Rizing Fund and with an initial corpus of about $100 million, it is promoted by ANZ Investment Bank’s former director and India head Rajesh Narayan and counts Yes Bank Ltd managing director Rana Kapoor, Tata Strategic Electronics’ chief executive Rahul Chowdhary, and retired Lt. Gen. V.J.Sundaram, who led the flight vehicle design team of the Prithvi missile programme, as advisers.
People in the industry say that as the funding business matures in defence sectors, investments will become more specialized, catering to specialized segments such as aerospace, electronics and engineering. Aerospace as a business, for instance, is already interesting for UTI Ventures.
“We feel there is a massive growth possible there. I think this sector has potential to grow like the software sector,” says Kumar.