If you ask Akhil Gupta, chairman and managing director of Blackstone Advisors India Pvt. Ltd, to define his firm’s investment focus, the answer never varies: “growth deals".

By definition, that would imply minority stake deals. Yet, in the last four months, the New York-headquartered private equity (PE) investor snapped up controlling stakes in two Indian companies—80% in business process outsourcer (BPO) Intelenet Global Services and 70.1% (pending open offer) in textiles manufacturer Gokaldas Exports Ltd.

Gupta, who did not comment for this story, is not contradicting himself. While Blackstone now practically owns Intelenet and Gokaldas, its stated approach to managing both companies will not be unlike that of a growth investor. This approach is critical in the Indian context because the market here has not yet evolved to the stage when PE investors can buy companies outright, as is the practice in Western markets, and overhaul them to earn superior returns. Like many of his peers, Gupta is aware that PE’s role as a value investor, while growing in scope, will have to remain subtle and limited for a few years more in this market.

Not surprisingly then, Blackstone has not made any moves yet to change management or overtly drive strategy in either of its two recent control deals.

In Mumbai-based Intelenet, where the management owns a 20% stake, the PE firm will primarily help the BPO to diversify its client base in overseas markets by referencing it within its portfolio and associate companies.

Intelenet’s previous shareholding, a 50:50 ownership by Housing Development Finance Corp. and UK’s Barclays Bank, restricted it from penetrating other financial services customers.

Similarly, Gokaldas’ promoter-management team, which now owns about 20%, will leverage Blackstone’s relationships with global retailers to bring outsourced manufacturing work to its facilities near Bangalore.

In deal terms, both would qualify as PE-led buyouts but, in terms of execution, are well removed from the aggressive leveraged buyout (LBO) deals that mark mature PE markets. LBO deals are those where a large portion of funds are borrowed in order to finance taking a majority stake in a company.

J.M. Trivedi, managing director of Mumbai-based Actis Advisers Pvt. Ltd, dubs such deals “growth buyouts".

Since 2002, the Indian PE market has admitted 11 “growth buyouts". “LBOs flourish in a market where growth rates are flat. Most businesses in India are growing at 15-20% annually," says Trivedi. This means most sectors are populated by relatively young companies which, on the one hand, require fast capital—i.e. equity capital—to grow and, on the other hand, need investors in the mould of business partners who will play the role of mentors rather than masters.

The steady increase in the number of growth buyouts year-on-year—up from two in 2002 to five last year—indicates that both PE investors and promoters of companies are getting better at achieving that fine balance. The growing numbers are now beginning to attract some of the world’s top-rung LBO shops and, in recent months, organizations such as Apax Partners, Providence Private Equity Partners Llc. and Aleutian Capital Partners Llc. have set up offices here in anticipation of a potential market for LBO deals.

Larger concerns: Ramnath says financial return is just one metric to measure success

In September 2003, when ICICI Venture acquired Tata Infomedia, now known as Infomedia India Ltd, from the Tata Group, it was still early days for buyouts in the country. Within a month of acquiring the company, the PE firm found that it would not be able to push through most of its business restructuring decisions with the existing management team at the helm. It took ICICI Venture about a year fraught with conflict to replace the management team (see case study).

Today a veteran of six buyouts, including the country’s first LBO—ACE Refractories in 2005—ICICI Venture managing director and chief executive officer Renuka Ramnath says PE investors have to take a holistic view, whether it is growth or buyout deals.

“When you go out and buy a company, you affect the lives of the management, employees, their customers and their suppliers. So, if you consider the overall stakeholder universe that you are affecting with one corporate action, it is fairly humongous. The financial return is just one metric for measuring success. What one does to the larger ecosystem is what will sustain this business in the longer term," she says. ICICI Venture eventually sold ACE Refractories to France’s Imerys this year.

Peer Actis also found itself in a bit of a whirl with one of its early deals—Punjab Tractors Ltd (PTL), in July 2003. PTL was not a buyout, but had a buyout-like situation. Touted as the first (also the last) PE-backed privatization deal in the country, Actis was to pick up a 28.4% stake and its agenda was to streamline the company’s business. Opposition came in the form of vice-chairman and managing director Yash Mahajan, who led an offensive against the PE firm’s moves to professionalize the company—until he stepped down in June 2006. So, while Actis was in fact a minority investor, its role was, in part, that of a buyout firm. Again, replacing the management was the only option that emerged to resolve the deadlock (see case study).

While Actis’ Trivedi declined to comment specifically on the PTL deal, he shares one insight from the three growth buyouts the firm has pushed through without incident subsequently. “There may be differences in the way you want to bring value to the table. It is absolutely necessary to discuss those aspects at the time of evaluating the deal," he says.

