Mumbai: A year ago, when equity markets had started sliding, closing out a funding avenue for companies, pundits had predicted that private equity, or PE, funding would gather pace in six-eight months time by when cash-starved companies would have little option but to lower valuation expectations and accept such financing.
Liquidity issues: Sri Rajan says India may be less attractive as the cash-on-cash returns are small, because of the smaller value of deals. Rajkumar/Mint
In those eight months, the equities market—measured by the Bombay Stock Exchange’s benchmark index, the Sensex— shrank further by some 45%, but there was little sign of revival in PE funding. Venture Intelligence, a Chennai-based tracker of PE and venture capital deals, says PE firms invested about $526 million, or Rs2,630 crore, across 36 deals in the March quarter, an 87% drop from the year-ago quarter.
In a phone interview, Sri Rajan, head of consultancy firm Bain and Co.’s PE practice in India, draws this trend to a few reasons: companies tightening belts and reining in capital expenditure (capex) plans, PE investors facing liquidity issues as also waiting for the uncertainty on earnings to clear, and the lack of larger deals that would boost returns. Edited excerpts:
What are the factors hindering PE flows?
One clearly is that the equity markets are down and the number of IPOs (initial public offerings) that have happened in the last one year are not encouraging. The second issue is liquidity. That will probably become better over the next few months.
Many LPs (limited partners, who invest capital in PE funds) around the world are hurting because values of their portfolios have come down. In many instances, LPs have had to revise their private equity allocations downwards, because they have a fixed percentage allocated to private equity. Because their investments in the equity markets have come down, their overall portfolio value comes down, and then they have to reduce the value of the PE exposure. The other issue is that the value of the PE exposure, when you mark it to market, has come down as well.
Are LPs defaulting on commitments?
More than defaults by LPs on the commitments they’ve made, what I hear is that they’re asking their general partners not to make too many investments till there is some more stability in their own balance sheets. However, what is interesting is that because the buyouts market in the US and western Europe has completely dried up, growth capital remains an area of interest for a lot of limited partners, especially in economies that continue to grow, and very specifically India and China.
Any risks that could hinder investments into India?
What may not make India as attractive is that the cash-on-cash returns that’s possible from deals is small, because of the smaller value of deals here. The simple math is that if you put in $1 billion, and you make a 20% return, then you make $200 million; if you had a $50 million investment (in a company in India), a 20% return gets you only $10 million. And smaller-value deals will continue to exist in India in the foreseeable future.
On the supply side, isn’t there also the factor that LPs prefer more liquid assets these days than PE?
There is an issue about liquidity in PE assets, but people also understand that at some level, the risk, compared to hedge funds, might be somewhat lower. It is certainly higher-risk than pure equity investments, but people also understand that you make returns if you put money into a solid private equity firm. Despite whatever has happened in the recent past, I don’t think people have written off PE as an asset class. There will be a demand for different asset classes, and clearly PE will be one of those.
From where do you see demand for PE coming in?
There are certain sectors where the ability to service the interest obligation is affecting earnings at firms. These are sectors where PE could potentially come in. There are other instances where capex has been announced; which, in some instances, you really can’t postpone. If you’re in the middle of a power project, where you’ve already put a lot of money, it becomes difficult to postpone capex. Power and infrastructure projects are seeking capital and PE money is coming in to fill the gap.
So when can we see a revival then, if at all?
My sense is that there will come a time, if the markets continue in the way they are and the liquidity issue persists, there will be no recourse (for promoters). At that time, valuation expectations of promoters will come down to a level private equity investors find attractive. What I can say is over the medium term—I can’t time it—India will still remain a pretty attractive market for private equity.