Mumbai: Private equity (PE) funds are increasingly making cross-border deals to help small and medium enterprises (SMEs) in their portfolios buy distressed counterparts overseas.

“We are helping portfolio companies to focus on expanding their operations and increasing their customers," said Sanjay Nayar of KKR India Advisors Pvt. Ltd at a PE conference in Mumbai last week. “We are looking at helping them to increase their market share through acquisitions abroad."

Besides KKR, other global PE funds such as Bain Capital Advisors (India) Pvt. Ltd and Carlyle India Advisors Pvt. Ltd are looking at growth opportunities in the West for cash-rich Indian companies. With gross domestic product growth at 7.9% for the quarter ended September, PE firms are of the opinion that Indian SMEs will emerge winners.

Such deals appear to be a win-win proposition for both sides. SMEs often have little or no financial leverage to make deals on the basis of their balance sheet and PE funds help them in that regard. Also, diluting equity to acquire assets increases the company’s value, which enables the PE fund to get a higher return when it exits.

“The trend is now trickling down to mid-sized and smaller companies," said Arindam Sen, vice-president (leveraged and sponsored finance) at GE Capital, which partially sponsored Tata Motors Ltd’s purchase of Jaguar-Land Rover. “We are working on some (deals)."

Nishesh Dalal, associate director (private equity group) at global consulting firm Ernst and Young, said Indian companies find these deals attractive because they open up access to superior technology in the West. “It also helps the foreign companies expand margins by cutting costs by offshoring their manufacturing to India," he said.

Auto components, information technology (IT) and IT-enabled services, and logistics and supply chain management are among the sectors that such deals are most prevalent in.

The trend is also partially because of high valuations India promoters are asking for, on the back of a bullish market that has risen about 110% since March and 73% since January. PE investments have declined from 424 deals worth $9.8 billion (Rs45,374 crore) between January and November 2008 to 196 deals worth $3.1 billion for the same period this year, according to data from Venture Intelligence, a research service focused on PE and mergers and acquisitions.

“Now is a better time to look for opportunities overseas, companies are available at cheaper multiples. Companies in the US and UK are willing to be sold at three-four times the Ebitda," Vishal Bakshi, managing director (merchant banking division) at Goldman Sachs, said on the sidelines of last week’s PE conference. He added that his firm has mandates for such acquisitions by portfolio companies of PE firms.

(Earnings before interest, taxes, depreciation and amortization, or Ebitda, is a function of the firm’s performance and indicates the ability to service debt. The margin is derived by dividing Ebitda by total revenue.)

“The challenge is in terms of quality deals in India at reasonable valuations," said Amit Chandra, managing director, Bain Capital.

Nitin Deshmukh, chief executive officer (private equity) of Kotak Investment Advisors Ltd, sensed such an opportunity last year when markets started falling. In April 2008, his firm funded the acquisition of a German contract research organization firm Omega Mediation Clinical Research Services by one of its portfolio companies SIRO Clinpharm Pvt. Ltd, a Mumbai-based clinical research firm.

“We are also looking for overseas acquisitions of CNC (computer numerical control) players for Bharat Fritz Werner Ltd," Deshmukh said. “It’s true that very attractive opportunities exist overseas today."

Bharat Fritz Werner is a Bangalore-based manufacturer of CNC machines and machine tools in India.

Ajay Lal, managing director, AIF Capital Ltd, a Hong Kong-headquartered PE firm that has invested in India, said such funding could also lead to follow-on investment opportunities and that most of these transactions could be asset purchases such as manufacturing plants.

In January 2008, JM Financial India Fund, the corporate private equity fund sponsored by JM Financial Ltd and Old Lane Partners, helped its portfolio company Sona Group acquire ThyssenKrupp Präzisionsschmiede GmbH, the precision forging division of ThyssenKrupp Technologies AG for €85 million.

PE funding is also more attractive for SMEs because it helps them avoid bank loans. “Companies may not resort to bank loans for such deals as they do not want to take on debt in their balance sheet," said Shobhit Agarwal, director, Protiviti Consulting Pvt. Ltd. “Also if they take on debt they will have to make interest payments towards the debt service ratio."

While target companies may occasionally enjoy some tax exemptions or benefits, they get taxed after being bought, raising the cost of acquisition, said Akhil Awasthi, managing partner, Tata Capital Ltd.

“As portfolio companies become large in size they look for consolidation and acquisition opportunities," said Lal of the trend. “We are buying supply chain platform and manufacturing units from overseas like the US and China."