For new entrants, these lessons hold true with respect to growth deals as well. Growth, or minority stake investments, dominate two-thirds of deals here and will continue to do so for some time. Most of the new entrants understand this and, like Blackstone, see growth deals as their entry strategy. That also means their role will be limited to bank-rolling growth with fast capital and improving corporate governance till businesses achieve adequate scale to warrant LBOs.

Growth deals are also an attractive interim bet because of their exit return potential—an average of 30% on the original investment. Exits such as Warburg Pincus’ $1.9 billion profit (about Rs7,700 crore) from Bharti Tele-ventures on a $300 million investment over seven years further reinforces the case for growth investments in this market.

But, being a minority investor in India has its own unique demands. Most mid-sized businesses, which is PE’s chief playing field here, are family-owned and often not professionally managed.

In addition, many of these companies are public because of the relatively low hurdle rates for listing on the domestic bourses. As a result, most of these companies have to be hand-held while they get their growth strategies in place, even bringing in professional managers. So, even though PE investors will be minority shareholders and have an arm’s length relationship with their investee companies on paper, they end up being much more closely involved.

Patu Keswani, chairman and managing director of Krizm Hotels Pvt. Ltd—the holding company for Lemon Tree Hotels—that received $63.6 million from Warburg Pincus, says: “On an ongoing basis, they keep questioning me. No one else does." Anil Singhvi, former managing director of Ambuja Cement India Ltd and now chief executive officer of Ican Investment Advisors Ltd, the Indian arm of Swiss asset management company Notz Stucki, says: “Ambuja’s system of corporate governance completely transformed and leapfrogged after 1999 when the company saw some PE (Warburg Pincus) investment."

Helping hand: Nitin Deshmukh, head, private equity, Kotak Mahindra Bank.

Nitin Deshmukh, head of Kotak Private Equity Group, focuses on sectors including life sciences, media and entertainment, and retail, and says he provides more hands-on guidance on strategy and operations, including re-organizing the board and advising closely on acquisitions from concept to integration.

Subir Gokarn, economist at rating agency Crisil, says this sort of mentoring role fills a critical gap that was created in 1991, when organizations such as Development Finance Institutions, which would provide money and mentoring to Indian companies, petered out.

“It is a very important role, and private equity is helping to fill that role now," he says. “It’s like picking raw talent and growing them," he adds, “On the whole, PE has been very positive for company performance, although they will have their failures."

Still, failures caused by PE can run deep. For example, a PE firm with a stake in a public company (Pipes) can make a block sale that devastates a company’s share price simply because it needs to return money to investors. Pipes constitute nearly 65% of total deals in India and the high dependence on Pipes is beginning to worry some limited partners (institutions which invest in PE funds).

“You can do Pipes as long as you apply a PE approach, which is changing governance, making it a professional company. There aren’t too many deals like that now," says Varun Sood, managing director, Capvent AG.

It is too early to measure the impact that PE has had so far on the performance of Indian companies. The $8.4 billion (about Rs35,000 crore) BPO industry is the closest example of an industry that has been nurtured by PE money—first, with seed capital in the late 1990s to growth through most of the 2000s and, now, merger-and-acquisition-led consolidation. But the Indian market is at least 10 years away from seeing PE firms take on the role that their counterparts in mature markets, such the US, play.

In the US, PE as an industry asserts that it brings efficiency to the market because it helps strong companies grow, buys up weak companies with potential and transforms them (which PE likes to call “unlocking value"), or takes a sick division and finds it a place to thrive in. This scenario, usually exemplified by robust LBO activity, hardly exists in India.

Saikat Chaudhuri, assistant professor of management at The Wharton School of the University of Pennsylvania, adds that for private equity to get more involved in its investments, “a number of reforms would have to take place in labour laws besides (changes in) general acceptance from a societal point of view." He adds that this is similar even to a market like Germany, where public scepticism (some view private equity investors as “locusts") have prevented deeper involvement, though this is starting to change. In India, these constraints prevent complex and controversial restructuring and LBO deals that have been done in more mature markets, particularly by American firms.

But, as the growth in the number of control deals in recent years indicates, PE firms are beginning to push the limits here, specifically in second-rung blue chip companies, a rung below large corporate groups such as the Tatas or the Birlas, or in public sector undertakings that require turnarounds. The current cycle of exits underway, the first since PE firms started investing here, will tell funds where they stand in India compared to their Western market peers in terms of unlocking value. Some already have their sights set on management buyouts and LBOs as they become available, which will happen as second generations decline the family business and large corporations divest businesses outside their core competency. Some of this is already starting to happen even as returns from growth deals begin to decline—three years ago, the talk was about 50% returns. Today, it is 25-30%.