Here’s a simple thumb rule for companies looking to pick the right private equity (PE) investor: Count the number of companies in its portfolio that have gone public.
Since February 2005, 22 Indian PE-backed companies have raised $1.58 billion through initial public offerings (IPOs) at home and abroad.
Industry observers say expect more of these type of IPOs for at least the next two years.
Interestingly, all of the top 10 PE-backed firms that debuted on the bourses last year are trading at a premium of between 3% and almost 65% to their listing prices.
For example, Mumbai-based WNS Holdings, backed by Warburg Pincus, which was listed on the New York Stock Exchange (NYSE) last year, is trading at a 13.63% premium to its listing price, while Pune-based Suzlon Energy Ltd is at the top of the heap with a 64.41% premium to its listing price despite taking a few knocks in recent weeks.
While stock market performance isn’t necessarily the best indicator of a company’s performance, most PE-backed companies do tend to follow more diligent corporate governance standards at the insistence of their investors.
This is one of the reasons why several recent IPOs by Indian companies, including WNS Holdings and EXL Services, have been able to debut on the US bourses and also attract better valuations on their offerings.
More significantly, it marks the emergence of a mature class of PE investors who have the staying power to take their portfolio companies public.
In India, PE investors have to be much more hands-on with their investee companies than they would be in the US. Most PE-backed companies here are relatively small and require a measure of mentoring in the form of streamlining business strategies, sometimes sourcing acquisition targets for global expansion and getting basic corporate governance standards in place.
While there have been more IPOs used as exit strategies by PE investors, trade sales, in which one investor sells the stake to another in a negotiated deal, however, continue to dominate PE exits in the Indian market. Such deals are also the cause for much heartburn among promoters of PE-backed companies.
In a trade sale, the promoter may not always have a say in the choice of the new shareholder. That can often be the case when the PE investor owns a significant stake in the company, anywhere between 10% and 40%.
Also, if a PE investor is in a hurry to exit, valuations can suffer and hamper the company’s IPO prospects in the longer term.
There are no reliable estimates on all the PE exits in India, but, as per informal industry estimates, out of the 49 PE exits in calendar 2006, only three were through the IPO route and five through secondary market sales. It is also not possible to ascertain the total value of PE exits for the year.
But this may change dramatically over the next couple of years.
The big indicator came this week, with Gurgaon-based business process outsourcer Genpact announcing plans for a $600 million (Rs2,460 crore) listing on NYSE in what will be the the biggest listing by an Indian PE-backed company. Genpact’s PE investors, General Atlantic and Oak Investment, are slated to sell an undisclosed portion of their aggregate 62.3% stake through the listing. The two invested $500 million in the erstwhile General Electric Co. operation in late 2004.
Both General Atlantic and Oak belong to a class of investors that had started betting on the Indian market as early as 2000-01. While the Genpact investment is fairly recent, both have built up sizable portfolios in the Indian market. The same is true for other India veterans such as Warburg Pincus, Actis, ICICI Venture, ChrysCapital and Citigroup Venture Capital (CVC).
“Most of these investors are reaching the end of their three-five year investment cycle. It helps that the capital markets are also buoyant now,” says Sanjeev Krishan, executive director, PricewaterhouseCoopers.
But what also sets these set of investors apart is the fact that they have been patient enough to wait.
As Warburg India managing director Rajesh Khanna puts it, “If you want to be fair to promoters, you will not do trade sales without their approval.”
Warburg, which has invested $1.4 billion in 24 companies, has done just one trade sale till date, Khanna says. Of course, management prudence also plays a big role in picking the right investor.
Mumbai-based Firstsource (earlier, ICICI OneSource) decided to go with Singapore-based Temasek Holdings in 2004. Other bidders, according to sources close to the deal, included Blackstone Group and Carlyle Group.
Firstsource managing director and CEO Ananda Mukerji declined comment on other bidders, but said that in the run-up to its IPO, which took place in January, Temasek’s credibility in the Asian public markets was a big asset. Temasek currently owns about 20% in Firstsource.
The case for public market exits is also strengthened by the fact that India, in PE terms, is still largely a growth market. That means PE investors can typically pick up minority stakes in companies—which is the case with 90% of investments here.
“A minority stakeholder usually cannot negotiate a trade sale at a premium to the stock price, unlike a buyout deal, where premiums are common,” notes Khanna.
Deals such as US-based Electronic Data Systems Corp.’s $380 million acquisition of Mumbai-based Mphasis BFL where Baring Private Equity sold its 35% stake, or Oracle Corp.’s $909 million acquisition of Mumbai-based i-flex Solutions earlier, when CVC sold its 43% stake for $593 million, are rare.
For the PE investors, their return multiples on trade sale exits averaged between two to five times the original investment.
Top 10 Private Equity-Backed Initial Public Offers (Graphic)